December 27, 2001

Market Advisor: Early Canola Sales Make Risk Management Sense

By George Flaskerud, Crops Economist
NDSU Extension Service

Marketing strategies need to be in place for selling canola in the bin and for buying put options on a substantial amount of anticipated 2002 production. A case can be made for getting this done in January.

For sales of inventory, consider elevator contracts that offer a storage payment for delayed delivery. Make sure that the storage payment or the price paid is sufficient to cover the additional cost of storage. That additional cost would essentially be the interest cost of money if operating loans remain to be paid.

Inventory sales during January should be accompanied by call options. The most effective call options would be those that are purchased for canola on the Winnipeg Commodity Exchange (WCE) versus soybean oil options on the Chicago Board of Trade. The May option should accompany inventory sales. Some elevators may offer contracts that include call options, in effect, minimum price contracts.

The put options should also be purchased on the WCE, using the November contract. Put options do not require delivery and can be used to manage price risk on a substantial amount of anticipated production.

An alternative strategy is suggested for those who choose to use cash forward contracts rather than put options. That alternative is to divide pre-harvest sales between January and May and limit sales to an amount that can be produced with certainty. Elevator contracts require delivery, which is why emphasis is placed on contracting a limited amount.

Why the focus on January and the use of options? The outlook is highly uncertain for a number of factors affecting the canola price. An understanding of these factors supports the marketing strategy presented.

Canola prices have increased considerably in the last year or so. The price at Velva was $6.79 per hundredweight on Nov. 24, 2000 and $9.15 on Dec. 13, 2001, an increase of 35 percent. On Dec. 17, the May canola futures contract on the WCE stood at $339.20 (Canadian) per metric ton, which was near the high of about $367 (Canadian) on August 13. The concern now is the direction and magnitude of prices in the months ahead.

An important function of a futures market is price discovery. The WCE futures market for canola indicates that current prices cannot be sustained. The market is inverted, which means that the nearby contract is at a higher price than the more distant contracts. When the January contract closed at $341.80 (Canadian) on Dec. 17, the May closed at $339.20 (Canadian) and the November closed at $314.80 (Canadian).

It will take a much improved basis to offset a reduced futures price and storage costs from January until May. History suggests that the basis could strengthen that much but it is by no means certain.

The poor canola crop in Canada has been largely responsible for the higher prices that we have seen. Production was down 29 percent from a year ago. This has resulted in ending stocks that Ag Canada projected on Dec. 12 to be only 6.7 percent of total use. This information can be found at http://www.agr.ca/policy/winn/biweekly/English/index2e.htm .

Although canola stocks in Canada are tight, the price of canola/rapeseed oil appears to be following the price of soybean oil. According to recent issues of Oil World, rapeseed oil in the Netherlands has traded around a $58 (U.S.) per metric ton premium to soybean oil since September.

What is likely to happen to soybean oil prices as the South American crop is harvested beginning in March? That crop is expected to be almost as large as the one harvested in the United States. Production problems in South America or in the United States may be necessary to move prices upward.

Canola oil could probably move independently of soybean oil prices next summer if another poor crop materializes in Canada. Although the odds favor normal weather, stocks are tight enough so that fixed price contracts would not be advisable.

It is also likely that canola acres will be increased in both the United States and Canada. The net returns from canola are likely to exceed those for a number of crops, especially in Canada.

Finally, loan rates are subject to the uncertainty of which government farm program will be passed by Congress. Locking-in a pre-harvest price at a level below the loan rate would not make risk management sense.

This review of the factors influencing the canola price suggests a marketing plan that takes action earlier rather than later. Further, the action taken should provide flexibility. Enough uncertainty exists that the marketing tool used should allow you to capture of higher prices if they materialize.

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Source: George Flaskerud, (701) 231-7377, gflasker@ndsuext.nodak.edu
Editor: Tom Jirik, (701) 231-9629, tjirik@ndsuext.nodak.edu