Grain Marketing in the BioFuels Era: Session 4: Marketing
Strategies: February 12 Ethanol
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Characteristics of price patterns in the BioFuels Era
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Market Opportunity-Bull Strategy 1.Price later (wait for a big
event) 2.No government programs 3.Consider selling at
harvest-replace with long futures/calls 4.Smaller returns for
storage Government Support Line Opportunity
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How BioFuels Era Impacts Prices and Marketing Level of crop
prices rise Relationship of crop prices change Volatility of crop
prices increases Government programs: Limited importance Risk
Exposure--$ of Exposure grow Cyclical Uncertainties as Boom/Bust
Odds Grow Coordination of linkage between growers and end
users
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Ethanols Growth? Lower Energy Prices Policy Federal Subsidy
State: MTBE Restrictions State RFS Much Higher Corn Prices Higher
food prices Technology-cheaper energy sources Unlimited Vulnerable
U.S. Gasoline use is about 140 billion gallons per year. Ethanol
has about 70% of the energy of gasoline.
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Predicting Price Direction Everyone is interested, but the
success rate is not encouraging
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Random Walk Model What? Successive price changes in futures are
independent and thus past prices are not a reliable indicator of
future prices And: Information tends to flow to the market in a
random nature. Thus the odds of prices being up or down tomorrow
are equally likely.
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Efficient Market Hypothesis At any given point in time, the
marketplace incorporates all of the information available, and
quickly and accurately formulates price. Assumes: A large number of
market participants Participants who are well informed Participants
are profit maximizers
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Conclusions From Random Walk and Efficient Market Hypothesis
Futures Prices are not predictable Futures Markets should not have
predictable trends Futures Markets should not have seasonality A
trader should not be able to profit from trend following or
seasonality of price movement It is difficult to make speculative
profits in futures trading from price prediction
USDA :Average % Miss on Crop Size: 1981 to 2005 Crops
MayJulySept Corn Crop10.2%7.8%3.9% Soybeans7.6%6.1%4.9% For May
2007: This is Plus or Minus 1.2 billion bushels
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Support for these Theories Past studies show in any given year
for small speculators about 75% lose money, ie. There are 3 times
more losers than winners This means that over 90% of small specs
would be net losers after 2 years AgMas: Project tracks corn and
soybean recommendations from Ag advisories show little net gain
from advisory information in totalsee examples
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Rejection of these Theories Empirical evidence suggest there is
seasonality of futures when the last 10-15 years are observed on
average--Maybe Some people do make money speculating in futuresDoes
not reject Theories Some advisory firms did substantially exceed
the average in pricing corn and soybeans (AgMas)Does not reject
Theories
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Some Relaxation of Theories While information is random, that
information sometimes has a trending nature to it. For example;
Weather trends USDA supply and demand reports Economic trends
(Favorable economic trends) News trends (Asian Financial Crisis)
Livestock production cycles
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Risk premiums may have to be paid, giving rise to seasonality
Buyer of futures perceive greater risk in the spring and early
summer for crops therefore will pay greater futures prices to Shift
risk of upside from themselves to a speculator At harvest, short
hedge pressure tends to drive futures to their lowest seasonal
price. At harvest, buyer feels little need to pay risk premium
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Purdue Conclusions on Speculation Beating futures markets at
price speculation is difficult. At any trading price, the odds of
prices going higher or lower is about 50/50. Limit your speculative
positions to acceptable levels. Always look for the best pricing
strategy, but also diversify them. If you have a speculative
objective also have a speculative Ouch point. Markets have NO
concern for you or your family, they can destroy your business if
allowed. The returns to non-speculative types of marketing
knowledge have higher odds of success than speculation. Stick to
your knitting. Returns for your time in other farm management
decisions are generally more profitable over time than market
speculation
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Optimum Pricing Strategies
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Overview What drives the pricing decision (criteria)?
Conceptual framework to consider in establishing your strategies.
Pricing clues from the past: Pre-harvest pricing Harvest-pricing
Post-harvest pricing (storage returns)
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Decisions In Pricing What drives the pricing decision? Timing
based decisions. Outlook Fundamental indicators Technical
indicators Use an analyst, or marketing service Cost of production
thresholds Cash flow needs Emotion--- Not Generally
Recommended
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Strategy Concepts Routine strategy, or discretionary decisions
Portfolio approach to marketing: Portion that is passive marketing
Portion that is active Decision weighting: Concentrate marketing
strategies Diversify marketing strategies.
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Pricing Clues From Past Patterns For Pre-harvest pricing: Do
new crop futures tend to have a seasonal pattern? Do new crop cash
bids tend to follow this pattern? For Post-harvest prices: Do they
tend to follow a pattern? Do they increase enough to cover storage
costs? On-farm Off-farm (commercial).
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About a 20 cent historic premium for pricing in the mid-Feb to
early-June period versus harvest
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About a 35 cent historic advantage for pricing in the mid-March
to late-June time period versus harvest
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New Crop Forward Pricing Window
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Pre-Harvest Pricing 1. Research on pricing strategies on both
corn and soybeans shows that pre-harvest pricing tends to help
increase the mean returns versus selling at harvest and also
reduces the variability of prices received over time. 2. The reason
is new crop futures for both corn and beans have tended to be
higher in mid-February to early-June period than at harvest. Thus,
on average, pricing some new crop in this time period has given
higher average prices in the past. 3. The price variability of new
crop futures also tends to be less in the mid-February to
early-June time period than at harvest.
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Pre-Harvest Pricing Pricing strategies that tend to work well
in the Pre-harvest period include: Forward cash contracting Selling
futures to hedge Buying put options, and Selling cash on a forward
contract and also buying new crop call options (this is called a
synthetic put)
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Hurt/Weitrich Study Soybeans Harvest Price = $6.04 May 15June
15July 15 Sell Futures: Futures hedge 6.096.186.17 Buy Puts: No
forward pricing and buy puts. Min price 6.226.296.06 Synthetic Put:
Forward Price and Buy Calls. Min price 6.136.176.05 Sell Calls: No
forward pricing and sell call. Max price 5.996.036.15 This study
was for 1975 to 1988. The spring highs tend to come earlier in more
recent years.
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Further Guidelines Related to Storage Be more aggressive at
pre-harvest pricing Have a stronger tendency to use forward cash
contracting Still need to follow the volume guidelines outlined
next Want to leave open the storage decision until later in the
summer/fall Tend to avoid forward cash contracting for harvest
delivery, but May forward cash contract for delivery out of
storage, or In the spring, sell futures or buy puts which allow you
to make the storage decision later in the summer/fall May tend to
sell Nov/Dec futures in the spring and then roll to March after
futures spreads widen in the summer or fall. Without StorageWith
On-farm Storage
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Pre-Harvest Pricing Volumes Generally pricing too large of
volume in pre-harvest is considered risky until yields are known.
The first 25% can often be priced with a forward cash contract,
generally without concern for ultimate yields. The portion from 25%
to 50% of expected conservative yields might be priced: Once yields
are more certain into the late spring or summer With options Or
forward priced after buying out-of-the money calls to protect
against upside price movements
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Pre-Harvest Pricing Above 50% of the expected conservative
yield Should not be done until yields are more certain Should be
done with options only Remain unpriced and buy puts Puts establish
a futures floor price, but Do not establish a final price, in the
case of rising futures Do not commit bushels to be delivered in
case of short crop yields Forward cash contract, and also buy
out-of-the-money call options to cover potential futures price
increases
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Pre-Harvest Pricing Should be more aggressive and start pricing
new crop earlier in years following a short production year. In
1995 there was a short corn crop due to low yields Begin to price
the 1996 crop as early as the fall of 1995 and into the spring of
1996. Generally you also want to be more aggressive at pricing
larger volumes, although still use options once you are moving
above the 25% to 50% of conservative production estimates.
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Pricing At Harvest Should generally be avoided with some
exceptions: When futures price spreads are inverted and the market
carry is small or negative. When prices are viewed as high. When
income tax management favors selling in the harvest calendar year.
When storage is not available, or commercial storage costs exceed
the estimated price gains (carry) offered by the market. When a
landlord or tenant is not willing to consider other alternatives.
When cash flow needs demand pricing at harvest
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Pricing at Harvest Even if you price at harvest: Consider bids
for later time delivery Calculate the storage costs Evaluate
whether a positive return can be gained from storing and pricing
for a later delivery period. Also, always look for any premiums for
early harvest delivery that you may be able to earn.
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Post Harvest Pricing Basis normally appreciates sharply at the
conclusion of harvest. Expect to see 15 to 20 cents per bushel
gain, or more, in the three or four weeks immediately after
harvest. Beans: Cash prices of beans tend to rise until early-
December, but tend to be flat to slightly downward into March. Then
beans tend to have final increase into spring The best pricing
window for beans is often the 30 to 60 days after harvest or into
March to mid-May. Those who want to continue to speculate on beans
might then consider doing so with futures or options.
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Post Harvest Pricing Corn: Corn prices have a tendency to
continue to rise into the spring period because there is no major
Southern Hemisphere competitive crops. The odds of receiving a
positive net return to corn storage into the spring are higher for
corn than beans, especially on-farm storage. Commercial, off-farm
storage over time has been about a breakeven situation Storage into
the late spring and summer generally does not cover storage costs,
so Either sell the cash grain and buy call options for potential
upside gain, or Store with the grain priced for summer
delivery.
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Review There are many aspects to establishing a pricing
decision. Pre-harvest pricing somewhat before or during planting
has tended to increase average prices versus harvest pricing.
Post-harvest pricing has tended to provide positive storage returns
for: Short term storage on beans either on-farm or in off-farm
storage, and for Storage into the spring for on-farm corn storage
only. There is much variation from year to year, thus There is a
need to read the market signals each year, and Make some adjustment
in pricing strategy. Diversification in a marketing program has its
merits
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In the End 1.When all the research is concluded, remember no
one knows for sure what the optimum pricing strategy will be for
next year. 2.The odds of most producers beating the market at price
speculation are relatively low. 3.Always know for sure how much
risk you can and are willing to take in the market. 4.Stick to your
knitting. Do your best job of pricing, but remember returns can
often be higher for time spent in production and general farm
management. 5.Diversify, because no one does know for sure what
will happen.
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The Ten Step Marketing Plan (CMS Disk 2, Unit 7)
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What Is a Marketing Plan? An orderly procedure to attempt to
achieve specific pricing objectives that meet the farms overall
goals.
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The First Step 1. Define Your Pricing Objectives Highest price?
Sell above average yearly price? Net price above yearly average
price? Price above the midpoint of the price range? Price in the
highest 1/3 of the price range? Price at a profit? Price to meet
cash flow? Reduce or minimize price uncertaintyrisk ?
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Suggested Objectives Use a strategy that allows you to increase
prices 2% to 5% above the average yearly price received by farmers
in your area, adjusted for storage costs. Implement a strategy that
will allow you to generate prices 5% to 10% above the average
harvest cash prices after you net out all costs of marketing
including storage cost, commissions, options premiums, etc. (Except
in short production years, or when futures price spreads are
inverted at harvest).
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The Second Step 2. Evaluate Your Personality What is your basic
business A professional price speculator, or A business person
attempting to generate a positive margin.
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More on Personality Do you make decisions on the basis of:
Emotions...GREEDHOPEand FEAR, or Rational, information based
decision making Good decision making involves looking at
alternatives Collecting information about alternatives Listing
advantages and disadvantages Calculating potential costs/returns
Evaluating the risks in each alternative Making a decision and
implementing Learning from your decisions.reviewing
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The Third Step 3. Integrate Budgets and Financial Position into
Marketing Plan Examine enterprise profit & loss. Does what
youre producing: Have reasonable chance of being profitable? Is it
the best economic use of the resources? Look at cash flow needs
implications for the timing of pricing and general cash needs How
is your net worth? What are the implications for taking risk?
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Whats Required? Enterprise Profit and Loss Estimates Cash Flow
Statement Net Worth Statement
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The Fourth Step 4. Understanding Government Programs
Pre-planting An understanding of Government commodity programs and
Crop insurance alternatives Harvest and post-harvest How do
government loans work? How do LDPs work and what are the
implications for pricing alternatives Know all relevant government
programs and details
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The Fifth Step 5. Evaluating Your Production Plan How much will
be produced When will it be available to be delivered What grades
or special premiums might be available When can these products be
priced? What is the pricing window? Generally at least 10 months
before harvest until 10 months after harvest.
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The Sixth Step 6. Evaluate Physical Handling and Delivery
Alternatives Transportation costs to various elevators Storage
costs and economics Premiums/discounts for grade-quality-volume
Grain grades and discounts For livestock Carcass premium systems
Optimum selling weights
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The Seventh Step 7. Evaluating Pricing Alternatives Futures and
their use Options and their use Cash forward contracting Basis
contracts Futures only contracts, or Hedge-to-Arrive Delayed
pricing Average pricing programs at the elevator
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The Eighth Step 8. Evaluate the Outlook Examine and study
historical price patterns of: Futures, basis, and cash prices Be
aware of the USDA balance sheets and basic price outlook they
provide, as well as other fundamental information. Spend some time
each week studying price charts and technical indicators. Read, or
talk with analyst who provide outlook information.
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The Eighth StepRevisited 8. Re-Examine the Risks Faced Once
More How much risk can you take? How much risk are you willing to
take? Remember the two largest risk in agricultural production are:
Price uncertainty, and Yield uncertainty Keep price risks to a
moderately acceptable level Remember markets do not care about you
as an individual. Prices can move sharply in an adverse direction.
The financial damage is compounded when an individual has a large
market position.
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The Ninth Step 9. Develop a Written Plan of Market Action
Writing down the plan will help you to formulate it in the first
place. Update the plan quarterly. Keep all past copies of your
plans. It will give you a benchmark to see how your marketing
thoughts progress from period to period, and Provide a better basis
for evaluating needed changes in the plans over time.
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The Tenth Step 10. Implement Your Plan and Continue to Learn
Put your plan into action. Follow through on the plan, even if
pricing opportunities look more promising than you had thought.
Remember market prices always reach a peak on a bullish day.
Monitor results and compare performance to your objective Evaluate
your plan. Learn from it, and Modify as needed.
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Course Evaluation Please fill it out Let us know what programs
you would like to see in the future Thank you!!!
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Questions To email in questions, either give them to your host
or send them to Corinne Alexander: [email protected]