April 26, 2011 Producers need to understand risk in this market
“How much risk can I tolerate?” This question is on the minds of many producers and the answer will partially depend on the producer’s financial condition and whether crop insurance has been purchased.
For some, crop insurance will cover production costs and may make up some of the gross income loss says Oklahoma Extension Economist Kim Anderson. An option to generate more income is to plant a summer crop. This option’s risk is the production costs. And, since most wheat is already at the heading stage, crop insurance is probably not available to cover the risk.
Some wheat producers forward contracted wheat for June 2011 delivery. Sufficient wheat may not be produced to meet the contract requirements. Options include settling the contract with the elevator or buying wheat from neighbors to deliver the bushels contracted.
Most elevators will settle a forward contract by allowing the producer to pay the difference between the contract price and the posted cash price plus a management fee of 5 cents to 10 cents per bushel. Some elevators may settle for the difference between the hedged price (elevators sell KCBT July wheat contracts to cover the price risk) and the current KCBT July wheat contract price plus a management fee.
Most forward contract prices are less than the current price. Thus, elevators have made margin calls to cover losses from the futures contracts. This expense is covered with the fee.
The third problem is if wheat is to be harvested, how it should be sold. The alternatives are to forward contract some wheat now, sell at harvest, sell in the fall, or stagger the sales over time.
The choice depends on price. When will the price peak: now, at harvest, or in the fall? Generally, weather will determine when.
Below-average hard red winter wheat production will set the stage for higher prices. If, like last year, foreign wheat production is less than expected, the wheat price could reach $10, which would probably happen in the October/November time period.
Anderson notes, two rules for this are: one, any strategy will outperform no strategy; two, staggering sales over time is a successful strategy used by many producers.