HEDGE-TO-ARRIVE CONTRACTS

Q & A - Part 1 of 2 

Montana MarketManager® is a marketing education program for grain producers.  Producers are strongly encouraged to visit with their grain merchandiser or elevator manager in regards to the specific grain contract(s) which currently exist or will exist in the future, and to fully understand the obligations and implications of any contract before authorizing with your signature.  Please read our disclaimer. 

 

Can you get out of a Hedge-to-Arrive if the market keeps going up? Even if you have the grain? 

Response from HTA Week Contributor: 
I consider a HTA as a cash contract, with the producer setting the basis and delivering the grain. If a producer wants to be moving in and out of contracts, he should get a broker, set up an account, provide that account with margin money, and make trades with his broker. At the end of the year, the producer can take his profit or loss from his futures trades, add or subtract them from the cash sales of his grain throughout the year to come up with his final cash price for that crop year. 

Response from HTA Week Contributor: 
If the elevator company is following the letter of the law, the short answer is no. Let me explain exactly what a HTA contract is and how it differs from having a short position in the commodities market with a commodity broker.

Commodity futures are regulated by the Commodity Futures Trading Commission (CFTC), an independent agency of the U.S. government. Trade is limited to those licensed individuals working with or for a clearing member of the commodity exchange in which you hold a position. Trading of regulated futures contracts without CFTC license is illegal. To trade futures you need to open and fund a margin account with a broker. Once you put on a position (short or long), you are required on a daily basis to fund your margin account if the market moves against you, or you can remove the excess cash when you have a profitable position. You can enter or exit the market as often as you like as long as you meet the margin requirements. 

A HTA contract is a cash wheat contract that is based off a specific price (4.50) of a named month (December 06) of a specific commodity (wheat) at a named futures exchange (KCBOT). Sometimes this and other lesser used contracts (minimum price) are referred to as hybrid contracts. This is because they are cash contracts that have a relationship to the regulated futures markets. One of the main attributes of a HTA is that a producer can gain the price protection he wants without tying up his money, and without having to make arrangements to have the cash to meet margin calls. 

This contract has been used without much notice for the last 20-25 years. In crop year 1995-96 the corn market was at levels ($2.60) that had not been seen for 24-30 months. Selling corn futures at $2.60 or better had been the right thing to do for the previous years. 1995-96 turned out much different; corn went to $4.00. People were unwilling or unable to accept the idea that market was for real and rolled the contracts into the following crop year, reasoning that the inverse in the market would disappear and they would get some of their money back. Inverses widened though and the blood started to flow: bankruptcies, contract defaults, etc. The CFTC stepped in and issued rules to prevent this from occurring again. The key rulings that affect us in this discussion where the following points:
           -  A specific delivery location is named and delivery is expected, not optional. 
           -  Rolling into the next crop year is not allowed

The CFTC ruled against the Andersons, Inc. for offering and selling illlegal futures contracts and violating the Commodity Exchange Act of 1994 in this 1999 CFTC Order. 

 

I know there were many HTAs taken too early and I would guess most were taken without the protection of a call option. Is there a strategy to salvage some of this loss or do we suck it up and move on?

While you may be shuddering at your actions now, go ahead and give yourself a pat on the back.  By selling a HTA early, you executed one or more steps in a marketing plan - written or otherwise.  MarketManager urges producers to write down their clear marketing plan for each crop year (example), and evaluate your final average price from year to year.  Remember that marketing plans don't have to be complicated to be effective.

Response from HTA Week Contributor: 
I do not pretend to be an options trader, so I can't offer any salvage strategies. The way I have always approached producers is to stair step into pricing. I would suggest you sell more to get your average price up. With the hot weather and deteriorating conditions this week, I realize this may no longer be as palatable an option as it once was.

Response from HTA Week Contributor: 
As wheat prices have moved higher, options strategies get more expensive by the day. We all have 20/20 hindsight; what looked good several months ago does not now. We have to remember we are probably not going to have the foresight to sell 100% of our crop at the high. We need to make sales based on historical averages, financial obligations, delivery periods and such. The wheat market rallying to these levels is great. While it does not do much for the crop we have sold now, the value of our unsold portion has increased greatly to bring our cash sale average up.

 

My question is if all these producers have Hedge-to-Arrive contracts with their local elevator, what incentive does the elevator have to adjust the local basis? They know the grain is coming, so why would they bid higher?

Response from HTA Week Contributor: 

Basis is the best indicator of supply and demand. When the end user wants grain, basis goes up. When the end user does not want grain, basis goes down. We are not only seeing large swings in the futures, but larger swings in the basis as well. The end user dictates basis and the question is, will he continue to buy grain at these numbers from the US, or will he seek his supply elsewhere? While the quality he can buy from the US is very good, sooner or later price becomes a factor.

Response from HTA Week Contributor:
Profitability in this business is driven by volume. If I take a wider than normal margin on a producer that has an existing HTA contract, I risk upsetting the customer such that he will go to the competition next time. We have to earn your business each and every year. There is no way I can make enough margin in one year to take the chance on losing the customer

Response from HTA Week Contributor: 
If an elevator were to become more competitive with their basis (increasing it), it could cause producers to lock in the basis instead of rolling their contracts, giving the elevator more predictability with their grain deliveries.

 

Why does every elevator differ on rolling contracts and/or buying them back? 

Response from HTA Week Contributor:

Every elevator has their own guidelines by which they operate. Consult your local elevator manager with any questions you may have.

Response from HTA Week Contributor: 
The elevators are operated by different entities. We make our own decisions and have our own ideas about how to manage risk and how to run our business. A level of risk acceptable to CHS might not be acceptable to Peavey or some other company.

 

What will happen to basis? Will it come back to its normal range or will it remain weak if the futures stay way up? My local elevator has a -.50 for October delivery. That hurts if you have already set the futures.  

Response from HTA Week Contributor:
If futures continue to rally, we can expect the basis to decline. The US farmer will continue to sell grain at these prices. The domestic milling market can only take so much and our overseas buyers may start looking elsewhere for cheaper, lower quality grain to meet their needs.

 

How good will basis get this year?  How will I know a good basis when I see it?

The PNW basis charts on Montana MarketManager will give you a good idea of the seasonal trends in basis, and show how the basis has moved against the average for 2005 and 2006. Click here to view the charts.

Response from HTA Week Contributor: 
Your local elevator manager would be a good source for the basis. While charts are always a good tool, they represent a very broad picture. Exporters, mills, shuttle loaders, single car shippers all have a different basis. Contact your local elevator manager for up to date and historical basis for your area.

Response from HTA Week Contributor:
In my own personal view I expect to see lower than normal basis levels than we have seen the last 5-7 years for the following reasons: Futures are at the highest levels we have seen in a long time. US wheat exports are forecast to be 100 million bushels lower than last year. Several importers of west coast winter wheat have announced that they will be buying smaller quantities of 13% protein; lower protein HRW and spring wheat will be used instead. 

Specific to HRS -- As of today one has to believe we will have a higher than average protein in the HRS. Historically in years of a higher than average basis we have below normal average protein. The duty on Canadian spring wheat has been lifted. Currently USDA is forecasting imports of 44 million HRS for this crop year compared to 12 million last year. 

I would suggest spending more time looking a the flat price than dwelling on basis levels. 

Response from HTA Week Contributor: 
The best thing to do is look at historical information. Look at charts of the bases and be realistic with your leaves. Try and sell above the average. 
 


Disclaimer: Montana MarketManager® is a marketing education program for grain producers. It is not a marketing advisory or brokerage service. The content herein is intended solely for informative purposes and is not to be construed, under any circumstances by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is obtained from sources believed to be reliable, but is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted.