The Risks and Rewards of Crop Contracts with Grain Companies

Posted on October 5, 2021


Crop contracts are useful tools for promoting and selling grain. They allow producers to reduce price risk and decide the best marketing strategy for their farm. Grain companies offer a range of contract forms, each with its own set of benefits for producers, as well as various levels of risk security, pricing flexibility, and cash flow.

A contract is a legally binding agreement between a grower and a buyer that commits the grower to supply a certain commodity on or near a certain date for a certain price. In a nutshell, a contract is an arrangement between two parties that can be enforced by law.

The contracts available and the terms associated with them will differ significantly between grain companies, making direct comparison difficult at times. The language used, which is often legal, varies and may be confusing. So to help you make your next move, we’ve recapped the different types of crop contracts and the advantages and risks associated with them.

Fixed-price/Deferred-delivery Contract (A.K.A. Cash-price Contract)

If a grain delivery is to take place in the current marketing year, it is referred to as a fixed-price contract.  If it is to take place in the new marketing year or after harvest it is referred to as a deferred delivery contract (DDC). It locks in the futures and basis component of your contract, giving you a cash price and delivery date for your grain. You agree to contract a specific quantity and quality of grain or oilseeds for future delivery at a fixed price. Payment is issued once the commodity is delivered.  Specialty crops such as durum wheat, lentils, peas, and so on, trade on fixed-price/DDC contracts.

Advantages

  • Opportunity to establish a fixed price and delivery period for your grain.
  • Ability to lock in a price for a specific grade and protein.
  • Eliminates the risk of a declining futures market.
  • Reserves space for future deliveries.
  • Helps manage cash flow requirements.

Risks

  • The net price of a fixed-price contract may not cover the cost of storing grain.
  • Futures prices and/or basis levels may improve after establishing the fixed-price c
  • If you cannot deliver the grain, you may have to buy out the contract, and that price will be the difference between the contracted price and the current market price plus any administration fees outlined in the contract.

Futures-first Contracts

In the case of exchange-traded commodities, a futures contract is a promise to supply or accept a certain quantity of the commodity at a certain price at a certain date.

Advantages

  • The grain company takes on the risks of changing futures values.
  • Locks in a delivery time to help manage on-farm grain storage.
  • Protects you from downward movement in futures prices.
  • Useful in areas where grain company competition is limited. Often in areas where there’s limited competition, companies will widen basis to keep the cash price the same.

Risks

  • You’re locked in with a grain company, and your basis is at the discretion of the company. This means you are open to the risk of a widening basis and the price would go down.
  • You don’t participate in any upward futures movement and lose opportunity get a higher price for your crop.
  • You’re committed to deliver the product to the grain company you contracted with, unlike using a broker to do futures/options or trading in the exchange.

Basis Contract

The term “basis investing” refers to trading techniques based on the difference between the cash price of a commodity and the price of a futures contract for the same commodity in the form of futures. The foundation is the term used in futures markets to describe this disparity.

Advantages

  • Locks in a delivery window for a commodity at a buyer’s facility. This can help with managing on-farm storage.
  • Eliminates storage costs and basis risk.
  • Minimizes the concern for on-farm stored quality.

Risks

  • With a basis contract, you are not able to take advantage of the carry offered in the futures markets.
  • Sometimes the cash price of a crop rises through a strengthening basis rather than through appreciation in the futures. If the basis strengthens then you will not be able to take advantage of that since you have locked the basis in.

Guaranteed or Minimum Price Contract

A guaranteed or minimum price contract gives you the security of a fixed minimum price, a distribution incentive, and cash flow while also encouraging you to compete in the market with the use of a put or call option.

Advantages

  • A floor price is set to shield you from the futures market falling, while also allowing for profit from higher rates.
  • Provides cash flow by paying the lowest possible amount at the time of sale.
  • Grain can be supplied immediately, but there is still time to negotiate a final price in the market.
  • It alleviates the stress and risk associated with competitive futures markets.

Risks

  • Since an alternative can only be re-priced once, having a marketing strategy and a futures target are important to make the best decision possible.
  • Minimum price contracts have a fee, but premiums are excluded from the purchase price and do not demand payment up front.
  • Additional payments for US trades can be exposed to foreign exchange risk.

Target Price Contract

This is the classic ‘set it and forget it model’. A target pricing contract allows you to select the price you would like to achieve for a certain quantity and quality of grain without having to monitor the ups and downs of the market.

Advantages

  • Ability to set a target price that meets business needs
  • No need to watch the markets
  • Keeps your marketing options open
  • Delivery is not required until the target price is triggered
  • Producers can change or cancel the target price prior to triggering at no cost

Risks

  • There is no price protection if prices go down.
  • The price may be triggered in a rising market.
  • The contract must be cancelled if the grain is marketed elsewhere.
  • The target price could be triggered throughout the day while the market is trading.

Deferred Pricing Contract

In this form of arrangement, the supplier pays a small fee to the elevator in exchange for the ability to price grain within a certain time frame.

Advantages

  • Deliver grain now, price it later
  • Storage fees are lowered by transferring ownership
  • Opens space in bins for additional grain storage
  • Puts you in a position to capitalize on market rallies

Risks

  • If prices fall, you assume the loss, the initial cost, plus interest.
  • Used only to capture potential short-term price increases, not long term

There are plenty of different contracts in grain marketing, and because your business is entirely unique to your own needs, it’s important that you have every opportunity to maximize profits. That’s where FarmLink’s grain marketing experts come into the picture.

Our team of advisors and analysts can help you capitalize on the ever-changing market and in turn, help you reach your financial goals. It may seem overwhelming now, but the more knowledge you have, the better your chances of succeeding with a solid contract — and that all starts with one conversation.

Book a free consultation with a knowledgeable FarmLink advisor today.

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