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Marketing high priced wheat is hard?

Feb 29, 2008 10:58 AM, By Kim Anderson
Oklahoma State University

A South Dakota wheat producer wrote, “I never thought high prices would be so hard to deal with. The right decisions are more important than ever.” At this writing, you can forward contract a truckload of wheat (1,000 bushels) for about $10,000. Less than a week ago, the same truckload was worth $9,000 and three weeks ago, the load was worth $7,700. Last year the load was worth about $4,500.

Prices are higher and more volatile than any time in history. The Kansas City Board of Trade (KCBT) is considering increasing the daily price limit form 30 cents to 40 cents. Their reasoning is that the 30-cent limit was set when wheat prices were in the $3 range.

Marketing alternatives are more expensive. At this writing, the KCBT July wheat contract price is $10.90. The $10.90 put option contract premium is $1.04 or $5,200 per contract.

Some Oklahoma and Texas Panhandle elevators are offering a minus 65 cents basis, the July wheat contract price ($10.25) for harvest delivered wheat. This time last year, elevators were offering a minus 43-cent basis for harvest forward contracts. Forward contracts are about 22 cents more expensive than they were last year.

Wheat producers now know what soybean producers have been facing for years. Wheat producers could also note how soybean producers manage $10 prices and relatively high daily price moves.

The first thing wheat producers need to do is get things into perspective. First, wheat prices could increase or decrease $2 per bushel between now and harvest. The weather will determine what wheat prices will do.

Second, very little can be done to control price. Sure, producers can forward contract, hedge or buy puts. But each of these actions has its own risk and none will guarantee the highest price.

A producer that forward contracted when the KCBT July wheat contract was trading near $7 locked-in harvested delivered wheat at about $6.50. They locked-in a $6.50 price for the amount or wheat contracted. They could forward that same wheat for $10.25 now.

Producers that hedged when the July wheat neared $7 also locked-in about $6.50, and $6.50 is still a relatively good price, good compared to any time in history. But, these producers have had to make almost $20,000 in margin calls for each 5,000-bushel contract sold.

Paying $1 or more per bushel for an at-the-money put option contract will set a minimum price at about $9.40 ($10.90 put - $1 premium - $0.50 basis). It will not matter if the market price goes up $1 or declines $1, buyers of these puts will receive at least $1 less than the harvest price.

Forward contracts, hedges and minimum price contracts (puts, calls) are great risk management tools. They may be used to ensure certain prices. These alternatives are not price enhancement tools and should not be expected to increase the price received.

My preferred strategy is to do nothing until April. In April, sell about 20 percent of the crop; sell wheat at harvest, September/October, and the last wheat in November. This strategy staggers the risk and results and averages the price.

Producers who want to sell wheat now should consider selling 5 percent to 10 percent at a time. One method is to set price targets and kill dates. Wheat may be forward contracted for $10.25. Sell 10 percent of expected production. Sell an additional 10 percent if the price reaches $10.75, $9.50 or sell on April 15, whichever comes first. This strategy forces you to sell whether the price goes up or down. When you sell the 10 percent or April 15, set the target prices and kill date for an additional 10 percent.

Important things to do are to relax; do not get enamored with current prices or big price moves and write down a marketing strategy. Then do not second-guess the strategy.