Crop contracts

The producer agrees to deliver some, or all, of the production from a specified number of acres. The purchaser guarantees to accept delivery. Most do not specify the price or the total volume of grain to be delivered. Some companies will allow pre-pricing of only part of the expected tonnage of crop on the contract prior to harvest. After harvest, however, a producer may contract or 'price' the entire crop.

Advantages of a production contract:

• eliminates the risk of restricted delivery opportunities for some, or all, of the crop
• no minimum delivery may be required in cases of crop failure

Limitations of a production contract:

• does not deal with price risk or, on crops where it applies, basis risk
• limits the choice of companies to which the grain may be delivered
• first-right-of-refusal price may mean selling to the contracting company when a higher price is available from another buyer; this is particularly applicable when a lower than base grade is produced and your product becomes subject to a price discount that was not specified in the contract

The producer agrees to deliver a specified amount of grain, oilseed or special crop to a crop buyer during a certain period. The purchaser agrees to accept delivery of the specified amount and pay a specified price.

Usually the contract specifies a certain quality or grade that is eligible for the guaranteed price. If the delivered product is lower quality than specified, the final price is usually discounted. The amount of discount should be specified in the contract, but some contracts specify that the discount will be the one in effect on delivery.

Advantages of a deferred delivery contract:

• eliminates the risk of future price declines on the contracted volume
• eliminates the risk of restricted delivery opportunities on the contracted volume
• does not require margins to lock in a price for future delivery
• widely available from local elevators, grain dealers, special crops buyers, and some feedlots and feedmills

Limitations of a deferred delivery contract:

• the amount of product specified in the contract must be delivered, or penalties may apply
• limits the choice of company to which the grain may be delivered
• the contracts do not allow producers to take advantage of later price rises
• timing of delivery may still be delayed by the buyer

A supply contract is an unpriced contract. A producer agrees to deliver a certain tonnage of grain or oilseed during a certain delivery month. The buyer guarantees to accept delivery during the specified month. The buyer may agree to pay the producer to store the grain on the farm but storage is only paid on product actually in the farm bin, not in the field. Usually, no storage is paid after the product is priced.

Supply contracts may be priced out (the price is locked in) at the time of delivery at the spot or street price for that day; some may be priced out prior to delivery. Supply contracts are offered most often by canola crushers and buyers of special crops.

Advantages of a supply contract:

• part of the cost of on-farm storage may be paid
• eliminates risk of restricted delivery opportunities

Limitations of a supply contract:

• the amount of product specified in the contract must be delivered
• limits the choice of buyer to which the grain must be delivered
• does not eliminate price risk

An open-basis contract is an unpriced marketing contract that is only available for crops where there is a futures contract for pricing. The producer guarantees to deliver a certain tonnage of crop during a specific period for a guaranteed futures price of a specified futures month. The basis, however, has not been finalized when the contract is signed.

The final price is determined when the seller chooses, or locks in, a basis. The final price is the initial guaranteed futures price for that commodity, plus or minus the basis that was locked in at the later date. An open-basis contract can be used for standing crop or for farm-stored grain. The basis can be locked in at any time up to the day of delivery. Hence the name, to-arrive.

Read Basis: how cash grain prices are established for more information.

Advantages of an open-basis contract:

• locks in the futures but allows the producer to take advantage of possible improved basis levels at a later date
• eliminates the risk of restricted delivery opportunities on the contracted volume
• can be used to lock in a high futures price without using a commodity broker or futures commission merchant
• allows a producer to speculate on strengthening basis levels

Limitations of an open-basis contract:

• requires a good understanding of basis and the factors that influence it
• used alone, it does not totally eliminate price risk
• limits the choice of buyer to which the grain may be delivered
• open-basis contracts are only available for commodities for which there are futures contracts

This contract is similar to a deferred delivery contract except that it is for forward pricing of grain to be shipped by a producer-loaded dealer car, rather than delivered to the elevator, crusher, grain dealer or special crop buyer.

Advantages of a dealer car contract:

• eliminates the risk of future price declines
• eliminates the risk of restricted delivery opportunities
• does not require margins for futures contract accounts
• available from grain dealers and some special crops buyers
• dealer cars may have a better basis level than facility delivery and, therefore, offer a larger net return to producers

Limitations of a dealer car contract:

• the amount of product specified in the contract must be delivered
• limits the choice of buyer to which the grain may be delivered
• dealer cars usually have a weaker basis level than producer cars for the same product
  • For information on producer cars, refer to Using producer cars to ship Prairie Crops.
• the contracts do not allow producers to take advantage of price increases
• producers must have enough product available to fill a car
• dealer cars, like producer cars, must be loaded by the producer
• spotting of cars may be delayed by railway train scheduling
• payment is not received immediately – payment is made after a car is unloaded at the final destination

This contract is like a deferred delivery contract to price crop for sale directly from the farm at a later, specified date. The crop buyer or broker finds a buyer and arranges for farm pick-up of the crop. The producer is paid by the buyer based on the unload weight, grade and dockage. Producers should keep a representative sample of crop from each truckload shipped in this manner.

Advantages of a farm gate purchase contract:

• eliminates price risk on the volume contracted
• no grain hauling by the producer
• price may be higher than the elevator price due to elimination of elevation charges

Limitations of a farm gate purchase contract:

• load size is unknown until truck unload
• payment is not received until after truck unload
• recourse in case of grade dispute may be more difficult

A minimum-price contract allows a producer to lock in a minimum price with the option to take advantage of a higher price should that opportunity arise. A minimum price contract may only be available for a crop that has a related futures contract. Typically, a crop buyer will use a put option to provide the minimum price contract.

Advantages of a minimum-price contract:

• allows a producer to take advantage of futures price increases while protected against price declines
• may be used independently from locking in the basis (buyer dependent)

Limitations of a minimum-price contract:

• the minimum price is usually less than that of a deferred delivery contract available at the same time by the cost of the put option plus an administration fee
• the put option premium can be quite expensive if the crop futures are volatile

Deferred pricing contracts are sometimes incorrectly called storage tickets. Deferred pricing contracts allow a producer to deliver grain or oilseeds and accept a small partial payment immediately. The producer agrees to a final price on or before a deadline date specified in the contract.

Advantages of a deferred pricing contract:

• eliminates on-farm spoilage risk
• reduces on-farm storage requirements
• eliminates the risk of restricted delivery opportunities at a later date
• allows pricing with just a phone call
• allows producers to take advantage of price improvements within a certain time after delivery

Limitations of a deferred pricing contract:

• price risk remains until pricing is completed
• stronger basis levels may not apply to grain already delivered via the deferred pricing contract
• the product must be priced-out and payment received within 30 days after delivery to be covered by Canadian Grain Commission bonding protection
• a large number of deferred pricing contracts expiring and priced in a short time may pressure future prices lower

A cash-for-futures contract is an unpriced marketing alternative that applies to crops with a futures contract. To use a cash-for-futures contract, the producer first delivers grain or oilseed and locks in the price for it either immediately or within a certain number of days of delivery. The producer receives payment for at least 50% of the product value the day it is priced. The remaining funds are used by the crop buyer to buy an equivalent tonnage of futures contracts on behalf of the producer.

If the futures price rises, the producer profits from the increase in value of the futures contract. If the futures price falls, the losses are covered by the funds held by the crop buyer. The producer must choose a point to close out the futures position to lock in the futures gain or loss.

Producers should be sure the buyer they are dealing with has a Registered Futures Commodity Merchant (RFCM) arm. If the company does not have an RFCM arm, they may be in violation of security regulations. Read Choosing a commodity broker for more information on RFCMs.

Advantages of a cash-for-futures contract:

• the producer receives partial payment for the crop while waiting for price improvement
• allows producers to speculate on the futures market without using a RFCM directly
• allows a producer to lock in a favorable basis, if available, at time of delivery

Limitations of a cash-for-futures contract:

• the producer is not protected against lower futures price risk
• there is significant risk of losing money on any futures trade
• cash-for-futures contracts only apply to crops with a futures contract
• the amount per tonne withheld by the grain company is usually higher than the margin deposit required on futures contracts required by RFCMs
• there is usually no interest paid on the money withheld by the grain company
• there may be an administration fee charged by the grain company for each futures contract purchased and sold
• cash-for-futures contracts not priced and paid in full by 30 days are not protected by Canadian Grain Commission bonding protection

A minimum-price contract is a priced contract that allows a producer to deliver a crop to a buyer, lock in a minimum price, but have the option to take advantage of a higher futures price. A producer delivers the crop to a buyer, prices it and is paid about 90 to 95% its value. The 5 to 10% of the crop value not received by the producer is used to buy a call option on the futures market. The producer has a minimum price locked in, but can take advantage of higher prices should they develop.

Like options, floor- or minimum-price contracts are only in effect for a certain time period. The producer must choose a point to lock in the price since the option doesn't automatically lock in the highest price available.

Advantages of a minimum-price contract:

• allows a crop grower to take advantage of possible futures price increases
• the producer is protected against price declines
• can be used to deliver during times of strong basis levels even if price increases are expected
• the greatest amount a producer can lose is the premium cost for the contract
• allows a grower to generate cash flow by pricing and being paid for the crop without holding it in the bin

Limitations of a minimum-price contracts

• a minimum-price contract does not guarantee the highest futures value
• the producer must be disciplined in choosing a futures value to price out the contract
• many of the contracts expire worthless because producers do not lock in a profit when it is available – instead, they often wait for a higher price and miss out on an opportunity
• the call option premium can be quite expensive if the crop futures are volatile
• the call option premium will be more costly the longer the minimum-price contract is to be in effect

A basis contract is an unpriced marketing contract only available for crops that have a futures contract. The producer guarantees to deliver, or has already delivered, a certain tonnage of crop at a fixed basis relative to the price of a specific futures month. The producer is able to lock in the futures price of the grain or oilseed any time before a specified date.

The final price is determined when the seller chooses, or locks in, a futures price. The final price is the chosen futures price for that commodity plus or minus the basis specified in the contract. A basis contract can be used for standing crop, before delivery of farm-stored crop or for crop at the time of delivery.

Advantages of a basis contract:

• locks in the basis but allows the producer to take advantage of futures price increases
• establishes delivery opportunity when used prior to actual delivery
• can be used in conjunction with the futures market to create a perfect hedge, in other words, a hedge with no basis risk

Limitations of a basis contract:

• requires a good understanding of basis and the factors that influence it
• used alone, it does not eliminate price risk
• limits the choice of buyer to which the grain may be delivered
• basis contracts are only available for commodities for which there are futures contracts
• basis contracts on delivered grain, not priced and paid in full by 30 days, are not protected by Canadian Grain Commission bonding protection

A target-pricing contract, sometimes called a grain pricing order (GPO), is also an unpriced alternative. In the contract, the producer states the price they would like to receive for a specified amount of crop. If the grain or oilseed reaches that price, it is priced automatically. This kind of contract can be used for growing crop, farm-stored crop or unpriced crop already delivered.

Advantages of a target pricing contract:

• the producer specifies the desired price in advance
• the product is priced without constantly watching the market
• allows producers to speculate on the market with crop in storage

Limitations of a target pricing contract:

• marketing decisions are isolated from the producer
• the market price could peak just below the producer-selected price, and a good marketing opportunity could be missed
• prices could rise above the target price but the producer would only receive the target price
• target-pricing contracts are often only in effect for a specified time period, usually 90 days
• target-pricing contracts on delivered crop, not priced and paid in full by 90 days, are not protected by Canadian Grain Commission bonding protection