Understanding Markets and Marketing - Washington State University · Washington State University...

Art

School of Economic SciencesCollege of Agricultural, Human, and Natural Resource 

SciencesWashington State University

Randy Fortenbery

Understanding Markets and Marketing

The objective of marketing is:

• NOT to make money in the futures market.• NOT to sell at the highest price of the year.• NOT to generate accurate price forecasts.

• TO minimize the risk associated with achieving a target level of income.

How is your grain price determined?

LO C A L E LEV AT O R : Grade Grain C ondition Grain Store Grain

R eveal the first public price for grain SU BTER M IN A L E LEV ATO R : Linked to local elevator by rail, barge, or truck O ften do not buy directly from farm ers M ajor function is to concentrate grain into large shipm ents

R eveal second public price for grain . Basically the local elevator price plus transportation and handling costs.

T E R M IN A L E LEV AT O R : Sell to export m arkets and processors. D o not buy from farm ers.

R eveal third public price for grain . Sub-term inal price plus transportation and handling costs.

EX PO RT TERM IN A L E LE V ATO R S:

V ery concentrated industry. O ver half of the U .S. export capacity is ow ned by C argill, Bunge, and Louis D reyfus. O ffer the export price to com pete in the international m arket.

Futures Market

• Sends price signals to the entire system

• Actively used at all levels of the grain market chain EXCEPT the farm

• Is unique in its application of financial leverage

Month Last Chg High Low

Dec-16 400'4 -0'6 400'4 400'4

Mar-17 419'2 2'0 420'6 414'0

May-17 430'0 2'2 431'2 425'0

Jul-17 441'6 2'0 443'0 437'0

Sep-17 455'2 2'0 456'0 450'4

Dec-17 471'4 1'2 473'2 468'0

Mar-18 483'0 1'2 483'6 482'4

May-18 491'2 2'4 491'2 491'

Soft Red Wheat Futures – 9:25 yesterday

July 2017 Futures Prices for Soft Red Winter Wheat

September 2017 Futures Prices for Soft Red Winter Wheat

July 2017 Futures Prices for Hard Red Winter Wheat

March 2017

https://markets.cahnrs.wsu.edu/Graph/Markets

Dec 13 - $4.74

Basis and Price Formation

Basis is the difference between a cash price at a specific location and the price of a particular futures contract. The cash price offered to a grain producer for any given marketing strategy is a function of local basis.

Basis Changes

•The lower the cash price relative to futures prices, the weaker the basis. A weak basis is good for cash buyers,and bad for cash sellers

•The higher the cash price is relative to futures, the stronger the basis. A strong basis is bad for cash buyers,and good for cash sellers.

Determination of Basis

Major Factors

• COST OF STORAGE: Determines basis over a given crop year. Also affects the price difference between a nearby and a distant futures contract in a given crop year.

• COST OF TRANSPORTATION: Determines basis geographically.

Determination of Basis

Other Factors:

• Local supply and demand conditions

• Grain quality

• Intensity of local Competition

Month Last Chg High Low

Dec-16 400'4 -0'6 400'4 400'4

Mar-17 419'2 2'0 420'6 414'0

May-17 430'0 2'2 431'2 425'0

Jul-17 441'6 2'0 443'0 437'0

Sep-17 455'2 2'0 456'0 450'4

Dec-17 471'4 1'2 473'2 468'0

Mar-18 483'0 1'2 483'6 482'4

May-18 491'2 2'4 491'2 491'

Soft Red Wheat Futures – 9:25 yesterday

Recording Basis

To record historical basis levels, collect closing futures prices for the contract closest to maturity (but not expiring in the current month) each Wednesday, and the corresponding cash price (collected later Wednesday or Thursday morning). Subtract the futures price from the cash price. Average the Wednesday basis calculations for each month to arrive at the average monthly basis level.

Odessa Washington White Wheat Basis

Jul Aug Sep Oct Nov Dec Jan Feb2008/09 ‐$0.71 ‐$0.41 ‐$0.80 ‐$0.85 ‐$0.50 ‐$0.86 ‐$0.48 ‐$0.21

Sep 2009/10 ‐$0.41 ‐$0.40 ‐$0.62 ‐$0.82 ‐$1.09 ‐$0.92 ‐$0.81 ‐$0.72Oct 2010/11 ‐$1.32 ‐$0.96 ‐$1.21 ‐$1.22 ‐$0.85 ‐$0.86 ‐$0.70 ‐$0.61

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun

2008/09 -$0.71 -$0.41 -$0.80 -$0.85 -$0.50 -$0.86 -$0.48 -$0.21 -$0.32 -$0.57 -$0.60 -$0.23

2009/10 -$0.41 -$0.40 -$0.62 -$0.82 -$1.09 -$0.92 -$0.81 -$0.72 -$0.65 -$0.61 -$0.54 -$0.60

2010/11 -$1.32 -$0.96 -$1.21 -$1.22 -$0.85 -$0.86 -$0.70 -$0.61 -$0.67 -$0.43 -$0.47 -$0.13

2011/12 -$0.51 -$0.72 -$0.74 -$0.66 -$0.73 -$0.75 -$0.37

Average -$0.74 -$0.69 -$0.86 -$0.96 -$0.82 -$0.88 -$0.66 -$0.51 -$0.55 -$0.54 -$0.54 -$0.32

Actual offer for August 2016$5.87 per bushel

Realized price $5

Actual offer for 2017 $4.85

Dice

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

2 3 4 5 6 7 8 9 10 11 12

Value of Rolling Two Dice

Prob

abili

ty

0

10

20

30

40

50

60

70

80

$4.50 $4.75 $5.00 $5.25 $5.50 $5.75 $6.00 $6.25

2009/2010 White Wheat Cash Prices

0

10

20

30

40

50

60

70

80

90

$6.75 $7.00 $7.25 $7.50 $7.75 $8.00 $8.25

2012/13 Crop Year White Wheat Cash Prices

0

2

4

6

8

10

12

14

$5.40 $5.50 $5.60 $5.70 $5.80 $5.90

Fall 2015 White Wheat Prices

0

2

4

6

8

10

12

14

$4.75 $5.00 $5.25 $5.50 $5.75 $6.00 $6.25 $6.50

July 2015 Futures Weekly Prices

0

5

10

15

20

25

$5.00 $5.50 $6.00 $6.50

2015 July Wheat Futures Prices

0

5

10

15

20

25

30

$5.50 $6.00 $6.50 $7.00 $7.50

2014 July Futures Prices

Large World Wide Stocks

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

$4.50 $4.75 $5.00 $5.25 $5.50 $5.75 $6.00 $6.25 $6.50 $6.75 $7.00Value of Rolling Two Dice

Prob

abili

ty

Normal World Wide Stocks

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

$5.50 $5.75 $6.00 $6.25 $6.50 $6.75 $7.00 $7.25 $7.50 $7.75 $8.00Value of Rolling Two Dice

Prob

abili

ty

Low World Wide Stocks

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

$6.50 $6.75 $7.00 $7.25 $7.50 $7.75 $8.00 $8.25 $8.50 $8.75 $9.00Value of Rolling Two Dice

Prob

abili

ty

Production Costs for Conventional Tillage Soft White Winter Wheat, More Than 18" Precipitation Quantity Price or Value or

Item Per Acre Unit Cost/Unit Cost/Acre

Gross Returns Wheat 80 bu Total Acres – 1000 = 80,000 bushels Variable Costs Seed: $20.70Wheat Seed 90 lb $0.23 $20.70 Fertilizer: $77.80 Nitrogen (dry) 90 lb $0.66 $59.40Phosphorous (dry) 30 lb $0.53 $15.90Sulfur (dry) 10 lb $0.25 $2.50 Pesticides: $31.42 Osprey 4.75 oz $4.10 $19.48Starane+Salvo 22 oz $0.50 $11.00Excel 90 3.2 oz $0.16 $0.51Brox M 1.6 oz $0.27 $0.43 Machinery: $55.10 Fuel 6.32 gal $3.50 $22.14Lubricants 1 acre $3.32 $3.32Machinery Repairs 1 acre $9.68 $9.68Machinery Labor 1.12 acre $17.80 $19.96 Custom & Consultants: $10.18 Rental Sprayer 1 acre $1.93 $1.93Rental Stubble Shredder 0.5 acre $11.00 $5.50Rental Ripper Shooter 1 acre $2.75 $2.75 Other: $21.75 Crop insurance 1 acre $21.75 $21.75

$0.00 $0.00

Overhead1 $10.85Operating Interest2 $6.24 Total Variable Costs $234.03Variable Costs per Unit $2.93

Fixed Costs: Machinery depreciation $22.86Machinery interest $13.11Machinery insurance, taxes, housing, licenses $5.34Land Cost* 1 acre $131.82 $131.82*Based on Share Rent Percentage: Landlord 33.00% Tenant 67.00% Cash rent $0.00Land taxes $6.33 Total Fixed Costs $179.45Fixed Costs per Unit $2.24 Total Costs per Acre $413.48Total Cost per Unit $5.17Notes: 1Covers legal, accounting, and utility fees. Calculated as 5% of operating expenses. 2Calculated as 5.75% interest on operating capital for 6 months.

Breakeven Analysis: - + 10% Base 10% Yield

Price 72.00 80 88.00 Operating Cost Breakeven $3.25 $2.93 $2.66 Ownership Cost Breakeven $2.49 $2.24 $2.04 Total Cost Breakeven $5.74 $5.17 $4.70 - + 10% Base 10% Price

Yield $4.95 $5.50 $6.05 Operating Cost Breakeven 47.3 42.6 38.7 Ownership Cost Breakeven 36.3 32.6 29.7 Total Cost Breakeven 83.5 75.2 68.3

Conflicting Market Information

$7.40

$7.60

$7.80

$8.00

$8.20

$8.40

$8.60

$8.80

Oct‐12 Nov‐12 Dec‐12 Jan‐13 Feb‐13 Mar‐13

Actual vs. Forecast Price 2012‐2013

Winter Wheat Price Low of October forecast Range High of October Price Range Forecast

$6.40

$6.60

$6.80

$7.00

$7.20

$7.40

$7.60

Oct‐13 Nov‐13 Dec‐13 Jan‐14 Feb‐14 Mar‐14

Actual vs. Forecast Price 2013‐2014

Winter Wheat Price Low of October forecast Range High of October Price Range Forecast

Developing a Grain Marketing Plan

Definition

• A grain marketing plan identifies a producer’s specific price objectives as the production and/or storage season progresses.

• It then identifies strategies available to achieve the price objectives.

Definition cont.

• While it may take several forms, it is generally most useful if it is written down, and reviewed relative to market conditions on a regular basis.

• A marketing plan must be flexible. A producer must be able to adapt to market conditions if it becomes clear that an earlier price objective is not likely to be achieved.

Four Major Factors Influence the Marketing Plan

• Personal feelings and attitudes about marketing.

• Financial needs of the business.• Seasonal price patterns.• Current price outlook.

Personal Attitude:

Speculator or Risk Manager

Speculator• Try for highest price of the

year.• Focus on day-to-day price

movement• Calculates money “lost” by not

selling at highest price.• Views prices as separate from

the business.• Planning horizon focused on

short term profits.

Risk Manager• Major goal is making a profit.• Focuses on survival and growth

of business.• Integrates marketing as a part of

the business.• Knows what price covers costs.• Planning horizon is long term

growth of business.• Does not dwell on “lost” prices.

Identifying Financial Objectives

• Identify risk bearing ability. This requires an accurate net worth statement.

– High net worth allows for a substantial loss without bankrupting the business.

– Small net worth requires careful consideration in absorbing risk.

• Identify costs of production. Include a charge for family living expenses.

• Identify acceptable return over production costs.

Identify Seasonal Price Patterns

• Identify Seasonality in Price.

• Identify Seasonality in local basis.

Examine Current Price Outlook

• Price outlook is a dominant force in many marketing plans. However, its importance is frequently exaggerated. Price forecasts tend to be quite poor as the planning horizon lengthens, and a portion of each year’s crop should be marketed based on financial considerations regardless of current outlook.

Market Plan DevelopmentStep 1

Futures Market• Hedge• Put Options• Call Options

Cash Market• Forward Cash

Contract• Basis Contract• Storage• Minimum Price

Contract• No Price Established• Hedge to Arrive

Market Plan DevelopmentStep 2

• Step 2 in the marketing plan development is to identify the specific marketing horizon(s).

• Pre-harvest• Harvest• Post-harvest

Market Plan DevelopmentStep 3

• The third step in developing a marketing plan is to segregate expected production into marketable units, and identify pricing objectives.

March Wheat Futures Prices

Result of Market Plan

• A road map is developed which lays out specific objectives you want to satisfy.

• If an objective is satisfied, you made an excellent marketing decision REGARDLESS of what happens to prices later.

• Establishes an informed criteria on which to base storage decisions.

• Identifies exactly how much speculation (risk) you are willing to tolerate.

What Should You Do?

Abnormally strong basis – get rid of cash price risk.

Futures prices in top third of historical range – manage futures price risk.

Strong basis and high futures prices – be very careful of betting very much on market outlook.