Taking steps to minimise grain market volatility

Grain markets have experienced huge volatility over the past eight months, so what can growers do to protect against such risks? Olivia Cooper takes a look



Arable farmers traditionally sell a proportion of their crop forward in a bid to iron out fluctuations in the market. But with current prices at historically high levels, should producers be selling more forward than usual – and what else can they do to maximise returns?


Selling forward always carries its own risks – some seasons it pays off; last year it did not. In a sharply rising market, growers had sold 50% of the crop before harvest, and about 90% by Christmas – a higher proportion than perhaps anticipated due to lower than expected yields. Since July last year, wheat prices have doubled, leaving those who entered the market early worse off than others who sold very little forward.


But that doesn’t mean farmers should be put off from selling their crops ahead for 2011, and even for the 2012 harvest, says Graham Redman, partner at the Andersons Centre. In fact, at current prices for 2011 almost all producers would be in profit before including the single payment. “People could quite easily be averaging £180/t for feed wheat – so everyone should be in the market by now.”


The traditional benchmark is to sell one-third by harvest, one-third at harvest and the remainder later on. “But I would expect to sell more earlier this year because the prices are so much higher.” And with harvest 2012 values similarly above efficient producers’ costs of production – if not by such a large margin – it may also be worth locking into 5-10% at today’s values.


But few farmers would sell blindly into a market without taking an educated guess, as to likely price trends. So what might the coming months or years hold? “Essentially, the high grain prices are being driven by maize rather than wheat,” says Mr Redman. “There is sufficient wheat in the world to meet requirements, but maize stocks are particularly tight, and this year’s crop hasn’t even been drilled yet.”


Whether farmers, particularly in the critical American mid-west, choose to plant maize or soyabeans, will therefore drive the market from April onwards. “Maize areas in the mid-west can swing by 20% – if they increase by that much it will be bearish for prices. That’s not to say cereal prices will collapse, but it’s something we need to keep a very close eye on.”


The swing from soya to maize, or vice versa, will clearly also impact on the oilseeds market. “Oilseed rape is a profitable crop for most farmers at the moment. The EU acreage seems to continue declining, but at the same time we are processing more and more for biofuels, so demand is very strong.” However, South American farmers are responding to continued Chinese demand with ever greater crops, so relatively minor changes to supply or demand could have a large impact on price.


At around the same time, winter crops in the Northern Hemisphere will emerge from dormancy, giving a clear indication of any winter losses. “Crop size, particularly in the former Soviet Union, will be enormously influential. However, with Russian exports currently banned, their internal price is not nearly as high as the rest of the world. That means their farmers are not as inclined to increase productivity, which could hold prices firm for another year.”


With such heavy influences on the market still to be seen, it is clear that volatility is here to stay. “An element of the current market is also being driven by commodity traders, who are not interested in bailing out at the peak, but at the point when they have made sufficient margin,” warns Mr Redman. “This means that the price can fall as rapidly as it has increased.”


But selling grain is only one way to manage risk. “Buying fertiliser could be a better hedge than selling grain. I can only think the price of fertiliser will go up as demand increases. Also, not many people are expecting oil prices to come down sharply in the near future.”


Taking steps to secure, as much as possible, the yield and quality of crops is equally important. When grain prices are low, producers tend to seek ways to cut input costs. But at today’s profitable levels they should try to maximise yields and quality by employing a full fungicide and fertiliser regime. “Your costs per hectare will be up, but costs per tonne should improve.”


Spreading the risk by planting different varieties and grades of cereal is another option, in case of losses. “Look at your rotation to make sure you’re getting the best from your land – and don’t forget to take extra care when keeping grain after harvest. Store management is as important as any marketing strategy.”


Those farmers producing premium products like milling wheat or malting barley should consider selling on a feed-plus contract. They should also agree quality specifications in advance, as well as fallback penalties for lower quality grain. This limits the risk of grain sold forward at high prices from being sharply discounted if quality is not up to the top specification. Testing everything before loading is also essential, to reduce the chances of lorry loads being rejected at the end destination.


Another option is to commit grain to a pool or tracker, operated by merchants with greater expertise in daily grain trading, says Giles Hanglin, head of agribusiness at Savills in the East of England. Although pools will never hit the top or bottom of the market, they, and trackers, are likely to find, or perhaps better, the average over the marketing period.


Farmers may also look into buying an option through their grain merchant. This used to be a cheap way to lock into a minimum price, while still being able to benefit from any rise in the market. However, since grain markets have become less predictable, the fees charged for options have soared, from about £3/t in 2007 to more than £20/t today.


“That means if you purchase an option to sell wheat at £150/t for November 2012, you would have effectively sold at £130/t after the cost of the option. The market is, therefore, going to have to rise by more than £20/t again just to break even.” However, for those who want to lock into a base price and still capitalise on rising markets, options are a relatively straightforward and transparent choice, if a little more costly than in the past.


“Volatility is now a long-term feature of the markets, and farmers need ways to manage it,” says Mr Hanglin. “Being able to produce an accurate budget based on real figures, instead of predicted ones, means producers can plan much better for the future. They can be more confident about forecast profit levels, and therefore better able to negotiate loans, rents and so on.”


Farmers can also protect their single payment against fluctuation in currency markets. “The single payment is converted from euros to pounds on 30 September each year. Since 2005, the Euro has strengthened from about 68p, to 86p last year – boosting the single payment by about one-quarter.


“Rather than accepting the rate on 30 September, farmers can approach their bank and set the exchange rate at a date of their choice.” At a cost of about 1% commission, producers can either lock into current exchange rates, or choose a minimum price option to fix a base in their single payment, allowing for uplift in value if rates later move in their favour, he adds.


“Risk management is not just about how you sell grain, it is about fixing costs of production and margins at a level you are happy with. Everyone has a different approach to risk, and with the wide range of products on offer, each farmer can make the right decisions for their business.”








Managing risk



• Sell more earlier this year


• Lock 5-10% of harvest 2012 at today’s values


• Buying fertiliser better hedge than selling grain


• More to lose by failing to secure premiums