Grain companies can still see profitability in a tough economic environment.
With harvest 2022 behind us, the commercial grain industry is once again faced with a year of very little to no-carry in the futures market.
Commercial grain companies use carry in the market to compensate for carrying grain. Therefore, years like the past year are met with small profitability expectations from many boards of directors, general managers and grain merchandisers.
I have seen firsthand, however, many commercial grain companies with record profitability in years of flat and inverted markets. What common practices do these companies use to spur their success in these types of years?
Profitable companies are masters of the noise
Thirty years ago, finding out more information was difficult and those who could get the most information could win. Information, however, has lost its premium over the years. There is no lack of availability of any type of information. Therefore, the ones who can filter out the most noise and get only the info they need are the winners today.
A year of no-carry is a year of tight demand, limited supply, logistic issues and even global unrest. Just because something is interesting doesn’t mean it is necessary to your commercial grain trading objectives. Focus on what you need to know to execute the job and don’t let emotion or anxiety get the best of you.
Profitable companies understand what the spreads are saying
The structure of the market communicates to a merchandiser whether they should be carrying cash or carrying grain.
Flat and inverted spreads mean that selling and shipping sooner than normal is generally the best course of action (carrying money). Trying to fight spreads in hopes of higher basis later in years like this has been a destroyer of working capital to many grain companies. Often, any higher basis you may sell is more than offset by the combination of inverses and interest costs it takes to get there.
Of course, many businesses don’t have the luxury logistically to just move all their grain early. That doesn’t mean sales can’t be made early for future delivery periods that can still lock in good margins before they are eroded over time with possibly worsening inversions.
Profitable companies stay out of the spot market
In times of volatility and tight supplies, the reactive merchandiser can get steamrolled. Planning and getting sales and purchases as far in advance as possible leaves an opportunity for margin. Refusing to be decisive, however, and just reacting as farmers sell in the spot market will likely mean little to no margin remaining.
The successful grain companies in these years are proactive on both sides of the bushel. They are in constant communication with end users about how and when to meet their needs and negotiating well into the deferred slots.
Tight supply years make buyers nervous and giving them coverage in times they are worried about supply can be very helpful to both parties. Successful grain companies also put great effort into helping their producers plan to make sales and encourage them to have in cash price offers at all times and for all delivery slots.
This helps the grain company plan for logistics and basis opportunity. In addition to capturing more margin than operating in the spot market, grain companies that do a good job operating this way reduce stress levels for all parties and build stronger trust and relationships with them at the same time.
Profitable companies keep their positions tight
In volatile markets, the little things can become very big things quickly. If you get loose with your position management, good margins can become negative margins overnight.
Successful merchandisers are constantly on top of both their price risk position and their spread risk. An iron clad risk management policy with multiple checks throughout the day can be a great way to be sure your price risk is always hedged.
Managing the spread risk isn’t always perfect, but the successful merchandisers are able to protect themselves. The simplest way to manage spreads is to always match up basis purchases and sales as soon as they are done. The spread structure at the time the sale is made is part of what makes the sale good, so locking in that spread when you make the sale eliminates the chance of losing your margin.
Another method of successful spread management in a year like this is to move short futures to the deferred months where delivery will likely occur and keep long futures in the nearby.
The general principle here is that in years like these, we aren’t typically going to gain a lot of carry in the market, but there is a substantial risk of a larger inverse. While no one wants to move short futures out with no-carry or at an inverse, if logistics dictate you will have to carry the grain that long, the folks that typically come out best are the ones who do it sooner rather than later.
Profitable companies keep it simple
This approach might be the most important ingredient to success as a merchandiser in any year. When you get right down to it, keeping it simple will help you execute in all the areas listed.
A wise man once said, “People try to make life too complicated. And if you don't uncomplicate it, you never get any place.”
Focus on what your business is. Make decisions as simple as you can make them. Lock-in margins when they are available.
Nobody is going to be perfect, so don’t dwell on the last decision. Go on to the next bushel and make another decision.
Sherry Lorton : May 23, 2014