As the season of fall harvest planning is upon us, let us take a moment to review the idea, and the reality, of the importance of having a grain flow plan.
Plan: (noun) – a method of achieving an end, a detailed program, an orderly arrangement of parts of an overall design or objective
We even have some simple and timeless quotes reminding us of the reality of plans.
"If you fail to plan, you are planning to fail." – Benjamin Franklin
"No plan survives contact with the enemy." – Field Marshall von Moltke
"Everybody has a plan until they get hit for the first time." – Mike Tyson
Perhaps for the grain elevator we can produce our own memorable one liner:
"No grain flow plan survives first contact with harvest."
Now, what if we even take another step back and start the season WITHOUT a grain flow plan? What really is the worst that could happen to the basis trader’s ability to merchandise grain?
Let us look at a few of the issues that come to mind for the seasoned merchant, and how the practice of planning can help mitigate them.
Paid too much for grain
Not in terms of cash price mind you (hey we’re happy when farmers can sell at or near record high price levels) but in terms of the buy basis. This usually happens one of two ways. First, bidding what seemed like a good conservative basis level for forward contracts months in advance ends up becoming less so by the time those bushels get delivered (looking at your freight and spreads). Second, not taking advantage of the time of high futures levels and letting the board do the heavy lifting for the cash price.
If you buy grain, you will likely be paying higher freight and interest costs this year, and your buy basis is the only thing you can control to cover those added costs. Know which bushels to chase and which to let go down the road. As my friend and colleague Tracy Henkel is apt to say, “you can’t merchandise your way out of paying too much.”
Failed to lock in favorable spreads
If there ever was a year wherein a “good” spread was completely subjective, this was it. While we all would hope to take advantage of carry spreads that pay at least 100% cost of interest, sometimes they simply aren’t available: so, then what? First off redefine what constitutes a “good” spread. If you’ve made a deferred sale, lock in the current spread. After all, you used that spread in figuring the margin before making the sale in the first place. Don’t fall into the trap of thinking the spread “has” to do anything.
For pre-spreading ahead of harvest, have a drop-dead date set for locking in carry spreads if your targets haven’t hit by then; don’t allow a few cents jeopardize your ability to merchandise profitably. For post-harvest don’t hesitate to lock in forward spreads as soon as you know you’ll need them. Waiting until roll day in this type of market environment likely isn’t a risk worth taking.
Didn’t sell enough bushels at that good level early on
If there is a common refrain across the grain industry regarding basis, it is “I didn’t sell enough!” The last couple of crop years have highlighted the necessity of both knowing your margin goals and being decisive once they are attainable. Perhaps the most important aspect of working out a pre-harvest grain flow plan, next to knowing how much grain you intend to handle, is knowing at what margin goal the grain will be sold. Developing a working understanding of your regional basis movement allows you to make informed decisions on selling, and this is done through a simple study of your basis history.
Likewise, developing a reliable history of how much grain you’ll be moving (and when) will give you the confidence needed to not only make a good sale, but to also sell a proper amount. Remember, the hardest thing to do in a flat or inverted market is to stay short the basis…especially at profitable levels. When judging whether or not to sell a particular basis value, the temptation is to ask, “if it’s gotten this high, how much higher can it go?” The more important question to ask is “what margin will selling this value give me, and how does it work with my anticipated grain flow?”
View selling basis values as a zone instead of a specific number, and always remember, just because you may have paid too high a basis for the grain doesn’t mean the sell basis has to (or even can) make up for the lost margin opportunity.
Your customer defaulted on their contract
Counterparty risk, while present each crop year, tends to be more profound and potentially more devastating during years with higher price volatility and flat/inverted spread levels. While you cannot control someone defaulting on a contract, there are steps you can take to help manage this risk. First and foremost is having meaning, regular communication with both your buyers and sellers. Get to know your customers’ operations and what’s is going on in your trade area. While this seems like a no-brainer, there are many merchants caught off guard when a producer shows up at harvest empty handed and unable to make good on the contract. As soon as you know there is a potential problem of contract fulfillment, act immediately.
Be familiar with how the mechanics of contract cancellation and contract rolling (both to another delivery period and another commodity) work and be prepared to have a potentially tough conversation with that producer. Ignoring these types of problems can only make them worse. While it may be tougher to discern if/when your buyer defaults on a sales contract, the same preparedness applies. Know what the options are for dealing with such a default, have a good grasp on replacement values, and understand what the NGFA trade rules have to say about remediation for such situations. Going into such a scenario with an idea of your Plan A, B and even C may not solve the issue, but it will at least give you the confidence needed to be decisive when that moment arrives.
Ran out of money
Perhaps the most important of all our worst-case scenarios, but certainly not the most difficult to manage. Many times, issues with lenders financing grain elevators can come down to a simple matter of communication and understanding. When markets are calm and supplies are ample, you may not feel the need to talk to your lender more than a few times all year, or them you. However, when the cost of forward contracting, maintaining hedges, and carrying company owned inventory goes up, so should the quality of conversations you’re having with your lender. Grain flow-based cash flow projections become not just necessary, but many times vital in allowing you as a merchandiser to do what the market is telling you to do.
Likewise, your lender having a good idea of what your credit needs could be during a sustained rally while carrying high priced inventory in the midst of difficult logistic conditions, all the while continuing to forward contract more grain, is paramount to minimizing any surprises during the marketing year. It goes without saying but having these conversations before such situations arise is always a good business practice.
Dwight Eisenhower may never have been a grain merchandiser, but his timeless quote certainly applies here: "Plans are worthless, but planning is everything."
Knowing your worst-case scenario is good but knowing how to mitigate your worst-case scenario is even better. Take precautions against the worst that could happen and open your merchandising up for the best that could happen.
-- Roger Gattis