MI Prospects
Five pricing strategies put to the test for the 2015 wheat crop (Part 1)
‘Post-Planting Averager’, ‘Four Thirds’, and the ‘End of Season Speculator’ are some of the strategies being simulated for the 2015 wheat crop. The diverse strategies have been designed to explore several different approaches to risk management, including; call options and forward selling, as well as targeting average prices post-planting and post-harvest.
Anna Lockwood, Market Specialists team
[email protected], 02476 478698
Introduction
This is the first article in a new series exploring five pricing strategies for the 2015 wheat crop, and the different approaches will be closely followed from planting through to the end of the marketing season – June 2016. The aim is to evaluate the performance of the different approaches and demonstrate how more technical approaches work.
The range of strategies highlights the fact that there is no ‘one size fits all’ approach when it comes to grain marketing. The choice and approach to risk management can vary largely between businesses, and should be designed around each individual enterprise. When devising a risk management approach it is also important to take into consideration individual cash flow and storage constraints.
Formulaic approach
The sale dates in each of the strategies for each lorry load have been pre-determined in order to demonstrate complete transparency. Although this approach has been taken in the exercise, in reality strategies need to be designed to be able react to the ever evolving market using the latest information. AHDB/HGCA’s Grain Market Daily has been designed especially for this purpose, providing daily market information, insight and analysis so that you can keep pace with the most relevant headlines and trends in the industry (click here to subscribe).
Key assumptions
This demonstration does not relate to a particular farming enterprise, and therefore, it is necessary to make some core assumptions. For the purpose of this exercise it has been assumed that:
- 250ha of feed wheat has been grown (equally as 1st and 2nd wheat)
- A yield of 7.70t/ha is expected – based on the previous UK five year average and will be overwritten by the actual yield once published by Defra in October 2015
- A production forecast of 1,925t has been calculated, which equates to 66 lorry loads (1 load = 29t)
- Each strategy is required to move at least 10 loads at harvest to mimic cash flow/storage constraints faced by many businesses
A full description of the assumptions used during this exercise can be found by clicking here.
No such thing as ‘average costs’
In this exercise, unlike previous risk management demonstrations, we have not taken into consideration any anecdotal costs in the key assumptions. The reason for omitting costs from the assumptions is because there is no real average cost when it comes to the national picture, due to the sheer level of variation that exists from business to business. Instead, farmers are urged to explore their individual costs of production and use this to inform individual pricing strategies.
The strategies
Post-Harvest Averager
The post-harvest average strategy is akin to a ‘do nothing’ type of strategy, which carries maximum risk (if global production is strong), but maximum reward should weather impact global production. Sales will be made in August-15 (10 loads), from September-15 – February-16 (6 loads per month), and from March-16 to Jun-16 (5 loads per month).
Post-Planting Averager
The post-planting average takes a similar approach as the post-harvest average, but spreads sales over the growing as well as storage period. Loads are sold every month of the marketing period with 10 loads sold in Oct-14, and 2-3 loads sold each month thereafter through to Jun-16.
Cautiously Forward
This strategy takes a cautious approach to forward selling with less than a third of the crop sold pre-harvest, and the remainder sold in the post harvest period.
Four Thirds
The four thirds strategy allows two-thirds of the crop to be sold very early on, in October-14 (22 loads) and November-14 (22 loads). To cover this aggressive approach to forward selling, a Nov-15 UK feed wheat Call option for 600t was purchased on 17 October. The option premium was estimated to be £8.20/t with a strike price of £137/t. The strike price of the Call option was around £5/t ‘out-the-money’ to reduce the cost.
End of Season Speculator
This strategy takes advantage of a Put option, and sales at the end of the 2015/16 marketing season. The Put option is purchased on the May-16 Paris wheat futures market at a premium of £7.86/t with a strike price of €176/t (c€11/t out-the-money). Sales of the crop will be made in June-15 (10 loads) and March to June-16 (14 loads per month).
This should be seen as a bit of a wild card strategy on two fronts:
- The bulk of sales happen at the end of the marketing season – essentially speculating on an end of season shortage of grain.
- The use of a Paris wheat option rather than one from the London futures market essentially reflects the limited liquidity in the London market. This could be seen as a more risky move as the current French quality issues have cast doubt over what the Paris futures currently represent, and so the correlation to UK physical prices. As a result, caution is advised when approaching this type of strategy.
Future updates
A strategy update will be published via Prospects on 16 December. Please also keep an eye on the Grain Market Daily (subscribe here) for updates to see how the strategies are faring in particular market conditions.
Throughout the demonstration we are also going to be taking a look at stress tests for particular strategies, analysis of the price components, as well as exposure analysis. If you have any particular questions or would like further detail on any of the strategies, please contact [email protected].
Key points:
- Five diverse pricing strategies on test
- 66 loads of 2015 feed wheat to market
- Regular updates via Prospects and Grain Market Daily