HTA Contracts Takes Money Out of Merchandisers’ Pockets and Puts It In Farmers’ Pockets
This essay demonstrates the value of Hedge to Arrive contracts, basis and the importance of separating the day the basis is set from the day you lock-in the futures. It also explains why farmers will greatly profit from understanding how futures and cash grain marketing are intertwined.
The names have been changed to protect the guilty.
By 1990, Hedge To Arrive (HTA) contracts had become a standard marketing tool offered by grain elevators in Ohio. I had been heavily promoting HTA contracts since December 1984 to put the basis appreciation in the farmers’ pockets, which meant, of course, those cents per bushel were coming out of the elevators’ pocket. Most grain merchandisers hated HTA contracts, but competition from those merchandisers who saw HTA contracts as a tool to attract grain required reluctant merchandisers to offer HTA contract to maintain their market share of grain procurement.
Chris fed-out a hundred head black cattle each winter and grew about 110,000 bushels of corn each year to go with 40,000 bushels of beans. Chris usually grew some wheat, primarily for straw, which he always had a two year supply of straw on-hand so if fall weather was wet, he could skip a year of wheat production.
Chris’s farm consisted of deep, black soil underlain with clay. If not tiled, 3 out of 4 years, yields were well below the state average. If tiled, as Chris’s land was, yields were consistently above the state average. Chris’s area got two rains in April and May that most farmers in his area did not receive. Consequently, Chris started planting corn in 1990 a full two weeks later than most of his area’s residents. None-the-less, he was done with corn on Memorial Day. Most of the corn in the surrounding 40 miles was already in the 2 or 3 leaf stage.
Chris had been a client of mine for six years. He had a low-key personality, but that did not mean his work ethic was low-key. He worked hard, cared deeply for his wife and four children and was an active member of the community for most events associated to promote the community and its youth. Chris was always busy with his farm or with his wife and kids. The six of them could be expected at every community event except at planting and harvest time. They were simply really fine people; the kind of people which are the back-bone of America.
Despite the late planting, by late July, Chris’s corn was obviously going to be one of the better crops Chris had ever raised. Normally, Chris would have about 25,000 more bushels of corn than he could store, but, in 1990, he was sure he was going to have 40,000 bushels he would not have room to store on the farm. In Chris’s part of Ohio, basis for fall delivery needed to be set no later than the first week of August before it started weakening going into harvest.
Chris and I were discussing that topic the first day or two of August 1990. Given his hybrid maturities and planting date, we agreed that his harvest was going to start 14 to 20 days later than almost everyone in the area. I told Chris that I expected fall basis to be at its weakest about the time he started harvest, but by the time his harvest was half done, basis would be firming as the area’s corn harvest would be winding down.
Basis is the difference between local cash price and the futures price. Basis is a function of local supply and demand whereas the futures price is a function of world supply and demand. The magnitude of the basis is largely determined by the cost of transportation to get surplus grain out of a community into the world market place or the cost to transport grain from the world market place into a community if that community did not produce enough grain to meet local demand.
Corn basis during harvest in a normal year in Eastern South Dakota can be as much as 80 cents to $1.20 under December futures whereas on the Delmarva Peninsula (East of Chesapeake Bay) where they feed 85 to 100 million bushels of corn per year to poultry and raise precious little corn, fall delivery basis can range from +20 to +90 December corn.
In Chris’s area, fall delivery basis is usually 30 to 35 under the December futures, but in the first few days of August 1990, fall delivery basis was already 40 under because the corn crop was going to be larger than normal. Storage and transportation were going to be more expensive than normal. I confirmed that Chris was going to fill his bins before he took corn to town. Therefore, I recommended Chris not set the basis in August on any fall delivery corn because:
1) the fall delivery basis was already weaker than normal
2) I expected the basis to be firming by the time Chris needed to take corn to town
Chris agreed and he went into the fall harvest period butt-naked on the basis. Chris had priced 90,000 bushels on a December HTA at $2.86 at the local coop just before the July 4th holiday. The HTA contract specifically stated Chris could fix (set) the basis in 5,000 bushel increments, which was a stipulation I had insisted upon for all the HTA contracts. Delivery of the corn was required before the next year’s harvest, but Chris could deliver any amount of those 90,000 HTA bushels from harvest of 1990 through August the next year.
By the first week of November 1990, the plan was coming together. The basis had weakened to -46 the 17th of October, but had already firmed to -40 by November first. The weather was great that fall and some folks were already done with corn. Clearly the harvest glut had already past in Chris’s area. Chris’s bins were going to be full by the 5th or 6th of November. I told Chris to not set the basis on anything until he had every wagon, truck and the hopper on his combine loaded to the gills and only then set basis on just 5,000 bushels, deliver those bushels and set basis on another 5,000 bushels until he had finished harvest. I was expecting the basis to firm through the balance of Chris’s harvest and, as usual, into the new year, which it did. By Thanksgiving, the basis was -20. Chris had about 10,000 more bushels to deliver. However, the plan went awry.
Chris called me about the 12th of November. He had called the grain merchandiser on the 6th to set the basis on 5,000 bushels, which was -38Z (38 under the December futures). On the 12th, Chris called the merchandiser to set the basis on another 5,000 bushels. The basis that day was 34 under the December (-34Z). Rick, the merchandiser, told Chris the basis was already set on 40,000 bushels at -038Z. Chris, not being the type of guy to accuse anyone of wrong-doing without collecting all the facts, Chris called me to ask if I had set the basis on 40,000 bushels, which, of course, I had not. He hurt my feelings a little bit to even think that was a possibility.
We decided Chris should call Rick and ask him who instructed him to set the basis on 40,000 bushels at -038Z. I wanted Rick to tell Chris the answer to that question. Chris seemed willing to accept he had made a mistake when talking to Rick about setting the basis on only 5,000 bushels or it was an innocent paperwork mistake. I knew it was a crook at work. The truth is Chris really did not want to know for sure and for certain Rick was cheating him, because his manhood would be tested. Chris hated controversy more than anything.
Rick more or less blew Chris off with, “Well, Chris, you had said you were going to deliver about 40,000 bushels by the time you finished harvest, so to save YOU time on the phone and paperwork for me, I set the basis on all
40,000 bushels. That way, YOU do not need to be concerned about it and can concentrate on getting your late harvest completed before it snows.”
Chris asked if Rick agreed the contract stated Chris could set basis in 5,000 bushels increments. Rick said he did not remember that being the case.
Chris said, “Rick, I have the contract right here in front of me signed by you and it states, ‘Basis can be set in 5,000 bushels increments at the discretion of the seller’”.
Rick said, “Oh, well, too late now. As YOU KNOW, Chris, once basis is set, it cannot be undone.”
Chris was not the kind of guy to argue with Rick. Instead, Chris called me and covered the substance of the conversation he had just concluded with Rick.
I told Chris, “Rick was lying because I was the one who insisted all my clients’ HTA contract that clause was in the HTA contract and I had to personally twist Rick’s arm to get him to do it.”
Chris was silent. I asked, “Is it OK if I go talk to Rick about your contracts?” He was reluctant. I explained to him that the basis that day was already -35Z, meaning Rick had already cost him 3 cents a bushels on 35,000 bushels which was $1,050 and it was surely going to cost him another thousand dollars and probably more than that.
Chris reluctantly agreed to let me talk to Rick about his contract.
Within the hour, I was sitting in front of Rick’s desk and explained why I was there. Rick cut me off and started into a 20 minute dissertation about how difficult it is being a grain merchandiser and gave examples of piles of BS using as much complex market lingo as possible he hoped would cause me to crawl out the door because I was intimidated by Rick’s “vastly superior” market knowledge.
I just sat there without expression the whole time, looking him in the eye as Rick became more agitated the longer he talked.
He finally paused to catch his breath and I jumped in with, “Rick, all of that has nothing to do with the fact that you intentionally cheated Chris out of several thousand dollars. You know it, I know it and Chris, who has been doing business with this coop for 20 years, knows it”.
Rick slapped both hands on the top of his desk as he jumped out of his $500 chair, which slammed against the wall. Rick yelled, “Roger! You don’t know how hard it is to make money merchandising grain! I work my ass off for these farmers and they have no idea how lucky they are this coop is here for them. Chris would have never had the possibility of these HTA contracts and the flexibility of an open basis if it was not for me! And Chris would have never understood any of this if you had not stuck your big nose into our business! You, Roger, are a constant pain in the ass!”
Rick was still standing. His face was so pink, it was almost red. Blood vessels in his throat looked like they were going to burst and squirt blood clear across the desk on me.
I said, “Ok, Rick, I think we understand each other’s position. Now, are you or are you not going to reverse the basis on the remaining 30,000 bushels so Chris can set the basis as he delivers the corn or do I tell Chris you knowingly cheated him out of more than $2,000, fully knowing you were in breach of the terms of the contract?”
“You tell him that! And you tell him if he has a problem with it, come tell me that to my face!”
I said, “Rest assured I will tell him exactly that! And, I will tell his Dad who was doing business with this coop long before you were born. And I will tell every farmer in this area I will ever talk to exactly the same thing for as long as I am alive.”
As I turned to walk out, Rick’s face was beet red.
As I expected, Chris did not say a word to Rick and I am sure he never told anyone else about it. When it was all said and done, I prepared a summary for Chris to determine exactly what Rick had cost him. It was an even $2,400.
Many grain merchandisers assume they can walk all over farmers. Certainly, not all merchandisers take advantage of farmers, but they know they can and many do just that primarily because farmers do not understand grain marketing.
Most farmers do not have the expertise to understand for certain in their own minds and even fewer understand grain marketing enough to dispute obvious cheats by their grain merchandiser. The second reason many merchandisers walk all over farmers is because they know farmers are unwilling to confront a crook even when they know the crook stole money from them. Farmers will take a gun to a guy stealing a $500 calf, but most farmers will say nothing when a merchandiser fleeces him for $6,000.
Separating the day the basis is set from the day futures is locked-in on just that 40,000 bushels of corn could have and should have made Chris $2,400.
Had Chris done a forward contract (locking-in the futures and the basis) for his normal 25,000 bushels of fall delivery corn, his forward contract price for fall delivery would have been $2.51 ($2.86 futures minus fall delivery basis of 35 cents = $2.51).
The day Chris did his HTA just before July 4th, the fall delivery basis was 35 under the December (-35Z).
Chris’s first 5,000 bushels delivered that fall was $2.48 ($2.86 futures minus basis of 38 cents = $2.48).
Had Rick not cheated Chris, the second 5,000 bushels would have been priced at $2.52 ($2.86 futures minus fall delivery basis of 34 cents = $2.52).
The third 5,000 bushel lot would have been priced at $2.56 ($2.86 futures minus basis of 30 cents = $2.56).
The fourth 5,000 bushel lot would have been priced at $2.60 ($2.86 futures minus basis of 26 cents = $2.60).
Etc., as the basis steadily firmed throughout November.
When Chris did the HTA in early July, he did not know he was going to have 15,000 bushels more than normal to deliver in the fall. Before HTA contracts were available, Chris would have done a 25,000 bushel forward contract at 35 under ($2.51 cash price –futures of $2.86 = -35) for fall delivery and 50,000 bushels for January and February delivery at $2.76 (20 under the March).