This Is What Is Wrong With the Way We Market Grain In This Country
When grain is contracted for a later (deferred) delivery at a fixed price, the grain elevator hedges those bushels in the futures market. That enables them to pay the farmer the contracted price when he delivers the grain at a later date.
For example, you do a December corn HTA at $4.40 on 50,000 bushels in June. When you deliver the corn in the fall, December corn is $3.60. The elevator sells your corn for $3.60 plus a mark-up to whomever. Where does the elevator get the other 80 cents to pay you $4.40 plus or minus the basis? That 80 cents comes from their hedge account where they sold December corn at $4.40 and offset that contract with a buy of December corn at $3.60 when they sold your cash corn.
What if corn is at $5.60 when you deliver the corn? The elevator pays you the HTA contract price of $4.40 plus or minus the basis and sells your corn for $5.60 plus markup. The elevator sells your physical corn for $1.20 more than they paid you and that $1.20 covers the $1.20 loss the elevator had in the HTA hedge. The elevator went short at $4.40 and lifted the hedge by buying December corn at $5.60 when it priced your cash corn.
As the price of corn rallied that $1.20 after the elevator went short at $4.40, every day the price of corn settled higher, the CBOT took that many pennies per bushel out of the elevator’s hedge account and put in the buyer’s account. The elevator had to maintain a cash balance for each bushel of the hedge (maintenance margin). So, between the time the HTA was initiated at $4.40 (short) and the delivery date when December corn was at $5.60, the elevator had to cover that $1.20 per bushel loss. On a 50,000 HTA, that would be $60,000!
Where does the elevator get $60,000 to fund their hedge account? Their lender and there is the problem.
Here is the rub: Lenders do not allow the elevator to use that delivery contract for 50,000 bushels as collateral for financing of the hedge. All lenders assume you farmers will not deliver one bushel of grain on your delivery contracts!
The hedge line credit of any elevator is determined by their net worth of hard assets and cash, excluding the cash grain delivery contract as an asset!
If your elevator business has $80 million in assets and $30 million in liabilities when they apply for a hedge line of credit, the maximum the lender will allow for margin calls is $50 million less liquidation fees and most likely, minus some lesser amount to have a cushion.
Let’s say by July, the elevator has 20 million bushels of corn on the books.
In 2012, December corn rallied from $5.10 the first of July to $8.13 by mid-August. Every elevator and farmer who was short as of the first of July had to meet margin calls of $3.03 per bushel in just 45 days! If the elevator was short 20 million bushels, they needed $60 million in cash, cold hard cash.
Their lender will not allow one cent of collateral on any of those 20 million bushels the elevator has contracted for delivery (worth $8 per bushel in August 20012) which have accumulated $60 million in value because when the farmers deliver that corn, they elevators will be selling that corn in the cash market for $8.13 plus or minus the basis!
In all my 38 years, I have never known one farmer to not honor his grain delivery contract except when the elevators changed the contract terms in 1995 and 1996.
Until lenders allow collateral credit for the cash value of the grain contracted for delivery, every year every elevator is in danger of running out of margin money, which will require them to breach their delivery contracts with farmers.
All that hell of the 1995-96 HTA debacle, which tore many communities apart, would have been avoided if lenders would have simply allowed a collateral value for the contracted grain held by the elevators. Many merchandisers during those years would not allow nor except any new contract sales by farmers at any price because the merchandisers were afraid of running out of money to pay margin calls. Some farmers offered to accept a contract price 50 cents under the market if the elevator would accept the farmer’s sales contract.
Until lenders change their policy, every year has the potential to be crisis for agriculture if the weather is bad anywhere in a major grain producing area of the world.
Is it possible for Cargill, mighty Cargill, to run out of margin money? Absolutely! Just watch what happens when corn gets to $15 a bushel, wheat goes to $25 and beans go to $30. That can’t happen, you say?
What would happen to bean prices if the Brazilian economy collapsed and the government was destroyed by civil war across the land similar what happen in USA in 1861? As well as all of Europe in 1914? Suddenly, the world would have half as many beans. How high would beans go? $30 would be cheap beans if that happened.
Venezuela in 2020 was a financial world power-house based upon their stable government and crude oil production. They were a prominent member of Organization of the Petroleum Exporting Countries (OPEC). Since 2016, Venezuela grocery stores can’t even keep bread on the shelves and its citizens are fleeing the country! I am sure vast resources of crude oil is a more stable money source than having to plant soybeans every year, as Brazil does, and hope the weather is decent.
Outside of Ronald Reagan and Margaret Thatcher, who would have thought in the 1980’s the mighty Soviet Union would have died in 1990?
Now, consider this, in 2008, spring wheat futures hit $25!
Yes, Cargill can run out of money. But if they do, it will be the least of our worries.
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