Price Risk Management for Canola
Producers in the Northern Plains
EB-74, November 2000
George Flaskerud,
Extension Crops Economist
and Professor,
Department of Agribusiness and Applied Economics
Bruce L. Dahl,
Research Scientist,
Department of Agribusiness and Applied Economics
William W. Wilson,
Professor,
Department of Agribusiness
and Applied Economics
Highlights
Price Risk Management for Canola Producers in the Northern Plains
Marketing Alternatives
Price Analysis
Comparison of Marketing Strategies
Market Planning
References
Appendix A. Managing Risk
Highlights
U.S. canola production is small compared to other countries, although it has grown rapidly in recent years. Production is concentrated in northern North Dakota.
Canola producers confront risk, even though canola often competes well economically with other crops. The objective of this study is to analyze price risk management strategies for canola growers in the Northern U.S. Plains.
Canola is not traded on a U.S. futures market but it is on the Winnipeg Commodity Exchange. The contract price is for a par region, which is an area around Saskatoon, Saskatchewan. Canola futures prices, which are in Canadian dollars per metric ton, are converted to U.S. dollars per hundredweight ($US/cwt.) in this publication. For an exchange rate of .674, a price quotation of $254 would convert to $7.77 in U.S. dollars per hundredweight ($254 times .674 divided by 22.046 = $7.77).
The expected price from hedging canola is the Winnipeg Commodity Exchange canola converted futures price adjusted by a typical basis, less brokerage fees and interest cost on the margin money held by the brokerage firm on the futures hedge. The transaction (fees and interest) cost may total $.07 per hundredweight for canola. For a price quotation of $7.77 in U.S. dollars per hundredweight and a basis of $1.00, the expected hedge price would be $6.70 ($7.77 less $1.00 and $.07).
Using the canola futures market to establish a hedge in a distant futures contract means that the hedge is subject to uncertainty about changes in the exchange rate. Analysis indicated that exchange rate variability is low over the usual life of a hedge, making the exchange rate inconsequential.
On-farm storage may be profitable. The profitability of storage is determined by selecting the month with the highest expected net price. This net price is derived by subtracting variable storage costs from an expected price for each month. The month with the highest net expected price is the month during which sales should be planned.
Prices and marketing strategies were analyzed using data gathered from several sources. The availability of price data for cash canola prices at Velva, North Dakota, limited the analysis to the 1993-2000 period.
Seasonal patterns for canola prices were examined for the marketing year, August to July. The pattern for Velva cash prices, on average, is to decline to lows in September and October and then increase to peaks in January and April. The pattern for nearby canola futures prices was similar. The history of the November contract indicates highs occurring in May with lows occurring in August, on average. In contrast, the May contract exhibits a pattern where highs occur in November and the lows in February, on average.
The Velva cash basis was derived relative to canola futures converted to $US/Cwt. The basis for the 1996-99 marketing years is summarized since a change in basing points for canola futures occurred in 1996 from Vancouver to the Saskatoon area. The cash basis after the change has a marketing year low that occurs in October and then increases throughout the remainder of the marketing year. The range of the basis is narrowest from January to April and is widest from May to October. The Velva cash basis was also derived relative to soybean futures and soybean oil futures.
Hedging of commodities relies on the relationship or correlation between futures and cash prices. The results strongly indicate that canola futures should be used to manage price risk rather than futures for soybeans, soybean oil or soybean meal.
A hedge ratio is the proportion of the futures position required to minimize risk associated with a cash position. Although traditionally hedges are 1:1, risk could be reduced further by using a hedge ratio of about .8 to .9. Risks could also be reduced further by adding positions in other contracts including foreign exchange and soybean oil. However, the added risk reduction potential of these is relatively small and would most likely be offset by the additional transaction costs required for the additional futures positions.
Preharvest and harvest/postharvest marketing strategies were analyzed. Caution must be exercised in generalizing about what might happen in the future based on the study since relatively few years were analyzed. A hedge ratio of 1:1 was used.
The preharvest futures hedging strategy was far superior to the other preharvest marketing strategies. Not only was the highest average price achieved but it was achieved with considerably less variability than from the cash sales at harvest strategy. The futures hedge also achieved the highest minimum and maximum prices of all the strategies.
Selective storage was the most profitable harvest/postharvest strategy. Storage was profitable during three of the six years analyzed. The challenge with selective storage is to determine which years to store and then when to sell. The net selling price must be calculated whenever futures prices and basis expectations significantly change until a sell signal is given. Even then, judgement must be exercised since the table of calculations is only a guide.
Development of a marketing plan is critical. Goals must first be evaluated. Other steps include evaluating the economic fundamentals of canola, the price needed to breakeven on production costs, the technical characteristics of the corresponding futures market, the establishment of price objectives, and a contingency plan. Marketing plans need to be reviewed and adjusted as new information becomes available. Ag Canada reports and USDA reports generally provide the basic information for updating the canola marketing plan. A marketing plan can be implemented using cash sales, elevator contracts, futures hedges and options. Making marketing decisions based on a marketing plan should improve marketing performance since farm management and marketing concepts will be the guide instead of emotions.
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Price Risk Management for Canola Producers in the Northern
Plains*
* This publication was produced with support from the Northern Canola Growers Association.
Background
U.S. canola production is small compared to that of other countries, although it has grown rapidly in recent years (Figure 1). Canada is one of the major producers of canola.
Figure 1.
Production of canola in the U.S. is concentrated in
North Dakota. During 1999, production in the state
totaled 10.855 million hundredweight (Figure 2), 80 percent of
U.S. production, according to North Dakota and
National Agricultural Statistics. Most of this growth occurred because of increased planted acres (Figure 3)
(canola yields have been relatively flat). The yield of canola
per harvested acre in North Dakota during 1991-99 (Figure
4) ranged from 1,180 pounds to 1,530 pounds and
averaged 1,347 pounds.
Figure 2.
Figure 3.
Figure 4.
The majority of production in North Dakota occurs in
the northern part of the state. The Northeast region of the
state produced the most in 1999 followed by the North
Central and Northwest regions.
Canola production has grown rapidly in North Dakota partly because the USDA Commodity Credit Corporation Loan program has made oilseeds more profitable than many other crops (Swenson). In addition, disease in small grains has made it imperative to include as much oilseed in Northern Plains crop rotations as possible.
Concentration of production in northern North Dakota has been facilitated by the location of a major processing plant at Velva. Another processing plant of about the same crushing capacity is located at Altona, Manitoba. Multi-seed crushing plants that crush canola are located at West Fargo and Enderlin, North Dakota and Culbertson, Montana. Canola is processed mainly for its oil.
Canola producers confront risk, even though canola often competes well economically with other crops. This publication focuses on managing the risk of marketing canola. Risk concepts are discussed in Appendix A.
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EB-74, November 2000
