Impact of Delayed Price Contracts on Corn Basis: A Conceptual Model and Case Study for an Ohio Local Market

Abstract

INTRODUCTIONStructural changes in grain markets, the lack of on-farm storage, increased farm price variability and the desire to separate the harvest delivery function from the pricing function have fostered the development and use of delayed price (DP) as a method of exchange in grain markets. Delayed price is a marketing agreement whereby the seller (often the farmer) delivers grain and passes title to the purchaser (often a grain elevator), but reserves the right to price grain at some future date [Wills]. The seller prices grain in some agreed-to future time period by accepting the buyer's price bid for cash grain sales in that future time period.Until the seller elects to price the grain, prices vary as new market equilibriums are established. The seller of DP grain accepts a "long" cash speculative position and earns speculative profits as price increases. Sellers enter into delayed price agreements when storage is in short supply and futures prices are forecast to increase or basis is expected to strengthen.In contrast, the buyer of DP grain accepts a "short" cash speculative position and earns speculative profits as price decreases. The buyer of DP grain minimizes futures price and basis risks associated with the speculative position by taking an offsetting long position in either the cash or futures market. Offsetting long cash market positions include storing grain, buying grain via a forward contract and -2 -selling grain via a DP contract. Offsetting long futures market positions include buying grain via a futures contract or a commodity option.All price and basis risks are eliminated when the elevator or buyer elects to offset the short DP acquisition with a long cash marketing position. Selecting a long futures position eliminates the price risk, but not the basis risk. In the latter case, the buyer must forecast basis movements in an attempt to earn an acceptable margin for performing the merchandizing function. Buyers minimize basis risk by charging the seller a DP service fee equaling the expected change in basis. Proponents of DP argue that the DP selling method improves grain merchandising operational efficiencies resulting in higher prices paid to farmers. The opponents argue that a local supply effect results in lower prices paid to farmers, and an unacceptable financial risk; the farmer is an unsecured creditor to the elevator until the gra~n is priced. These debates are contributing to the passage of state grain marketing legislation in Ohio, and other states to regulate DP contracts to better protect farmers and grain traders. Although the debate is intensifying and is circulating throughout the Midwest and South, the advantages and disadvantages of DP have been discussed only in the popular press and by legislators. To date, researchers have not examined the issues conceptually or empirically.This article develops a conceptual model to explain the economic effect of the DP selling method on prices paid to corn farmers by an elevator (the effect on local bases) and tests the theory using ...

Developing the Regulatory Environment for Competitive Agricultural Markets

“…This and other pricing strategies provide greater marketing flexibility and increased pricing flexibility but require safeguards against mismanagement and financial failure of the buyer. Baldwin et al (1987) found that delayed pricing strengthened the basis in 2 out of 4 years, with no significant change in the other 2 years. The delayed pricing technique has gained wide-spread acceptance with 28 percent of corn sales, 32 percent of soybean sales, and 26 percent of wheat sales, moving under a delayed price contract.…”