How Grain Trading Works After the Farmer

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Details: Category: Main Site Content; Created on Monday, 01 March 2021 16:03; Last Updated on Monday, 01 March 2021 16:03; Published on Monday, 01 March 2021 16:03; Written by Joe Schmidt; Hits: 3775

This Seems Inefficient

It can seem that way but it’s important to remember that the original seller of the grain, the farmer, may not want to sell the grain when an end user wants to buy it or vice versa. This means there needs to be risk takers and risk managers all trading grain between one another to make sure there is liquidity in the market every day for the farmer to sell when they are ready and for the buyer to be able to get product when they need it. This is why there are so many market participants involved with getting grain from here to there.

Some larger companies have tried to integrate several of these steps to increase efficiencies and improve profit margins, but it can still lead to inter-office trading or other outside integrated companies still trading with each other. The steps don’t change, but the number of players involved might.

The system still works because trading grain between multiple companies helps reduce risk, because no company wants all their trades with one country or one customer because of everything that can potentially go wrong. Credit issues or quality demands with customers can always develop. Freight spreads constantly change, while trains and trucks don’t always run on-time and vessels can get backed up at ports. Plus, demand changes over time too. This type of trading done once the grain has been sold off the farm is known as “arbitrage” and it’s the key to profitability and efficiency in the grain trading world.

The Market Is Always Looking for a Profit

If a trade could be done more profitably with fewer “middlemen” then it would. Every trader knows someone else is trying to cut them out of a trade to earn a little more, just like they are trying to cut someone else out. Farmers do this too by selling direct whenever they can. All this competition is what keeps the market as efficient as possible.

Since all grain goes through this complex trading system, it helps prevent someone from easily walking away from trades without causing financial strain. Similar to how difficult it is for farmers to walk away from trades without a penalty, each company in the trading chain usually can’t cancel without a cost. However, cancellations can occur when there is economic gain for all parties involved throughout the trading chain.

Futures Prices Aren’t a Factor in Cancellations

It may surprise some farmers, but once farmers sell their grain, futures are not really a factor for those in the trading chain. Instead, companies determine profitability of trades based on the basis and spreads off the futures market. As companies trade grain, they exchange futures positions with one another all the way through the system to minimize price risk beyond basis, spreads and transportation costs.

Traders Are Monitoring Global Freight Spreads and Basis Constantly to Maximize Profitability

Right now, South American corn delivered to different ports throughout Asia is nearly 50 cents cheaper than U.S. corn. While this lower price might mean that less corn will be bought from the U.S. going forward, it doesn’t automatically mean there will be cancellations.

Purchases and Sales Are Never Final – Back and Forth Trading Can Continue Until the Grain is Shipped

A trader who has already purchased corn from a U.S. port to be delivered to Asia may see they can now buy South American corn much cheaper. So, that trader may ask that U.S. corn seller what they would be willing to buy back their corn sale for. If this happens, and the price is right, it can create a domino effect throughout the entire chain of traders. Each then going back to see who is willing to buy the grain back and at what price.

As the trade works backward through the trading chain, each trader will look for the best-selling opportunities available. After all, it doesn’t matter where the grain is coming from (i.e., elevator, export facility, etc.), every trader is always looking to make a profit. Maybe another exporter has a strong bid or maybe a train scheduled from Nebraska to Washington could instead be rerouted and sold to Mexico.

First Rule of Business – Buy Low and Sell High

Despite all the middlemen involved in these trades, the market stays efficient because everyone is looking to “buy low and sell high,” even through its a cancellation process trade. This may mean traders will sell the grain all the way back to the company that originated the grain in the first place. For example, that elevator who originally sold the grain on a train may now see that a local ethanol plant is willing to buy for a higher price than what the export chain wants to sell it back to them at. The origin elevator could then buy back the train and move it to the local ethanol plant for a profit.

The Catch – The Cancellation Process Has a Price

No company in the chain will likely do this work for free though. Each company will probably want to make a profit on every trade transaction. And the more work it is, the more profit that is likely required. For example, changing the destination of one train to a different location is a lot quicker and easier than having to cancel that train and find 400 trucks to move the grain of that one train to an ethanol plant.

While traders will demand a profit to make a change, they can’t charge whatever they want. Instead, market competition for everyone involved determines the price and profitability at each step in the cancellation process. After all, it takes a lot of trucks to fill a train and a lot of trains to fill a vessel. Therefore, not all of a vessel’s grain will necessarily originate from the same Midwest elevator. It’s usually spread across many elevators in multiple states, which creates lots of competition.

In theory, farmers could be a part of the cancellation process too. A farmer could potentially make a little profit, if they were willing to tell their elevator that for the right price, they would haul their already sold grain to another location for a premium when the contracted shipment time comes around.

Cancellations Can Be Very Complex and Expensive

There can be up to 10 transactions involved with cancelling an export order if all transportation companies are considered in the trade. Which gets us back to the cost difference between South American and U.S. grain at 50 cents right now. For some trading chains, it might cost more than 50 cents per bushel to cancel a contract, but for others it might a lot less. This uncertainty can contribute to market price swings as no two trades are going to cancel out the same way.

Cancellations Can Quickly Have a Rippling Effect on The Market

If a large cancellation does happen, first there will be local basis pressure as traders try to find a home for sizable amounts of grain. Then the spreads between futures contracts will widen, because the market suddenly doesn’t need grain as badly or quickly. Both scenarios can then put pressure on the futures market.

While public reporting of cancellations is always a little bit after the fact, the market usually has already seen them through sudden domestic basis drops or transportation adjustments. That’s why there are often cancellation rumors when the futures market falls substantially, but then the market will quickly rebound if there aren’t any export confirmations within a few days.

Cancellations in Reverse

While the example above showed how a foreign buyer could cancel U.S. grain purchases, the opposite can happen too. If ethanol plants or the feed sector can’t procure enough corn, they can raise their basis bids high enough so elevators with grain sold for export can ask their buyers if they want to cancel their trades. If this happens, the request will then be sent through the export chain for consideration. This sometimes happens after a basis rally causes spreads between futures contracts to narrow and often leads to futures rallies.

The grain trading process after it leaves te farm is complex with many moving parts and players. And while cancellations can occur, they are more likely to happen when there are large imbalances in world prices. Supply and demand will always win out to make sure grain is moved to the area with the highest need and those willing to pay for it. It may seem inefficient; however, having so many different market participants creates a lot of competition, which in the end mitigates risk for everyone.