Forward Contracts for Organic Farmers
Fact Sheet | Forward Contracts for Organic Farmers
WHAT ARE FORWARD CONTRACTS?
Farmers can make many types of agreements for selling their crops to grain buyers. Forward contracts are a type of contract with a grain buyer that allows a farmer to lock in a price in the present for shipment at a future date. In this way, a farmer can guarantee a price for a given volume of grain even before the seeds have been planted, assuming those seeds make it to harvest. Having a contract prior to harvest gives the farmer more certainty, because they have agreed to sell a certain amount of bushels or acreage to a buyer at a specific price.
HOW CAN FORWARD CONTRACTS HELP ORGANIC FARMERS?
Limited Storage
Some farmers cannot store all their harvested grain in their on-farm bins and need to make sure they can move a certain amount right at harvest time. A forward contract guarantees the farmer that they can sell grain at a set price at the time they need it sold.
Crop Insurance
When a farmer takes out insurance on a crop, has a covered loss, and makes a claim, the insurance provider will usually honor a forward-contracted price. This means that if the grain has a claim against it the insurance company will pay the farmer for their loss at the contracted price. Without a forward contract the insurance will reimburse at the commodity rate for that crop, which is often lower than the price in a forward contract.
Secure Budget
Sometimes a farmer identifies the price they need at a minimum to meet their budget. If a forward contract meets or exceeds that budgeted price, it may be beneficial for that farmer to lock in some or all of their crop, knowing they are making a good profit. This reduces risk, and peace of mind is certainly valuable.
Hedging
What if a farmer agrees to a forward contract, but months later when they harvest market prices are much higher? They will have to sell their grain at the lower forward-contracted price, and miss out on those higher prices. To avoid this, farmers often hedge against loss, by covering part of their harvest with a forward contract and playing the market with the other part. If the farmer locks in a part of their crop at a certain price, part of their income will be guaranteed. They can then wait and see the market conditions after harvest and try to capture higher prices if they exist. This hedging also provides some security if prices fall, then the farmer at least got a good price on the part of their crop for which they have a forward contract.
TERMS TO KNOW
Acreage Contracts
Acreage Contracts commit a certain amount of acres to the buyer, and the grower sells what that acreage produces. An acreage contract can be for part of the crop, a certain field, or 100% of the acres in a certain crop. There will usually be an estimated total for bushels or tonnage that is expected, but essentially the grower sells whatever is produced on the contracted acres.
Bushel Contracts
Bushel Contracts are more straightforward, and the grower commits a certain amount of bushels or tonnage of grain and is expected to deliver at a given time. While bushel contracts are more common on the spot market after harvest, they are also written as forward contracts.
Act of God Clauses
Act of God Clauses are common in forward contracts. In the event of crop loss or crop failure due to something outside of the grower’s control (such as weather, war, civil unrest). The grower’s loss is “forgiven” when it is proven by a third party. Act of God clauses do not cover poor farm management, such as weed problems. These exceptions are essential for forward contracts, but not all buyers provide them.
Right of First Refusal Clauses
Right of First Refusal Clauses give the forward contract buyer the first opportunity to buy any overage on a contract at the contracted price. Depending on the marketplace, the buyer will decide what’s in their best interest.
Freight On Board (FOB)
Both forward contracts and spot contracts will be written either as FOB or delivered. An FOB contract means that the freight costs are covered by the buyer, so that they will arrange the freight with a carrier of their choosing and will come and pick up the grain right at the farm. This is beneficial if the farmer doesn’t have their own transportation capabilities.
Delivered Contract
The contracted price includes delivery to a specific location, usually directly to an elevator. If the farmer has the ability to deliver grain themselves, this can be a good option, as it gives them more flexibility with loading and shipping and they control the process all the way to the unloading of the truck.
Spot Market
If farmers are selling their grain after harvest, they often sell through the spot market, which is the current market price. On-farm storage is important as farmers follow the market price and sell when they feel the price is right. Spot market contracts are usually straightforward and will include a specific price, volume, and shipment time frame.
PITFALLS
Comfort with the unknown
It’s hard to know where prices are going to be after harvest, or even a couple weeks out. The organic grain marketplace is constantly changing, so committing to a forward contract can be difficult for newer organic farmers who don’t know what to expect. Farmers and advisors can familiarize themselves with the marketplace and talk to buyers in order to understand the organic grain market from a wider perspective and get an idea of where things might go.
Weather
Committing a crop or acreage before harvest means that something needs to be produced. Weather plays a big role in producing a crop, and a farmer may be worried about commitments if they don’t get favorable weather. This is a big reason to include an Act of God clause in forward contracts. They can provide some peace of mind, knowing sellers are protected from some types of crop loss/failure.
ORGANIC GRAIN IS UNIQUE
Organic grain is shipped differently than conventional
Organic grain is shipped differently than conventional. Conventional crops are commodities, where one load of corn from Ohio is the same as a load from Minnesota, and they can be mixed, combined, and shipped as a single product. The infrastructure for organic is not built-out like conventional (elevators, processors, storage facilities, etc.). Organic elevators are sparse, but finding the right buyers can connect farmers to good markets. Because it is more scarce, organic grain is often shipped long distances and is not constrained by the local elevators that usually buy all of the conventional crop nearby. Organic grain can get picked up via truck in the midwest and go to either coast.
TAKE AWAY
Depending on a farmer’s rotation and location, there may be more or less local options for their organic crops. It is always worth knowing the options in the wider market to maximize the grain price.
Research reported in this publication was supported by The Organic Center and the Foundation for Food & Agriculture Research under award number TOCFFAR-EXT-002. The content of this publication is solely the responsibility of the authors and does not necessarily represent the official views of The Organic Center and the Foundation for Food & Agriculture Research.