Farmers who contracted to deliver a portion of this year’s crop at a specific price but can’t fill it because drought cut production have a problem.
Depending on the contract they are obliged to either find the equivalent grain elsewhere and deliver it, or pay the grain company what it costs to acquire the grain. Either way the farmer faces a potentially big bill — in some cases thousands of dollars — depending on how much grain they are short and the difference between the price they locked in and today’s price (see ‘How the numbers could add up‘ below).
But it’s also a problem for grain companies, because the grain they bought from farmers earlier has already been sold, says Wade Sobkowich, executive director of the Western Grain Elevator Association (WGEA), which represents Western Canada’s biggest grain companies.
However, farmers didn’t sell the whole crop, so contracts can be filled, albeit at a higher cost.
“There’s enough (uncontracted) grain out there to fulfil the export and domestic sales that have been entered into by the grain companies,” Sobkowich said. “It’s a matter of it settling out in the right place in a commercial and competitive environment at the right price.”
Why it matters: This year’s drought will cost Western Canada’s grain industry more than what was lost in yield.
Farmers who sold more grain than they produced face additional financial hardship as they struggle to find replacement grain or buy back their contracts. And grain companies, that had already sold that contracted grain, face losses if they can’t deliver or are forced to pay more to get replacement supplies.
The Keystone Agricultural Producers (KAP) wants farmers short on their contracts to talk to their buyers right away.
KAP is also asking grain companies to consider reducing “administration fees” related to adjusting unfulfilled contracts. KAP wrote the WGEA about the issue Aug. 10.
“We’re just asking for that consideration,” KAP general manager Brenna Mahoney said in an interview Sept. 7. “The marketing business is all about relationships. Those grain handlers know these farmers.
“It’s a commercial relationship. We are sensitive to that, but producers are going through a really tough time.
“This is a crisis and we need all parts of the value chain to evaluate their link to that farm and that producer and that producer’s viability.”
Sobkowich agrees farmers short on their contracts should immediately inform buyers.
The ‘administration fee’ KAP referred to “is probably an antiquated term,” Sobkowich said.
“In the past it has been used to dissuade a farmer from cancelling a contract if they had the grain and it has also been used for grain company costs above and beyond what the replacement value would be.”
When prices go higher than the contracted price there’s a financial incentive to try and get out of the contract to get the higher price. To prevent that a grain company might charge the farmer more than just the cost of acquiring replacement grain.
However, this year, because of the extraordinary decline in grain production due to drought, most WGEA-member companies, but not all, are only charging farmers, what it costs to replace the grain the farmer can’t deliver.
“This is not a cash grab situation,” Sobkowich said. “Every company out there wants the grain. They would rather have the grain than any replacement value because they need that grain in order to execute on the sale. So if the farmer has ways of sourcing that product outside of their farm that would make everybody happy, especially if the farmer is not happy with replacement value or the fee being set by the grain company. There are competitive alternatives potentially. And if the farmer can’t source the grain at a better price that speaks volumes about how the grain company is setting the value.”
As if resolving unfulfilled grain delivery contracts wasn’t complicated enough, competition between grain companies adds to it. An example is when a farmer has signed contracts with several different companies and has some grain, but not enough for all of them.
“Each one of those grain companies wants the grain and wants their competitor to offer the buyback,” Sobkowich explained. “What that means is they (companies) are not necessarily motivated to take a loss on the purchase because they want their competitor to take the loss so they can be the one to acquire the grain because the producer is obviously going to deliver the grain to the one that offers them the least sweet deal on the buyback.”
When grain companies can’t fulfil a contract they face contract extension fees. If the company can’t source the grain then they will default and forgo the revenue it would have otherwise earned.
Grain buyers are explaining to farmers why they need the grain they agreed to deliver, Sobkowich said. Given the extra costs some farmers are unhappy, he said.
“But regardless of how you slice it and how you add it up grain companies are trying to get replacement value so they can execute on their contacts and everything that goes along with it — preserving their reputation, supplying customers, keeping customers happy, avoiding contract extension penalties, avoiding contract defaults, keeping customers — all that stuff.”
How the numbers could add up
Here’s a simplified explanation of how the costs to farmers are calculated:
- Farmer Smith contracted to deliver to his local elevator 15 bushels an acre at $12 a bushel from 700 acres of canola. That delivery would earn $126,000 (15 bu./ac. X $12/bu. X 700 acres = $126,000).
- But Farmer Smith harvested 10 bushels an acre. When delivered it will earn $84,000 from the elevator (10 bu./ac. X $12/bu. X 700 acres = $84,000).
- However, Farmer Smith is short 5 bushels per acre on the contract. The elevator says it will cost $20 a bushel to buy the 3,500 bushels (5 bu./ac. X 700 acres). Farmer Smith didn’t deliver so therefore Farmer Smith owes the elevator $28,000 (5 bu./ac. X $8/bu. X 700 acres).
- The elevator company pays Farmer Smith $56,000 ($84,000 for what he delivered — $28,000 to buy from elsewhere the 3,500 bushels he agreed to deliver but couldn’t because of low yields).
- But Farmer Smith has crop insurance. His 10-year average canola yield is 38 bushels an acre. He has 80 per cent crop insurance coverage. That means a payout is triggered when his yield falls below 30 bushels an acre. Harvested 10 bushels an acre so the crop insurance payout will be based on 20 bushels an acre at the crop insurance value of $11.23 per bushel for a total payout of $157,220 (20 bu./ac. X $11.23/bu. X 700 acres = $157,220).
- When the crop insurance payout and elevator earnings are totalled Farmer Smith grossed $213,220 ($157,220 + $56,000 = $213,220) on 700 acres averaging $305 an acre.
Manitoba Agriculture and Resource Development in January 2021 estimated canola operating costs at $273.06 an acre and $412.57 an acre when land and equipment costs are included, allowing nothing for the farmer’s labour and living. In this example Farmer Smith is more than $100 short of breaking even.
Some contracts will be much more complex, including factors such as spring cash advances, which pays a farmer a portion of what they are expected to earn on the crop they have yet to produce. It’s a loan and the farmer repays it when the grain is delivered.
For more content related to drought management visit The Dry Times, where you can find a collection of stories from our family of publications as well as links to external resources to support your decisions through these difficult times.