Carrying charges in the crop markets

Some producers in Alberta have questions about the price spread for crops between delivery months. Neil Blue, provincial crop market analyst with Alberta Agriculture and Forestry looks at its cause and how to take advantage of it.
Blue says that a spread between future month prices for crops with a futures market is particularly noticeable. “The price spread is most often one where prices are progressively higher in forward futures months within a crop year. When crossing over into a new crop year, the supply-demand situation may change so the spreads between months have a different interpretation.”

Sometimes that progressively higher price spread is termed a carrying charge market. Within a crop year delivery period, the amount of carrying charge is a measure of what the market is paying to store the crop from one period to the next.

“A strong carrying charge market - one where that price difference is large - is saying that we don’t really want that product near-term, but we will pay you to store it to deliver later on,” explains Blue. “A carrying charge market - or higher price going forward - should not be interpreted to mean that prices are expected to move higher in the future.”

“When the spread, or carrying charge, is low or maybe even the nearby crop price is higher than the deferred price, the market is saying, ‘we want that product right now.’ So, the spread between months of futures or cash prices is within a crop year is part of market analysis,” he adds.

The spread in prices is often measured against what the commercial costs of storage and interest are for the actual crop in a facility.

“That varies somewhat for each crop,” says Blue. “For canola, the commercial carrying charge is about $5.50 per tonne per month. The market seldom pays that much of a carrying charge, but some market analysts follow the ratio or percentage that the market is paying of that full carrying charge.”

“For example, on January 17, 2019, the futures spread between March and May canola was $8.50 per tonne. Compared to full commercial carrying charges of $5.50 per tonne per month - or $11 per tonne for that two-month period - it calculates to a price spread of just less than 80 per cent of full carry. Analysts watch for a change in that carrying charge percentage as a signal of change in market demand.”

Blue says that for producers to take advantage of the spread on price, by capturing that carrying charge in the futures or cash market, they have to lock it in. “That can be done with a deferred delivery contract, a futures sell position or by using an option strategy.”

“Again, the carrying charge does not necessarily mean that prices are expected to rise in the future. However, carrying charges can provide an opportunity to have the market pay a producer to store crop while waiting for the delivery period. That payment advantage can be greater than interest saved or earned by having the sale proceeds on hand earlier.”

As for using a crop payment advance while waiting for that delivery period, Blue says that is a good marketing strategy to consider. “That advance, of which the first $100,000 is interest free, is available from a few sources, including the Canadian Canola Growers Association and the Alberta Wheat Commission.”