Wednesday, August 31, 2011

Cash advance program needs to fit with the new market

First – to dispel a misunderstanding.  The Advance Payment Program (APP) is not a CWB program; it is a federal program offered under the Agricultural Marketing Programs Act.  The CWB is simply the administrator of the program for wheat, durum and barley.  Unfortunately, some producers think that they will lose cash advances on wheat once the single desk is gone.  That just isn’t true.

However, with the removal of the single desk, the economics of wheat, durum and barley marketing will change and it makes sense to take a hard look at the Advance Payments Program with the objective to ensure it fits well with the new market realities.

Features of the Advance Payment Program

The following points paraphrase the description of the program on its website. (Some editorial liberties were taken.)
  • The cash advance “rate” paid to producers is based on the average market price of the grain estimated by Agriculture Canada that will be payable to producers over the crop year.  The rate is limited to no more than 50% of the estimated value.
  • The maximum cash advance available to each producer is $400,000. The first $100,000 is interest free.
  • The “production period” for APP is 18 months and generally runs from April to September of the following year.  This means producers have a maximum of 18 months to repay their cash advance.
  • Producers repay cash advances as their grain is sold.  The advance program is repaid in full before the producer receives any payments for grain sold.

These features represent limitations to the program that should be looked into, to make the program work more effectively in a market environment in which producers can readily respond to true market signals.

In an unregulated market like canola (and as we expect to see in wheat), inter-month futures spreads and deferred pricing options are important and valuable market signals and tools for producers.  For example, at harvest time, canola producers are presented with spot prices (for immediate or nearby delivery) as well as prices for later delivery that are, at times, significantly higher than the spot price.   

These higher prices are the market’s way of telling producers that if they commit to a deferred sale, they will be paid to store their grain instead of delivering it right now.  But the need for cash flow at harvest has often kept farmers from taking advantage of deferred premiums as they are forced to sell on a spot basis.  Producers selling more canola than the system really wants leads to weaker harvest basis levels than would otherwise happen.

Many producers taking out an advance still need cash flow from spot sales at harvest.  Therefore, there are still more spot sales of cash crops made than the market really needs at that time.  We know this because of the large price differences between spot and deferred prices; these price differences are seen as very weak cash basis levels and wide inter-month futures spreads.

With the CWB single desk system, this is not an issue.  With the CWB, producers do not react to market signals to decide when to sell and deliver; it doesn’t matter when the producer actually delivers the grain, his net price is the same – the Initial Payment plus any Interim Payments and Final Payment.  In the new market, this will change.

Possible Solutions

Cash advances could be designed to enhance farmers’ ability to respond to market signals.  Often, deferred sales provide better returns than spot sales (carrying charges in the market); in this way, they pay producers to store grain.  If the cash advance was “tied” to the deferred sale, the value of the sale would be known and therefore, more of the value could be advanced to the producer; perhaps as much as 90% of the value (as opposed to 50% of the estimated crop value, as it is now).  Not only would this help with cash flow, it would encourage strategies that provide better returns for producers.

In addition, there are a number of financial tools emerging that could be used to insure the transaction, further supporting these types of strategies.

In the event that cash advances were tied to a deferred sale, when a spot sale is subsequently made, the producer would receive the total payment of that sale, as the advance would not need to be repaid until the deferred contract is delivered.  This too would lead to less grain being sold in the spot position to generate cash flow; unless, of course, the market signals indicated to sell more.

Going forward, as a general concept, cash advances should support the proper use of market signals.  Better yet, they should work hand-in-glove with the market and the signals it sends.
Advance Payment Program

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