Grain and oilseed prices for harvest 2011 have benefited from the recent steep rise in arable commodity markets.

Most variable costs are known and, despite recent fertiliser price rises, budgets for well-run arable farms should be showing a profit for the 2011 crop. Fuel remains the biggest outstanding variable in both price and use terms.

While very little is known about the fundamentals of next harvest, the wheat area is likely to rise. “At these price levels you would have to expect the world to plant more wheat,” says senior analyst Jack Watts at the HGCA.

“With the spot wheat market at £155/t and November 2011 at around £130/t, there is a danger that growers might find this disheartening. This should not stop them making proactive marketing decisions with the aim of minimising downside exposure and maximising upside opportunity.

“Exposure to 2011 market volatility begins at planting and, while farmers give a great deal of their time to yield management, they need to devote more time to price management,” says Mr Watts.

“To combat the threat of volatility, a pricing strategy is essential and should protect the business rather than be a speculative tool:

• Work out true cost of production – include all costs, not only direct costs

• Take account of cash-flow needs, especially input payment patterns which are are changing, to avoid forced sales

• Consider storage availability and the ability to preserve quality

• Include sensitivity analysis to changing prices, yields, interest rates, other costs

• Look at forward markets well in advance of planting, which can help hedge wheat prices against input purchases

• Monitor market information

The aim is to protect against downward market movements while keeping opportunities open to benefit from a rise in prices. Options allow this, but cost and management time is required.

“With volatility having caught out early sellers in some years, options are of increasing interest,” said Mr Watts.

For example, a grower could sell all his 2011 wheat forward now and take an option contract which would entitle him at a future date to buy wheat at the current futures price. The physical sale protects him from a drop in grain prices but the option allows him to benefit from a rise in the futures price. This type of option currently typically costs £15 – £20/t.

Those who consider options too expensive could employ a similar strategy but on only half of their crop, suggests Mr Watts.

An alternative is to sell nothing and buy another type of option, known as a put option at a price outside the current futures price range. This can be compared to “disaster insurance” to protect against big downward movements and at the same time allow gain from upward movements.

“It is a useful strategy in periods where markets are above costs of production and the farmer wants to cover costs as a worst-case scenario. No sales have been made so the upside opportunity remains. The cost of this option is lower but you have to wait for the market to fall before it can be exercised.”

On the back of greater farmer interest in forward sales of the 2011 harvest, grain trader Gleadell has opened its 2011 pool a month early and sold around 20% of the grain already committed.

“It’s relatively early days and we don’t know what wheat price will be like next harvest. The experience of a big price one year and a collapse the next makes it prudent to lock something in,” says managing director David Sheppard.

“Grain prices for next year are pretty attractive, we’ve advised growers to book something, even if it’s only 10 to 20%. High prices often make people veer away from pools but the appetite has been greater for 2011.”

Minimum price contracts are also on offer. These give growers the benefit of further price rises after grain is sold but, with wheat at £130/t ex-farm for next November, growers would rather take a normal forward price than take off the £17-20/t cost of the option which backs this type of contract, says Mr Sheppard.

Robert Kilby is responsible for grain marketing policy for farm management company Sentry’s annual production of almost 100,000t and has taken advantage of minimum/maximum price contracts on wheat and locked into minimum prices for malting barley.

“We normally feel pre-drilling grain prices are generally some of the best values around in the year, although there are some obvious exceptions,” said Mr Kilby. “We are usually about 20% sold by the end of September for the forthcoming harvest but this year it is likely to be nearer 30 to 35% at around £130/t for November 2011 as an average for feed wheat.

“We have also been locking in malting barley contracts at £130-150/t for harvest movement and around 10% of oilseed rape. We feel these are good values at present, setting a solid base to work from.

“Our strategy is to sell on our known net margins, locking in 5% more on each significant rise, protecting our landowners’ bottom line. As we know our costs for seed, fertiliser (95% bought) and spray, we more or less know our net cost per tonne on budgeted yields. Fuel is our only significant variable.

“The prices we have achieved give us a return in the region of 30% against known input costs. We may well see prices continue to rise in the short term but our strategy is risk management, not trying to second-guess the top of the market. If the world produces a big wheat crop next year we could well see next year’s values fall significantly. We have sold 5% of our 2012 wheat as well.”

While expecting wheat area to rise for 2011, Ben Mackowiecki of Savills’ Cambridge office does not forsee a big change. He thinks that firmer prices across most commodities will encourage a slight rise in all combinable crops, with growers sticking broadly to their rotations.

About 20-25% of 2011 grain has been sold by a sample of Savills consultants, although individually they have sold anywhere from 5% to 50%. Most of their nitrogen has been bought and about 50% of P and K.

Mr Mackowiecki suggests continuing to sell 2011 wheat little and often, keeping an eye on forward prices, not just futures, and getting several up to date quotes.

“A wait-and-see strategy on the majority of the crop is not a sensible option this year. There are some good malting barley contracts available at up to £160/t which potentially gives excellent returns for good-quality crops.”

He cautions growers to carefully calculate costs of production including accounting for differences in soil types. “Each farm should be treated individually, using its own figures. Many budgets show a good return at current commodity prices, but it would be a very different picture if prices returned to those of a few months ago.

“With the wheat price having gone from £95 to £150/t, home saved seed will have increased by at least 30%, and bought seed has probably gone up 15-20%.”

The day you go in with the combine you’re already halfway through the marketing year for that crop. If you have sold nothing then it’s as if you have taken the position that you expect prices to rise, says Anderson’s Graham Redman, who compiles the John Nix Pocketbook.

Although 2011 prices are firmer than many would have expected, it is still crucial to be realistic in budgeting and calculating costs of production so that growers can arrive at a target selling price, he says:

• Be realistic

• If grain price reaches your target, do something about it rather than hoping it will continue to rise

• Remember to budget for storage and drying costs

• Allow for likely deductions

• Account for weighbridge charges, HGCA levy etc

• Remember cash flow is important

• Depreciate machinery in a method for management accounts (regardless of how the accountant does it)

• Compare performance with costings data from other farms, sources like Nix

• How necessary is expenditure – calculate opportunity cost, for example, of replacing a tractor – what else could that cash be used for?

• Work out costs of regular operations such as ploughing and examine alternative of a contractor or neighbour to do jobs either now or when the current tool needs replacing.