Hemp Biomass Crop Insurance and Price Risk- How to forward sell with @PanXchange
Julier Lerner, Founder and CEO of PanXchange, Inc
On February 6th, 2020, the USDA released details of three types of crop insurance for US growers of industrial hemp. This is a terrific opportunity for hemp growers, but there are many questions on eligibility and two immediate challenges for the growers. First, the deadline to apply is March 16th (For WFRP, the deadline ranges from January 31st to March 15th).
The three types of insurance are:
- Multi-Peril Crop Insurance (MPCI) provides coverage against loss of yield
- Noninsured Crop Disaster Assistance Program (NAP) coverage protects against losses associated with lower yields, destroyed crops or prevented planting where no permanent federal crop insurance program is available.
- Whole-Farm Revenue Protection (WFRP) provides a risk management safety net for all commodities on the farm under one insurance policy and is available in all counties nationwide. This is not a new program, but hemp is now included in the coverage for 2020.
The option for hemp producers to access insurance policies when growing hemp in the 2020 season is a great development for the industry. The programs will give hemp producers the same tools to hedge against crop loss that is presently available to other US farmers. If applying for it were a top priority, farmers could easily make the deadline. However, all three types of insurance require the crops to have a sales contract for all of the insured hemp.
The obvious challenge is finding legitimate buyers for such a large quantity of hemp. As all growers know, with a dearth of commercial entities with the working capital to purchase biomass and capacity to process it, even locating buyers for the 2019 crop was difficult. Moreover, we’ve watched biomass prices fall from an old crop (2018) high of over $40 per pound in July to today’s price of $8 per pound and lower. This begs the question; at what price would buyers be comfortable committing to a forward purchase?
Forward contracting against an index (benchmark) has long since been the custom in mature commodity markets and we’re already seeing PanXchange customers negotiating the use of our pricing data for this purpose. It is the single, most efficient way for growers and buyers to address forward price risk while securing future transactions. Here’s a high-level example of how it works:
- A grower in Kentucky is seeking crop insurance and finds a processor who wants to ensure that she will commit 100,000 lbs in October, 2020. Of course, they cannot agree on what a fair price is for October delivery, so they agree to price the contract against the September PanXchange Kentucky biomass price when it’s released.
- However, the seller knows the buyer but A) is worried about credit risk and demands prepayment and B) believes her biomass typically sells at a $0.30/point premium to the PanXchange benchmark due to its extraordinary quality. Thankfully, the PanXchange benchmark is quoted in USD per percent CBD so we don’t have to worry whether the 2020 crop will come in at 7%, 10%, or somewhere in between.
- The Buyer agrees the quality is higher but A) will not commit to 100% prepayment this far in advance and B) agrees the biomass is superior but incurs significant costs getting the biomass to their facility since it’s much farther away from him than most other growers.
Here’s what they conclude:
Between the premium for high quality and the discount for extra transportation costs, they agree that a fair price for biomass delivered in October at the farmgate is the September PanXchange Kentucky biomass benchmark plus $0.10/percent CBD/pound. They also agree that the odds are good between the percent CBD and the September price that the contract will hold a value of at least $4.00/lb. The buyer agrees to a good faith pre-payment of 25% of this amount, payable upon signing the contract ($100,000).
The PanXchange Kentucky Biomass Benchmark for September 2020 is published at a value of $0.60/pct CBD/lb. The biomass has an 8% CBD content, so the contract value per pound is (0.60×8)+$0.10) or $4.90 per pound. Since the buyer has already paid $100,000, the total he now owes is $390,000.
Again, this is a high-level example on how to use PanXchange benchmarks to mitigate price risks in forward contracts. Please contact us if you have specific questions on how to implement this contract structure.