The Cost of Forward Contracting in Mississippi River Barge Freight and CIF NOLA Markets

Grain elevators often use paper markets to mitigate the risk of (or hedge) their cash grain positions, as well as establish a profit margin through basis trading. Typically, merchandisers use futures or forward contracts to perform these transactions. However, in order to liquidate a cash grain position, grain transportation must be arranged in order to deliver the grain to the buyer. For elevators located along the Mississippi River system selling to Gulf export elevators in New Orleans, that mode of grain transportation is most likely river barge. Contracts for barges are bought and sold by grain merchants either directly with barge lines or through private brokers, and barge contract freight rates fluctuate daily based on supply and demand. Many elevators attempt to mitigate barge freight price risk by forward contracting barges. Unlike typical forward contracts, however, these barge contracts are for the purchase of a service, grain transportation, rather than a commodity such as the grain itself. The question that this study seeks to answer is whether a systematic pricing bias exists in this market that creates a forward contracting cost to either party (buyers or sellers). Results show that a cost of forward contracting barge freight exists at three months out, but the magnitude and the party incurring the cost varies by season.An additional important price discovery and risk management “paper market” also exists in the form of CIF NOLA (cost of insurance and freight, to port of New Orleans) basis bids, traded through brokers. These bids function similar to traditional forward contracts, however, like a futures market, firms can offset their forward contractual obligations by offsetting positions in a liquid off-exchange paper market. Analysis shows that this liquidity, coupled with a good institutional balance of long and short market participants mostly removes the pricing bias commonly found in forward contracting in corn and soybeans, although a small risk premium still exists in wheat and especially sorghum.