The Cost of Forward Contracting Wheat

One of the basic principles of economics is that there is no such thing as a free lunch. In regard to forward contracting, we might expect the same. A farmer who forward contracts wheat is receiving a service. The farmer is protected from price risk. The grain company takes care of paperwork, default risk, futures commission, margin calls, and basis risk. However, the grain company also benefits because the grain company has a known source of grain at a known price. Thus, economic theory cannot say for certain that a farmer who always forward contracts will, on average, receive less than a farmer who always sells at harvest. Barkley and Schroeder derive a theoretical model of forward contracting with live cattle and argue that who pays the cost of forward contracting is an question. Therefore, this paper reports a study of Gulf forward basis bids for hard red winter wheat which sought to determine what on average a farmer is paying for the service of forward contracting.