Canadian Wheat Board

Farmers

June/July 2006

The CWB Early Payment Option (EPO) provides producers with additional cash flow during the crop year upon delivery of their grain. The EPO also provides a floor price for the grade contracted, and participating farmers are eligible for further payments when pool returns exceed the payment value they have locked in.

EPO programs are offered on wheat, feed wheat, durum, Nos. 4 and 5 CWAD (feed durum), feed barley and selected barley, all with a minimum sigh up of 20 tonnes.

Cash flow is generated using the EPO by paying farmers a percentage of the Pool Return Outlook (PRO), less a discount, within 10 business days of delivery. The Early Payment Values (EPVs) are offered at 80, 90 and 100 per cent levels of the PRO for all programs.

The PRO is a point-in-time estimate of the final pool returns. It is determined using CWB sales forecasts, production trends in major grain growing regions and overall market trends. As the crop year progresses, the PRO estimates reflect final returns with more certainty due to CWB sales progress during the crop year.

Reference grades are used to determine the EPV, discounts and EPO payments for each of the programs offered.

EPO Programs for 2006-07:

Grain	Early Payment Value of PRO			Reference grade	Deliverable grades
	80%	90%	100%
Wheat	√	√	√	No. 1 CWRS 13.5	Nos. 1, 2 & 3 CWRS
				No. 1 CWHWS 13.5	Nos. 1, 2 & Nos. 3 CWHWS
				No. 1 CWES	Nos. 1 & 2 CWES
				No. 1 CPSR	Nos. 1 & 2 CPSR
				No. 1 CPSW	1 & 2 CPSW
				No. 1 CWRW	Nos. 1 & 2 CWRW
				No. 1 CWSWS	Nos. 1 & 2 CWSWS
Durum	√	√	√	No. 1 CWAD 13.0	Nos. 1, 2 & 3 CWAD
Designated barley	√	√	√	Standard Select	Spec. Select,
				Two-Row	Select & Stand.
				Standard Select	Select for Two-Row
				Six-Row	or Six-Row
Feed barley	√	√	√	No. 1 CW Barley	No. 1 & 2 CW
Feed wheat	√	√	√	CW Feed	No. 4 CWRS,
					No. 4 CWHWS,
					No. 3 CWSWS & Can. Feed
4 CW durum	√	√	√	No. 4 CWAD	No. 4 CWAD
Feed (5 CW) durum	√	√	√	No. 5 CWAD	No. 5 CWAD

Why does the EPO discount fluctuate?

At the time of EPO sign-up, producers lock in a discount that is associated with the EPV they chose. The discount covers the cost of the risk coverage, administration and time value of money resulting from issuing the earlier payment. Pricing schedules are available on the CWB Web site www.cwb.ca or by calling 1-800-ASK-4CWB.

Separate discounts are posted daily by grain for each EPV level. The higher EPV levels are more expensive and reflect the CWB's higher risk in guaranteeing the payment value. The CWB hedges this risk using a combination of futures, put options and completed sales.

Since the CWB uses both Canadian and U.S. futures exchange markets, the value of the Canadian dollar also affects the discount cost on a daily basis. Generally speaking, as the U.S. futures rise in value the costs to hedge the different EPO levels become less. Please refer to the chart below, "100 per cent EPO Discount vs. Minneapolis Spot Futures", for example the premium cost of a put option will be less in a rising futures market but become more expensive in a declining market and these changes are reflected in the daily discount cost.

The cost of the discount will also fluctuate throughout the crop year. Generally, the discount will tend to decrease in cost for each EPV level as the crop year progresses. By completing additional sales throughout the crop year the risk cost of the EPO discount is reduced as the pool return becomes more certain.

As the crop year progresses the EPO discount will tend to decrease. The difference between the PRO and Net EPV reflects the discount cost.

What amount of additional cash flow is generated using the EPO?

The EPO will generate an additional payment from the CWB within 10 business days of the producer receiving the initial payment for the grade and protein delivered. The additional EPO payment is calculated as the difference between the EPV and the initial payment for the reference grade of the class contracted less the cost of the discount.

Let's take an example of locking in an 80-per-cent EPV for 1 CWRS 13.5 and delivery of 2 CWRS 13.0 on September 14, 2006:

EPO additional payment = EPV - reference grade initial - discount + incremental payment

	$ per tonne	$ per bushel
EPV No. 1 CWRS 13.5	$156.80	$4.27
Initial of reference grade (No. 1 CWRS 13.5)	$133.60	$3.64
Discount	$0.75	$0.02
Incremental payment for delivery in September *	$0.00	$0.00
EPO additional payment	$22.45	$0.61

* EPO contracts offer an incremental payment to compensate farmers for grain delivered later in the crop year. The payment represents the time value of money to the farmer.

The producer deliveries 2 CWRS on September 14, 2006 and receives an initial payment of $122.00 per tonne. Freight and elevation costs need to be deducted to arrive at the farm gate price. Regardless of the grade and protein delivered (Nos. 1, 2 or 3) the producer will receive an EPO payment of $22.45 per tonne.

The producer is also eligible for CWB payments when pool payments exceed their EPV.

If the grade delivered is not the reference grade, producers are eligible for future CWB payments when initial payments for the grade delivered exceed the total gross EPO payment they have already received.

Total gross EPO payment = Initial payment of grade delivered + EPO
additional payment + EPO discount - incremental payment.

Total gross payment = $122.00 + $22.45 + $0.75 - $0.00 = $145.20.

Therefore, when the CWB initial payment for 2 CWRS 13.0 exceeds $145.20, the producer will start to receive pool payments.

Producers should establish the grade of their grain prior to entering EPO contract.To accommodate grading issues the producer can contact the CWB to assess transfer opportunities between milling and feed grade EPO programs. The EPV and discount costs will be reevaluated taking into consideration market risk premiums at the time of transfer and may result in higher or lower discount costs.

What should be considered to maximize EPO cash flow?

Producers should consider their delivery opportunity through CWB delivery calls prior to making EPO contract commitments. Making EPO commitments that match delivery opportunity will ensure maximum cash flow generation through the EPO contract. As sales are completed throughout the crop year, the initial payments are increased. When the initial payments are increased the lower percentage EPVs additional payment value is reduced.

The EPO contract is a pricing contract and is separate commitment from Guaranteed Delivery Contracts (GDC) and Series A, B and C delivery contracts. Farmers can sign multiple EPO contracts during the crop year to manage the cash flow available through the EPVs offered, considering their delivery opportunity and the discount costs.

In the chart below, illustrating the 2004-05 CWRS 80 per cent EPO level, the value of the EPO becomes zero as the initial price surpasses the Net EPV value. If deliveries continue to be placed against this 80 per cent EPO contract the farmer would still be responsible for the discount cost but not receive any additional payment.

As the initial price increases producers should consider utilizing the 90 and 100 per cent EPO levels to maximize payments and take advantage of generally lower discount cost later in the crop year.

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Farm Business Representatives are willing to meet with farmer groups to hold PPO workshops. As well, you can call 1-800-275-4292 for more information on the PPOs.