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Handle the Upside’s Downside
By Charles Johnson
3/29/2008
By Charles Johnson, Farm Journal National Editor
Feeling nervous? You’re certainly not alone. This new era of record-setting commodity prices combined with skyrocketing inputs pushes risk higher for farms and ranches across the nation.
With so much upside potential for grain, the downside also looms large. For livestock producers facing profit-shattering feed costs, the downside is already all too real.
“You’d think with $5-plus corn, people would have a good attitude about the future. I’m finding the opposite, as they did not get the top price. It bothers me,” says Moe Russell, a risk management consultant in Panora, Iowa.
“There’s no question in my mind that these are great times it looks like we’re going to have. At the same time, there’s more risk, and I’m seeing more fear among farmers than at any time in the past nine or 10 years I’ve been in business,” says Jeff Hunt, a cash grain marketing adviser with Commodity Marketing Services in Owensboro, Ky.
Managing risk, which is always important, now becomes more crucial than ever. Crop insurance can put a floor on potential losses, making it a must-buy for many operators. Astute marketing, too, can help maximize market gains. Facing jaw-dropping rises in input costs, it makes sense to take steps to curb them, where possible, as well.
“The value of these crops is so high, you have to protect them. It’s very important to look at crop insurance this year. Look at it this way: In the past, we were insuring a Yugo. Now, we’re insuring a Jaguar,” says Corrine Alexander, a Purdue Extension ag economist.
Stoney Hargett, who farms near Alamo, Tenn., learned from past mistakes and signed up for crop revenue coverage (CRC) on all of his fields for 2008.
“You’re not going to find me backing off that. The biggest mistake I made last year, with all the changes we had in crops, was ending up with some fields not insured. With our weather problems that cost me more money than any other single thing,” Hargett says. “I look at not having crop insurance like taking insurance off the house because it hasn’t burned down yet. Crop insurance is what’s allowing me to sleep at night.”
Other crop insurance products may work better for some producers. The revenue assurance product puts no limits on how much harvest price can differ from the base price, as crop revenue coverage does, explains Gary Schnitkey, an Illinois Extension farm financial management specialist.
For corn this year, for example, CRC can increase or decrease $1.50 per bushel from a $5.40- per-bushel base. Using a computer modeling technique, Schnitkey puts odds at 30% that harvest price exceeds crop revenue coverage limits.
“In either case, CRC would have limits and would pay less than revenue assurance,” he says.
“If premiums are equal, I’d pick revenue assurance over CRC. This year, I wouldn’t say to pick the one with the lower premium. Be aware that there are those limits with CRC. If you do go with CRC, you might want to get a put option at $3.90 to pay for any price decline,” Schnitkey says.
County-based insurance products remain popular in many areas but may not be best for individual situations, says Steve Pitstick, who farms and sells crop insurance in Maple Park, Ill.
“Farmers could be at greater risk if they farm in one general spot because the county-based product is based on a county average,” he says. “You might be better off to get an individual policy if your farm is all together. It’s based on your yield history, rather than a county average. It’s not as simple as the county product but the risk to reward can be greater.”
Pitstick’s customers faced some initial sticker shock when they saw crop insurance premiums at $60 to $70 an acre this year. “The thing to remember is, you’re still paying 11 bu. to 12 bu. of corn for insurance, the same as when you had $2 corn. The cost is the same percentage of gross it has always been. What farmers are facing is double jeopardy. They’re handling twice as many dollars but can lose twice as much, too,” Pitstick adds.
Schnitkey and other economists say marketing plays a bigger role than ever in risk mitigation. “When prices go above the insurance guarantees, you might consider selling grain or buying put options,” he says.
“I’m advising grain farmers that they probably want to presell at least half their average harvest so they’re locking in the margin,” says William Lesser, a Cornell University ag economist. “Then you’re all right unless costs move up and price moves back down.”
That alone can cause sleepless nights, says Delton Gerloff, a University of Tennessee ag economist. Many farmers forward contracted last fall, he says, missing out on this winter’s surging market.
“Maybe they sold a little too quickly. Now the question is, how do they make up for that? It’s difficult to do,” Gerloff says.
“Whatever they choose, it’s going to be expensive. Options are higher priced. It’s hard to know when to make those marketing decisions now. It’s really tough to decide when to go in and capture some of these prices. The data indicate we could sure support the idea that these prices are going to continue for a while, but who really knows?”
In west Tennessee, Hargett says he’s trying several new marketing tools to help boost his average, particularly an innovative Cargill program.
“It’s tied to a contract and it makes no difference what the price is. There are no margin calls. I can still lose if the market goes down, but I’m not losing cash. It’s pretty exciting. I started wheat at $5 and added value to it and got up to a good price,” he says.
Watching inputs could be as important as anything you do, says John McKissick, a Georgia Extension ag economist. He recommends using forward contracts to lock in input costs. Already, some poultry farmers do it to nail down propane costs, he says.
Working with suppliers can help. Risk management consultant Russell suggests going to input suppliers and saying, “Here’s the deal: I am willing to commit to buying all my inputs from you. You need to know you are going to have a customer so you can manage your risk and I need a reliable supplier.” Russell believes there’s a 10% savings in that approach for both parties. He suggests using the tactic with seed, fertilizer and chemical dealers.
How Long Can It Last?
Expect high-priced corn for as long as a decade, says a just-released 10-year outlook projection from the Food and Agricultural Policy Research Institute (FAPRI).
Ethanol demand combined with livestock feeding and sustained exports should keep the price at least near current levels, say FAPRI economists. In addition, biodiesel mandates will push soy oil prices higher, increasing 1.28% to 3.60% each year.
Along with bioenergy mandates, high crude-oil prices will help keep ag commodity prices high during the period, says the report. FAPRI looks for world ethanol usage to hit 3.61 billion gallons a year by 2017. Ethanol price is pegged to fall during the next five years due to increased supply, than rise again to $1.52 per gallon by 2017. The price for biodiesel should almost double to $6 per gallon.
The report anticipates strong, growing economies in China, India and Vietnam and continued depreciation of the U.S. dollar.
World meat trade should increase along with per capita consumption, and the U.S. and Brazil will gain market share of meat exports, the report says.
FAPRI predicts biodiesel will drive soybean trade up by 17% to 32% during the decade, with the U.S., Brazil and Argentina accounting for 81% of world soybean production. Meanwhile, China will buy 57% of total world soybean exports by 2017/2018.
Click here to read bonus material from the story.
You can e-mail Charles Johnson at cjohnson@farmjournal.com.
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