Manage Price Risk

By Barb Baylor Anderson
Progressive Farmer Contributing Editor

You've heard it before. One way to increase profitability is to do a better job of marketing. Yet, some farmers can't, won't or don't take the time to revisit their marketing efforts.

"The majority of farmers still struggle to adapt to financial and price risk management. It's more psychological than anything, because some farmers simply don't want to change the way they do things," said Steve Johnson, Iowa State University farm-management specialist. He leads three ag marketing clubs during the fall and winter months, plus four women-only grain marketing groups to drive discussions about using marketing tools and strategies.

"The price outlook is not the reason we meet. Farmers spend about 80% of marketing time on outlook and 20% on tools and strategies. It needs to be the other way around," he says.

While farmers seem to have a good handle on managing production risk, Johnson believes most don't manage finance and marketing risks as effectively.

"When it comes to limiting financial risks, for example, there is a benefit to not waiting until the last minute to buy crop inputs. You save money. But, we are in an environment of last-minute decisions. Good risk managers recognize this. They manage financial risk accordingly," he said.

Good risk managers also look to make better marketing decisions. "Production margins are tighter, and basis is wider than just a few years ago, but the basics of pricing commodities has not changed," Johnson said.

He offers 10 steps to help farmers effectively manage price risk.

1. Know Your Actual Cost of Production. Keeping good financial records is a must and can help you establish informed preharvest marketing strategies, manage costs and make sound financial decisions regarding capital expenditures.

2. Consider the Next 12 Months of Cash-Flow Needs. Farm financial pressures can get in the way of decision-making, especially if working capital is a concern. Rather than sit on old-crop supplies waiting for the right sales opportunity, make educated sales that mesh with cash-flow needs. Sitting on too many old-crop bushels gets in the way of pricing new-crop.

3. Use Actual Production History (APH) Data. Determine proven yields, and use them with crop insurance as a marketing tool. APH can provide a good guideline for the number of bushels you can price early to have enough crop or an indemnity check to cover the sale.

4. Build in a Reasonable Profit Margin. Johnson said to shoot for 5% to 10% return on investment. When price highs occur, make incremental sales. Let go of ego and greed. If you miss spring and summer rallies, it means long fall and winter months with unpriced bushels.

5. Understand Seasonal Futures Trends. Missing seasonal futures price opportunities is a common mistake. Futures price highs generally occur in late spring and early summer months. Since 1990, 85% of new-crop futures price peaks in corn happened between mid-April and mid-August. New-crop corn and soybean prices peaked on the same day this year, July 11. November soybean futures closed at $10.21 3/4, while December corn futures closed at $4.28 1/4.

6. Track Local Basis Weekly. If you want to understand your local area's demand for grain at different points of the year, track your basis. Also, consider that most elevators and processors offer basis contracts. These could eliminate storage and basis risks, yet generate cash-flow and still allow you to benefit from higher futures prices in the deferred months.

7. Leverage Revenue Protection (RP) Crop ‌Insurance. RP gives farmers the freedom to sell more of their guaranteed crop insurance bushels to generate needed fall and winter cash-flow. The revenue guarantee uses the higher of the projected or harvest price multiplied by the farm's APH multiplied by the level of coverage elected. Subtract actual production multiplied by the harvest price to determine a potential indemnity payment.

8. Use a Variety of Crop Marketing Tools. Farmers have 12 to 15 different marketing tools at their disposal, but Johnson said most use only spot-cash, hedge-to-arrive and forward-cash contracts. He suggests broadening opportunities while remaining disciplined. Lock in futures when prices are high. Set basis when it narrows as futures decline and buyers need bushels.

9. Calculate On-Farm vs. Commercial Storage Costs. Try not to place large quantities of unpriced bushels into commercial storage. Paying drying, shrink and commercial storage costs while accepting a lower cash price via basis usually results in a lower net cash price than the harvest price that was available. Place delivered bushels on a basis contract if you think the deferred futures price bottom is made.

10. Develop and Implement a Crop Marketing ‌Plan. Want to find another $50 to $100 per acre in 2018? Johnson challenges farmers to lower costs $50 per acre through lower fertilizer costs and applications, reduced tillage and renegotiated cash rents while increasing revenue up to $50 per acre by preharvest marketing during late spring or early summer. Consider timing cash sales when basis narrows, and save money with less drying, shrink and commercial storage costs.

"Farmers must stop marketing like they did 30 years ago. You will rarely outguess USDA reports, National Weather Service forecasts or commodity fund investors," Johnson explained. "If things don't change, more farmers will sell their machinery and end up renting their farmland to their neighbors who can manage both financial and price risk."

PLAN FOR PROFITABILITY

The Iowa Soybean Association collaborated with Mike North, president of Commodity Risk Management Group, and Steve Knuth, AgWest Commodities, earlier this year to host "Planning for Profitability" meetings in nine locations across the state. The goal was to outline strategies for minimizing risk and maximizing profit as farmers lay out marketing plans.

"We provided a holistic view of the marketing process at the farm," North said. "We reviewed current markets and prices, and provided tips to capitalize on profitability opportunities."

North advises farmers to begin by making price the foundation of the plan then adding in tools and strategies needed to meet those price expectations. For example:

-- Use the carry in the market with storage to manage price, not just to store crops. Be prepared to manage sales by rolling them forward.

-- Expand the marketing thought process. If you are putting in more storage, make sure you use it for a pricing opportunity, not just for harvest logistics.

-- Offensively manage basis and pricing opportunities separately.

-- Use futures and options to create flexibility and added security in risk management.

"Every marketing tool has its challenges. Learn how to use them. If you don't have the time to learn, develop a relationship with someone you trust, draft a plan and execute it," North explained.

WILD CARDS COULD MOVE MARKETS

Best-laid marketing plans may need to be revisited throughout the year, especially if any "wild card" events rock commodity prices. Trade consultant John Baize offers his top five concerns:

1. Development of widespread drought in Argentina and Brazil (With plentiful global soybean stocks, a substantial cut in South American production could shake up prices.)

2. Disruption of U.S./China trade because of a conflict over North Korea or a war between the U.S., Japan and South Korea with North Korea

3. A major slowdown in Chinese imports

4. Collapse of U.S. talks with Mexico over North American Free Trade Agreement that looks like it would end the trade agreement

5. Disruption of shipping on the Mississippi River because of flooding, such as what occurred with Hurricane Katrina, or a major disruption of shipments to the Pacific Northwest because of a severe winter

SIGNS OF SATISFIED MARKETERS

Farm Credit Services of America (FCSAmerica) surveyed nearly 650 farmers in nine states to define a satisfied marketer. Knowing cost of production is critical. Other findings include:

-- One-third are mostly or completely satisfied with their marketing practices and results.

-- Satisfied marketers are more likely to price as soon as the market offers a profit and to price multiple crop years, and less likely to sell most of their crop right after harvest or to price based on market fear or cash-flow needs.

-- More satisfied than dissatisfied marketers use their cost of production to set an initial price goal. Satisfied marketers are likely to have written marketing plans.

-- Farmers use an average of four to five marketing tools. The most popular is storage—82% store grain at least occasionally, and 20% always store.

-- Crop insurance plays a supporting marketing role, not just for crop failure.

-- Operations of 1,000 or more acres, and farmers with higher levels of crop insurance employ a fuller range of marketing tools. Farmers with revenue protection of at least 80% also are more likely to price prior to harvest.

-- More than two-thirds use cash-forward contracts and spot-cash sales, while only a quarter of respondents use futures or options.

-- Farmers 35 and younger are more likely to use hedge-to-arrive contracts and lock in the carry when they store. Younger and larger operators are more likely to use their cost of production to set a marketing price.

To view the full survey report, visit www.fcsamerica.com/GrainMarketingInsights

(AG)

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