UK Grain Marketing Series November 5, Todd D. Davis Assistant Extension Professor. Economics

Transcription

1 Grain Marketing & Risk Management Overview UK Grain Marketing Series November 5, 2015 Todd D. Davis Assistant Extension Professor

2 Risk vs. Uncertainty Most use these words interchangeably in conversation but they are different. Risk = Known Unknowns Aware of these risks and can take steps to mitigate loss Drought, flooding, hail, insect / weed pressure Futures price are lower than expected, cash prices lower than expected; costs increase Interest rate on debt increases; Bank caps operating line of credit Hired labor has an accident and is injured on your farm Gov t bans exports. Gov t changes crop insurance program. Uncertainty = Unknown Unknowns Aware of these risks but difficult to mitigate loss. Just hang on for dear life.

3 Should we Eliminate All Risk? Would there be profits in a risk-free world? No. There is a risk-return trade-off. The greater the risk, the greater the expected return. Risk Management can reduce the bad outcomes but could also lower average return Management is identifying what risks to absorb and what to manage through risk products

4 5 Categories of Risk Risk Type Example Management Practice Production Risk Drought, floods, hail, insects/weeds Crop insurance, scouting & spraying Marketing Risk Futures market variability, cash market variability, costs increase Hedging, Put Options Cash-forward Contracts Written marketing-plans Flexible cash leases Financial Risk Increasing interest rates, cashflow problems, credit constraint Restructuring debt to match asset life; fixed interest rate loans; cash-flow budgeting Human Risk Employee injured; lack of skilled employees Insurance; mechanization Legal Risk Gov t bans exports; changes to crop insurance program Farm organizations / commodity organizations

5 Dec Corn Monthly Average Closing Price ($/bu) Look at the greater risk in the corn market = $2 range = $6 range

6 20% of years with 20% or greater loss Simpson County % Deviation from Trend Corn Yield 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% -70% -80%

7 30% 20% 10% 0% -10% -20% -30% -40% -50% -60% % of years with 20% loss or greater Butler County % Deviation from Trend Corn Yield

8 What would an additional 3% interest due to your P&I payment? Interest rates are at historic lows. Can only go up.

9 Marketing vs. Price Taking Price-taking is selling without protection or regard to future price potential. An example is selling off the combine each year. Marketing involves: setting pricing objectives that cover costs; using risk management tools to lock in futures price, set a price floor, or lock in a cash price Objective isn t to sell at the highest price each year (although that would be nice). The objective is instead to create a plan that provides revenue to cover costs, family living and business growth. You strive to sell at profitable levels

10 Green River Area Cash Corn Price Index (% of MYA Price) When are prices lowest? Highest?

11 $2.00 $1.50 $1.00 Change in the December Corn Futures Contract from Feb to October Most years the Futures price is much higher prior to planting than at harvest. $1.47 $1.82 $0.50 $0.20 $0.44 $0.31 $0.00 -$ $0.47 -$0.38 -$0.17 -$0.29 -$0.32 -$0.48 -$1.00 -$0.78 -$1.50 -$1.27 -$1.26 -$1.12

12 Price Fundamentals Market fundamental are the components of supply and demand that will determine the price for a commodity Supply of Corn = Beginning Stocks + Production + Imports Use of Corn = Feed + Industrial + Ethanol + Exports Supply Use = Ending Stocks Ending stocks will never be zero or negative. The market will drive price higher to curb use.

13 Why do we care? Developing Price Potential Intuition Expect higher prices: Reduced acreage or yield Stronger than expected use (exports) Production problems in competing exporter countries Projected decrease in ending-stocks Expect lower prices: Increased acreage or yield Weaker than expected use (exports) Abundant production in competing exporting countries Projected increase in ending-stocks

14 Where do we get this information? USDA provides monthly Supply and Demand Estimates for domestic and world crops (WASDE) Other Key USDA Reports: Prospective Plantings March 30 th (Planned Acreage) Acreage June 30 th (Planted Acreage survey) Production August to November, January (Farmer and field surveys) Grain Stocks (quarterly) measure of on-farm and offfarm stocks to derive feed demand

15 More information USDA Foreign Ag Service Exports and commitments Ag Attache reports provide insight to export competitor s crop, economy and potential exports USDA Crop Progress Reports April to November: provides measure of crop planting progress, development and condition.

16 Futures Price data: Market Information The CME is the platform that trades commodity futures and options. Free Futures and cash quotes: DTN: subscription required. News, market quotes (cash and futures). AgWeb: provides futures quotes and cash market bids for a defined region. Enter your zip code and receive quotes from nearby facilities.

17 Look at how the Dec Corn Futures Contract Reacted to USDA reports 10-Jan January (Final) WASDE $ Feb USDA Outlook Conference $ Mar Prospective Plantings $ May Most Recent High $ May Iowa Corn Planting Deadline $ Jun Acreage Report $ Aug August WASDE $ Sep Sep WASDE $ Sep Final Stocks Report $ Oct Oct WASDE $ Oct Delayed Harvest $ Oct Delayed Harvest $ Nov $3.74 Change from Sep 30 +$0.53 Source: DTN

18 Risk Management Planning 1. Identify sources of risk in your farm business. Think about quality of your land, yield potential and variability Input costs? Land rent competition? Where are your markets? Competition for bids? Amount and cost of debt? 2. Measure your risk What is your yield variability? How likely is a 20% lower yield?

19 Risk Management Planning 3. Assess risk bearing capacity Ideally you should have financial records Can use budgets and loan information to get an idea What happens to profitability, cash flow, cash reserves from: lower yields, lower prices, higher input costs higher interest rates Your amount of debt will drive ability to bear risk

20 Risk Management Planning 4. Evaluate your risk tolerance How comfortable are you with the risk bearing results? Those that are uncomfortable with risk might want to be more proactive in use of insurance, pre-harvest pricing, and forward contracting to reduce revenue uncertainty Those that are comfortable with risk may be willing to be more adventurous Risk tolerance is the feelings that keep you awake at night. Your marketing and risk management needs to reflect how well you sleep.

21 Risk Management Planning 5. Set risk management goals Provide a basis for decisions Set priorities of how to manage risk Used to measure progress Example: purchase Revenue Protection crop insurance at the 80% coverage level; Forward contract 40% of expected production at a price that covers total production costs + cash rent + P&I payment

22 Risk Management Planning 6. Identify effective risk management tools Right agronomic practices seed / chemicals / fertilizer bundle Irrigation Crop insurance Market risk tools

23 Risk Management Planning 7. Seek professional assistance University Extension Crop insurance agents Agricultural lenders 8. Make a decision and implement the plan 9. Evaluate the results. Learn what worked / what didn t and adjust for the future

24 Risk Bearing Capacity Example 2 farms with same amount of land, costs, % rented, rental rate, yield and sales price Farm A Farm B Total Acres Owned Cash Rent Land Value $3,750,000 $3,750,000 Machinery $500,000 $500,000 Grain Inventory $370,000 $370,000 Savings $150,000 $150,000 Total Assets $4,770,000 $4,770,000 Yields: 150 / 50 Price: $4 / $9.10 Rent: $200/acre Farm A=40% Debt/Assets Farm B = 70% Debt/Assets Total Debt $1,908,000 $3,339,000 Net Worth $2,862,000 $1,431,000 Debt is at 5% interest, 15-year note

25 What Happens to Return over Variable Costs, Rent, and P&I Payment? Farm A = $183,821 P&I payment Farm B = $321,687 P&I payment $0 -$50,000 -$100,000 -$150,000 -$200,000 -$250,000 -$300,000 -$350,000 -$400,000 Base 20% Lower Yields Farm A 20% Lower Prices Farm B Increased Rent $50/acre Higher Interest (+3%)

26 What Happens to Savings? Started with $150,000: $200,000 Base 20% Lower Yields 20% Lower Prices Increased Rent $50/acre Higher Interest (+3%) $150,000 $100,000 $50,000 $0 -$50,000 -$100,000 -$150,000 -$200,000 -$250,000 Farm A Farm B

27 Take away message Your ability to absorb a loss (risk) is different than your farming parents due to land base, debt, cost structure (family living), etc. What your older farming partners/relatives do may not be in your best interest to manage risk Now is the time to work with your records and determine how your business would absorb lower yields, prices, etc? How would you manage such a loss? Sell grain? Increase debt?

28 Where do we go from here? December 8 = Futures and Options Commodity Challenge Game Hands-on experience January 19 = Cash market tools February 16 = What risk strategies worked in the past and why? March 3 = Developing a marketing and risk management plan for 2016

29 Discussion Board The discussion board at: continue class discussion. will be used to Good place to ask questions, talk about the markets and the Commodity Challenge game Jason, Greg and I will also post news items that are related to risk, profitability and the grain markets

30 Thank you for your attention! Questions? Todd D. Davis x 243