Hedging margins

DANIEL LOOKER 09/30/2011 @ 2:54pm Business Editor

Last July, Bruce Peterson, who farms with his brothers, Brian and Chris, near Northfield, Minnesota, was getting ready to buy some of his fertilizer for the 2012 corn crop.

“Once we buy fertilizer, we'll hedge a portion of the crop,” he says. The timing, especially this year, can be tricky.

But, as Bruce puts it, “if you're willing to have a significant outlay on one input, you should be willing to put a price floor on corn with hedge-to-arrive contracts, futures, or options.”

There is risk to not doing that. What looks like a positive margin of high-priced corn over high-priced fertilizer could shrink drastically if the Petersons buy fertilizer now and wait to sell 2012 corn later at a lower price.

“It probably makes sense to sell 10%, 15%, or 20% of the crop – maybe not the same day you buy the input but when there's an uptick in the market,” he says.

Bruce and Chris consult once a week with a consulting service, Commodity and Ingredient Hedging, a Chicago-based firm founded in 1999 that specializes in helping producers lock in profitable margins with forward pricing. Chris, who runs the farm's 14,000-head hog-finishing operation makes separate calls to CIH.

The three brothers farm almost 6,000 acres of corn, soybeans, and a small amount of alfalfa in a partnership called Far-Gaze Farms. Bruce calls himself the “point man on fertilizer.” Brian buys diesel fuel for the farm's machinery and propane for drying. Chris buys seed. “We'll kind of bounce ideas off of each other,” Bruce says.

Far-Gaze Farms has been working with CIH for about six years. The firm uses each client's history of yields and costs, as well as historical futures prices to compare potential margins with historical ones, says Jon Greteman, a CIH account executive in West Des Moines, Iowa. It doesn't try to forecast price trends.

For crop farmers, the service costs $3,600 a year for a minimum of 52 sessions of consulting, regardless of farm size. Livestock producers pay $9,000 annually.

Except during busy planting and harvest seasons, most weekly consulting sessions are in front of a computer, using GoToMeeting conferencing software to look at charts and data. Each client has his or her own Web-based dashboard that shows margins. For new clients, entering cost and production records can be time-consuming, Greteman says. “In the long term, it definitely pays off to make good decisions.”

Historical trends in grain futures prices are easy to find. Records for input prices can be more challenging. Greteman says heating oil prices give an approximate history of trends for diesel fuel. Natural gas prices are a proxy for anhydrous ammonia.

His clients rarely use futures in those commodities to hedge their costs, though. The minimum volume can be too big (42,000 gallons for heating oil). And natural gas prices don't track perfectly with anhydrous, creating basis risk.

“We can still make decisions when they're locking contracts in,” Greteman says, “and then they can go to their fuel supplier and lock in the amount they need physically.”

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