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Hedging margins

DANIEL LOOKER 11/18/2010 @ 11:39am Business Editor

Norm Brown, who farms about 1,500 acres near Aledo, Illinois, and finishes 40,000 hogs a year, is fine-tuning the goal of every farmer – making a profitable margin. For decades, soybean processors have locked in crush margins between the price of beans and oil. Commercial feedlots hedge cattle and corn.

Since July, Brown has been using Commodity & Ingredient Hedging, LLC, in Chicago to help him decide exactly when to make those tough decisions. He’s using CIH for the half of his hogs that get purchased feed, not his own corn. (For the other half, he uses Russell Consulting Group.) CIH offers Web-based tools that allow farmers to calculate their profit margin plus a weekly hour-long consultation with its team of account executives. The website’s margin model uses futures prices that are updated hourly to show each producer’s margin if it’s not all locked in. CIH charges a $9,000 annual fee for the service. (See an August snapshot of Brown’s potential first-quarter 2011 margins on the next page.)

“You can’t even get started with CIH unless you’ve got a good, confident handle on cost of production,” Brown says. If anyone has a good handle, it should be Brown, whose other enterprise is the accounting software company, FBS Systems.

So far, Brown has found that even with help from CIH, the simple concept of maintaining a margin between his corn/soybean meal inputs and his finish hog outputs is, in fact, complex.

“One of the things that’s very complicated about locking in a margin is time-frame match,” Brown says. In the first quarter of 2011, he uses February and April lean hog futures and March corn futures. The Web model of margins isn’t a substitute for accounting, he says. “It doesn’t show you what your actual profit and loss was. This is a vehicle to help you understand what’s going on and at least come up with a strategy,” Brown says.

In late August, when lean hog futures were about $78 per cwt and corn futures were running around $4.50 per bushel, the CIH web based model showed Brown’s operation with a potential open market margin of $7.74 per cwt in January, $9.56 per cwt in February, and $8.59 per cwt in March. That’s after Brown put in his own estimates for the cost of other feed ingredients and non feed costs.

A month later, he’d locked in more of his inputs and hogs for an even higher margin. By then, he had sold 50% of his hogs, and had bought 62% of his corn and 20% of his soybean meal. The open market lean hog margin was $8.94 per cwt for the first quarter of 2011. Brown’s own margin, based on his costs and futures positions, was $10.92 per cwt or about $22 per hog. CIH records show that over the past 10 years, for that time of year, Brown’s margin was above the 96th percentile.

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