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How Cheaper Crude Oil Impacts U.S. Farm Profits

At every seminar and webinar I did this winter, I was asked the same question: What will the price of crude do to profits? 

This is a difficult question to answer. I can envision several different scenarios unfolding. However, the simple answer is in two parts:

• Short-term: Lower energy prices are bearish for grain prices, especially ethanol and corn prices. 

• Long-term: It is a very positive economic factor for U.S. and global consumers.  

4 Questions

To arrive at my answer, I studied four separate questions.

1. What is the effect of lower gasoline and reduced costs for heating homes? Lower energy prices are a huge windfall for consumers around the world. Every $10 down in crude oil increases U.S. consumer buying power by $170 billion dollars. The dollar-per-gallon cut in home heating oil saves U.S. consumers $70 billion dollars.

2. Where will the extra consumer money go? The early economic data shows U.S. consumers reducing debt. Others are taking the extra money each week and going out to more restaurants. This has been good news for cattle, hog, and dairy producers. 

3. What will this do to ethanol? Now the bad news. Lower crude oil prices will reduce ethanol profitability. If crude stays in the $40 to $60 range for 2015, the impact on ethanol production will reduce by 3% to 5% in 2015. 

As I look ahead to 2016, it may be that much or more. I have been amazed at how efficient many ethanol plants have become. They have more staying power than oil producers in the Bakken region. Still, with all that said, it is not going to be pretty. 

4. How much will the government take? Governments in the U.S., Europe, and Asia now see the opportunity to raise gas taxes. Ouch! It is going to happen; it is just a matter of when. 

The bottom line is, lower energy prices will accelerate the consolidation pace in the gas and oil industry and in the ethanol industry. 

The stock value of several of the big oil companies and publicly traded ethanol manufacturers has been cut in half; some are down by over 80%. The smaller, less efficient plants will close. 

How long will energy prices stay low? Not very long. I am not talking about going back to $100, but $70 crude by late in 2015 is possible. 

I am surprised at how fast the rigs are pulling out of North Dakota. The total rig count there is down by over 50% and may drop another 25% in 2015 if crude stays below $60 per barrel. The more rigs that shut down, the faster prices will turn around. 

A Wild Card

Russia is the biggest wild card. I am nervous about what Vladimir Putin, the president and energy czar in Russia, will do to make crude oil rally back. Lower energy prices are taking a huge economic toll in that country. If crude stays below $60, then Russia will run out of money. Putin will not go broke without putting up a fight. This could get ugly. 

3 Scenarios

Here are three scenarios I see as possible as we go into a period of lower energy and commodity prices.

1. An optimistic scenario. Crude oil rallies back to over $70 by the third quarter of 2015. Planted corn acres are down, and a couple of weather scares boost prices. You get the chance to hedge some new-crop corn at over $4.80 per bushel and new-crop soybeans at over $11 per bushel. 

2. A realistic scenario. Crude rallies back to $60 to $70 per barrel by the third quarter. Planted corn acres are down, and a couple of weather scares boost prices. You get the chance to hedge some new-crop corn at over $4.40 per bushel and new-crop soybeans at over $10.50 per bushel.

3. A negative scenario. Crude oil stays below $50 per barrel for all of 2015. As a result, ethanol production drops by over 10% in 2015. Corn prices fall below $3 per bushel; soybeans fall to $7.50. 

4 Suggestions

These scenarios will have dramatically different effects on your farm operation. So with all of the uncertainty, what should you do to manage that risk in 2015? 

   Here are four commonsense suggestions.

1. Get the last of your 2014 cash corn and soybeans sold on any weather scare this spring. 

2. Buy the right revenue crop insurance product for your farm.

3. Get some additional new-crop hedges put on between April and June. 

4. For the bushels you do not hedge, get new-crop price protection using puts. If my most negative scenario unfolds, then those puts will keep you in farming. 

One Final Thought

Figure out a way to stay liquid and profitable during 2015. By 2016, things will be better. In 2016, all of my long-term grain cycles turn higher. 

It looks like 2012 was a high in farm income, and 2015 will be a low. It is tough to get bullish at the bottom, but try to do it. I think prices will put in a major low in 2015. The most likely time for that low is either March or October of 2015. 

Make a plan to survive through 2015, and you will be rewarded with 2016.

NOTE: Trading of futures and options has substantial financial risk of loss and is not for all investors.

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