Drought's silver lining
This has been a rough year for producing a crop. Between frosts last spring and the drought over the summer, U.S. producers have been challenged. But some things actually do grow well in a drought: crop prices, for example.
As temperatures soared last summer, so did grain prices. Both corn and soybean crops achieved record-setting prices. At harvesttime, the markets were providing prices that will establish records for national average cash prices.
Since mid-July, the corn market has set prices at or above the $7-per-bushel range. Soybeans topped $14 per bushel at roughly the same time. With prices at such high levels, the 2012 corn and soybean crops will be the most valuable crops the U.S. has ever produced.
These record values arise not only from the lack of production due to drought and temperature extremes, but also from the strong demands that have built up for both crops over the last decade.
With ethanol demand leading the charge on the corn side and export demand driving the soybean market, both markets have grown and experienced relatively tight stock levels over the past few years. And that tightness in stocks meant there was (and is) very little cushion in case of a short crop.
Over the period from 2000 to 2005, the annual average corn demand was 10.2 billion bushels, and annual average soybean demand was 2.82 billion bushels.
Since 2006, those annual average demands have grown to 12.4 billion bushels for corn and 3.16 billion bushels for soybeans. That's a growth rate of 21% for corn and 12% for soybeans.
The growth in demand has set the stage for sustained higher prices, and the drought has kicked the price movement into high gear.
The demand increase also has raised the lower boundaries for crop prices. Prior to 2007, monthly average corn cash prices would sometimes drop below $2 per bushel, and monthly average soybean cash prices would approach $5 per bushel. Since 2008, the lowest monthly average corn cash price has been $3.25 per bushel, while the lowest monthly average soybean cash price has been $9 per bushel.
These higher cash prices have strengthened farm balance sheets across the nation. In 2008, while the rest of the economy sank into recession, U.S. net farm income was approaching record highs. In 2011, as the general economy slowly grew, U.S. net farm income topped $115 billion.
And the projections are that, even with the significant production pullback caused by the drought, 2012 U.S. net farm income will set another record, over $120 billion.
This improvement in the bottom line has not been evenly distributed, and many of you still face financial hardship. But the aggregate numbers show that a sizable portion of you in row-crop production have built up your financial reserves.
The strength in the farm balance sheet has definite marketing implications. As you conduct your business in the aftermath of this year's drought, there's limited panic or necessity selling since, as a row-crop farmer, you have the funds to meet cash flow needs. This allows you to be more selective and strategic as you look to market your crop.
Market in multiple blocks
As you look at the futures markets going into harvest, markets provide prices that offer attractive opportunities. Corn futures for the 2012/2013 crop seem to have found a consistent range in the high $7s and low $8s. The major issue for the 2012 corn crop is the lack of carry in the futures.
The price for July 2013 corn, while a great price, is roughly the same as the price for December 2012 corn. The market is not offering anything for storage. This market is looking for the crop now, not later. And given the effects of the drought, the market is paying a strong price to get the crop now.
Iowa State University ag economist Bob Wisner once said, “It's hard to lose money when you're making a profit.” Today's prices are profitable, so it makes some sense to move some bushels. How much to move depends on several factors, such as the amount of storage you have and the quality of your crop.
Market in multiple blocks, both before and after harvest. Chasing that one big sale at the highest price often leaves you marketing at lower prices and cursing the missed opportunity. When profitable prices and margins are available, it's good to take advantage of them without completely locking yourself down. Selling the crop in multiple lots lets you ride the markets up in a rally, and it can give you some security when the markets trend down.
This fall is a good time to consider placing some price protection underneath the crop you plan to store into spring. Just like you use crop insurance to protect against low crop yields or revenues each spring, look at price insurance each fall.
That price insurance can take different forms: a forward contract at the local elevator, a futures hedge, or put options. But again, with profitable prices on the board now, it makes sense to protect those prices.
For example, as of mid-September, a $7 May 2013 corn put option would cost you 25¢ per bushel. That put will provide a floor price around $6.50 per bushel – not a great price by today's standards but still profitable. And that put option also allows you to capture higher prices this spring if the market rallies while protecting you from lower prices should they occur.
If crop quality in storage is a concern, another way to capture potentially higher prices this coming spring is to sell the crop now and to purchase call options for spring. By moving the crop, you can eliminate your worries on quality. The call option will provide returns if prices head higher. And the minimum price you could receive is the cash price you sold at, less the call option premium.
The same type of discussion holds for soybeans as well. Futures prices for 2012/2013 soybeans have been in the high $16s and low $17s – profitable prices. And again, the market is not currently offering returns for storage.
In the soybean market, the storage play is more risky given the South American tendency to concentrate on soybean production. Thus, shoring up some price insurance going into spring may be even more critical.
Regarding both preharvest and postharvest marketing, spread sales out to capture profitable prices and margins whenever they occur. Looking forward to the 2013 crops, you have some opportunities to put some price protection on those crops as well.
With your preharvest marketing, consider these three guidelines:
1. Preharvest-market only the amount of crop that you can and will cover with crop insurance.
2. Align preharvest sales with input purchases to meet your cash flow needs.
3. Take advantage of profitable margins with small sales, and stay on the sidelines if profitable margins cannot be obtained.
Thinking about next year's crop now opens up a window to capture better returns on the 2013 crop whenever they occur over the next two years (preharvest or postharvest).
Preliminary production cost estimates for the 2013 crops are around $4.50 per bushel for corn and $11.30 per bushel for soybeans.
Looking at the futures markets for the 2013 crops, corn has been pricing in the $6 range, while soybeans are around $13 per bushel. So profitable margins are on the board for 2013.
And just as you can put price protection on the crop in the bin, you can also put price protection on the crop you will plant next spring.
You can forward-contract bushels, use a futures hedge, or purchase put options.
As the markets show, the expectation is that U.S. and world production will be better in 2013 and 2014. That expected increase in production is pushing longer-term prices down, but they're working off of the heightened prices from the drought. Also, the markets are still carrying a weather risk premium as we wait to see how soil moisture conditions set up this spring.
So while the drought put a damper on this year's production, it also opened up some significant marketing opportunities for both this year's and next year's crops.
Although prices have backed off with this year's harvest, significant marketing opportunities remain within reach.
As it stands, the 2012 corn crop will be valued at over $80 billion, and the 2012 soybean crop will be valued at over $40 billion. Both of those totals will set records. And with the next year's crops already being priced above expected production costs, 2013 looks to be another year in the black.By Chad Hart, associate professor of economics at Iowa State University.