Crops Marketing and Management Update

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1 Crops Marketing and Management Update Department of Agricultural Economics Princeton REC Dr. Todd D. Davis Assistant Extension Professor -- Crop Economics Marketing & Management Vol (9) September 19, 2016 Topics in this Month s Update: 1. September 12 th Crop Production Report Shows Large Corn and Soybean Crops 2. September 12 th WASDE Update: Increasing Corn, Soybean and Wheat Stocks 3. Comparing Harvest-Time and January Cash-Forward-Contract Bids and Managing Risk 4. Comparing Storage Costs and Spot Price Appreciation from October to Spring and Summer 5. Corn and Soybean Storage Risk Management Alternatives to February How Have Storage Hedging with March Futures and Puts Performed since 2000? 7. How Do I Get on the Distribution List to Receive this Newsletter? Topic 1. September 12 th Crop Production Report Shows Record Large Corn and Soybean Crops The September 12 th Crop Production report provided an updated objective yield and farmer survey yield projection for both corn and soybeans. Analysts were expecting the report to show a lower corn yield from the August projection of bushels/acre. The market sentiment was that the 2016 growing season was not perfect enough to support that very optimistic yield estimate. Expectations were for a U.S. yield of bushels/acre. USDA surprised the market by reducing the 2016 yield by 0.7 bushels/acre to a projected yield of bushels/acre (Table 1) which would still be a record, if realized. Table Corn Yield and Production Projections for 2016 and 2015 for Midwestern and Southern States. Yield (Bu/Acre) Production (Million Bushels) Sep 2016 (F) Aug 2016 (F) 2015 Sep 2016 (F) 2015 Midwest States Illinois ,300 2,013 Indiana , Iowa ,666 2,506 Kansas Michigan Minnesota ,472 1,429 Missouri Nebraska ,730 1,693 North Dakota Ohio South Dakota Wisconsin Midwest Total 13,101 11,933 Southern States Alabama Arkansas Georgia Kentucky Louisiana Mississippi North Carolina Oklahoma South Carolina Tennessee Texas Virginia South Total 1,381 1,117 United States ,093 13,601 Where did USDA trim the corn yield? The yields in Indiana and Iowa were reduced by 2 and 1 bushels per acre, respectively, from the August report. Still the I-states (Illinois, Indiana and Iowa) are projected to increase corn production by 664 million bushels over last year s production. USDA made larger changes to yield in states around the edge of the core producing region. Yields in South Dakota, Ohio, Nebraska and Missouri are projected to be 5, 1, 3, and 1 bushels/acre lower, respectively, than in August. Likewise, USDA increased the projected yields by 6, 5, and 2 bushel/acre for Kansas, Michigan and Wisconsin, respectively, from the August report. The September report projects the Midwest corn crop to be billion bushels larger than last year (Table 1). 1

2 USDA reduced the projected corn yields in most of the Southern States, except for increases in Virginia and North Carolina, from the August projections. Kentucky s yield was reduced by 2 bushels/acre from August to a projected 172 bushels/acre. The Southern region is projected to increase corn production by 264 million bushels over the 2015 corn crop (Table 1). The 2016 US corn crop is still projected to be a record at billion bushels which, if realized, would be an increase of 1.49 billion bushels over 2015 (Table 1). Analysts were expecting USDA to reduce the crop below 15 billion bushels so this report was bearish. Analysts were expecting USDA to increase the US soybean yield to 49.4 bushels from the August estimate of 48.9 bushels/acre given the condition of the crop and the relatively better perceived growing season for soybeans than for corn. USDA continued the surprises by projecting the 2016 yield at 50.6 bushels/acre which would be a record if realized (Table 2). Table Soybean Yield and Production Projections for 2016 and 2015 for Midwestern and Southern States Yield (Bu/Acre) Production (Million Bushels) Sep 2016 (F) Aug 2016 (F) 2015 Sep 2016 (F) 2015 Midwest States Illinois Indiana Iowa Kansas Michigan Minnesota Missouri Nebraska North Dakota Ohio South Dakota Wisconsin Midwest Total 3,499 3,236 Southern States Alabama Arkansas Georgia Kentucky Louisiana Mississippi North Carolina Oklahoma South Carolina Tennessee Texas Virginia South Total United States ,201 3,929 USDA increased soybean yields in the Midwest from the August report. The largest increases (4 bushels/acre) were in Illinois and Kansas. Projected yields were increased in Indiana and Iowa by 3 and 1 bushels/acre, respectively, from the August report. The 2016 Midwest soybean crop is projected to be 263 million bushels larger than last year s crop (Table 2). The Southern region is projected to harvest about the same sized soybean crop as last year. USDA increased soybean yields in Kentucky and Tennessee by 3 bushels/acre from the August report which off-set the effect of lower yields in other Southern states. The state average soybean yield in Kentucky is projected at 51 bushels/acre (Table 2). The US is projected to harvest 4.2 billion bushels of soybeans in 2016 which would be a record, if realized. The 2016 crop is currently projected to be 272 million bushels larger than the 2015 crop. The large corn and soybean crops are going to weigh heavy on stocks placing the focus on increasing use throughout the marketing-year. The market is already looking forward to the October Crop Production report as it will incorporate the USDA- FSA certified acreage information to better estimate the amount of acres that were prevented from planting this year. The question of the amount of prevented planted acres is something the market wrestles with each year. As harvest gets underway, USDA will include actual harvested yield data which greatly improves the production estimates. Topic 2. September 12 th WASDE Update: Increasing Corn, Soybean and Wheat Stocks The September WASDE was expected to show a reduction in corn ending stocks based on the assumption of USDA reducing the 2016 corn yield. The smaller than expected yield reduction cascaded through the corn balance sheet to reduce corn stocks by a smaller than expected amount. The September WASDE made minor adjustments to the old-crop balance sheet by lowering exports by 10 million bushels which increased the old-crop ending stocks by that amount (Table 3). For new-crop corn, the 0.7 bushel/acre reduction in yield translates to a reduction in production by 60 million bushels from the August estimates. Still, the record corn crop of billion bushels is projected to increase supply by 1.46 billion bushels over last year (Table 3). 2

3 Table 3. U.S. Corn Supply and Use Change from Estimated Projected Planted Area (million) Harvested Area (million) Yield (bushels/acre) Million Bushels Beginning Stocks 821 1,232 1,731 1, Production 13,829 14,216 13,601 15,093 +1,492 Imports Total Supply 14,686 15,479 15,397 16,859 +1,462 Feed and Residual 5,040 5,323 5,200 5, Food, Seed & Industrial 6,493 6,560 6,567 6, Ethanol and by-products 5,124 5,200 5,200 5, Exports 1,920 1,864 1,915 2, Total Use 13,454 13,748 13,682 14, Ending Stocks 1,232 1,731 1,716 2, Stocks/Use 9.2% 12.6% 12.5% 16.5% +3.9% Days of Stocks U.S. Marketing-Year Average Price ($/bu) $4.46 $3.70 $3.60 $3.20 -$0.40 Source:September 2016 WASDE - USDA: WAOB. Corn demand is projected to be a record billion bushels but will not be able to absorb the increase in supply. Corn for ethanol is projected at billion bushels. Similarly, corn exports are projected at billion which would be the largest amount exported since 2007, if realized. Feed/residual use is projected to increase by 450 million bushels over last year with some of that due to the increase in residual (measurement error) that occurs whenever there is a large crop. The projected corn ending stocks at 2.38 billion bushels would be the largest level since 1987, if realized (Table 3). The stocks-level is about 16.5% stocks-use as compared to 54.9% in The point is that the corn market benefits from much stronger demand in than 29 years ago. The US Marketing-Year average (MYA) corn price is projected at $3.20/bushel which would be $0.40/bushels lower than the MYA price (Table 3). Analysts expected a slight increase in soybean ending stocks in the September report due to the projected increase in yield and production. With a record yield of 50.6 bushels/acre, the 2016 US projected soybean crop was increased 141 million bushels from the August projections. If realized, the 2016 soybean crop will be 272 million bushels larger than last year s crop (Table 4). Table 4. U.S. Soybean Supply and Use Change from Estimated Projected Planted Area (million) Harvested Area (million) Yield (bushels/acre) Million Bushels Beginning Stocks Production 3,358 3,927 3,929 4, Imports Total Supply 3,570 4,052 4,145 4, Crushings 1,734 1,873 1,900 1, Exports 1,638 1,843 1,940 1, Seed Residual Total Use 3,478 3,862 3,949 4, Ending Stocks Stocks/Use 2.6% 4.9% 4.9% 9.0% +4.0% Days of Stocks U.S. Marketing-Year Average Price ($/bu) $13.00 $10.10 $8.95 $9.10 +$0.15 Source:September 2016 WASDE - USDA: WAOB. The September report increased old-crop soybean exports by 60 million bushels from the August report for total exports at 1.94 billion bushels. This late season surge in exports lowered old-crop ending stocks to 195 million bushels which is a 4.9% stocks-use ratio. The increase in the 2016 projected yield increased the 2016 soybean crop by a projected 141 million bushels which partially off-set the smaller carry-in. The soybean supply is projected to increase by 281 million bushels over last year. The September report increased crush and exports by 10 and 35 million bushels, respectively, from the August report (Table 4). The soybean ending stocks are projected at 365 million bushels which would be an increase of 170 million bushels over last year, if realized. Without the increase in projected yield and assuming the increase in use, the ending stocks would have fallen to 224 million bushels due to the increase in projected use. Under that scenario, the stocks-use ratio would have tightened to 5.5% supporting higher prices. The take-away message is that the soybean market does not have cushion to withstand a production problem in South America or significant reductions to the projected 2016 US soybean crop in future reports (Table 4). 3

4 Table 5. U.S. Wheat Supply and Use Change from Estimated Projected Planted Acres (million) Harvested Acres (million) Yield (bushels/acre) Million Bushels Beginning Stocks Production 2,135 2,026 2,052 2, Imports Total Supply 3,026 2,766 2,917 3, Food Seed Feed and Residual Exports 1, Total Use 2,436 2,014 1,936 2, Ending Stocks , Stocks/Use 24.2% 37.3% 50.7% 47.5% -3.2% Days of Stocks U.S. Marketing-Year Average Price ($/bu) $6.87 $5.99 $4.89 $3.60 -$1.29 Source:September 2016 WASDE - USDA: WAOB. The September report did not make any adjustments to either the old-crop or new-crop wheat supply and use projections. The continuing story is that of building stocks. The stocks-use ratio has increased to over 50% for the marketing-year and the projected stocks-use ratio for the marketing-year is 47.5%. Increasing stocks has forced the US MYA price drastically lower from $6.87/bushel in to $4.89 in to a projected $3.60/bushel in The current stocks level is the largest since the marketing-year. This current period of growing US stocks is coupled with global growth of stocks to 249 million metric tons (MMT) for the marketing-year. Topic 3. Comparing Harvest-Time and January Cash-Forward-Contract Bids and Managing Risk As corn and soybeans harvest picks up speed, it is worthwhile to start thinking about how to market unpriced grain. The unexpected strength in spot prices from harvest in 2015 to May and June 2016 illustrates the benefit of using low-cost on-farm storage to enhance profitability instead of selling at harvest. Some managers plan on storing until the New Year to defer taxable income. January sales are sometimes made based on cash flow needs rather than returns to storage. Managers should understand the per bushel costs needed to cover production costs plus storage. Some may want to use forward contract on a percentage of expected production to reduce revenue risk if the price is at a profitable level. Let s look at current harvest-time and January cash forward-contract (CFC) bids and compare the potential prices to budgeted variable costs, land rent, fixed costs, and a minimum storage cost from October harvest to January. The production costs, fixed costs and land rent are from University of Kentucky budgets for Western Kentucky assuming harvested yields of 172 bushels and 51 bushels, respectively, for corn and soybeans based on the September Crop Production estimates. The minimum storage costs include the opportunity cost of deferred revenue at harvest (5% annual interest), shrink (1.25% corn, 0.25% soybean) and $0.10 per bushel cost of additional handling and labor to move grain in and out of storage. These cost estimates do not include any utilities expense for fans or on-farm drying. These are bare minimum costs of on-farm storage from harvest to January. The minimum costs are assumed at $0.18/bushel for corn and $0.26/bushel for soybeans. 4

5 $4.20 $4.10 $4.00 $3.90 $3.80 $3.70 $3.60 $3.50 $3.40 $3.30 $3.20 $3.10 $3.00 $2.90 $2.80 $2.70 $2.60 $2.50 July 11 Figure 1. October 2016 and January 2017 Corn Cash Bids with Per Bushel Costs. $11.50 $11.25 $11.00 $10.75 $10.50 $10.25 $10.00 $9.75 $9.50 $9.25 $9.00 $8.75 $8.50 $8.25 $8.00 Harvest January TVC+Rent +Fixed Costs +Min Storage July 13 July 15 July 19 July 21 July 25 July 27 July 29 Aug 2 Aug 4 Aug 8 Aug 10 Figure 2. October 2016 and January 2017 Soybean Cash Bids with Per Bushel Costs. Aug 12 Aug 16 Aug 18 Aug 22 Aug 24 Aug 26 Aug 30 Sep 1 Harvest January TVC+Rent +Fixed Costs +Min Storage Sep 16 Sep 14 Sep 12 Sep 8 Sep 6 Sep 1 Aug 30 Aug 26 Aug 24 Aug 22 Aug 18 Aug 16 Aug 12 Aug 10 Aug 8 Aug 4 Aug 2 July 29 July 27 July 25 July 21 July 19 July 15 July 13 July 11 Sep 6 Sep 8 Sep 12 Sep 14 Sep 16 Figure 1 compares the October corn CFC (blue column), January CFC (red column) to production costs plus rent (black line), overhead costs (green line) and minimum storage costs to January (red line). While not covering total costs, the July 18 th January CFC provided the last best risk management opportunity. As prices have worked lower, managers need to know per bushel costs to accurately set pricing objective. Current bids are well below the cost of overhead and storage to January 2017 (Figure 1). The soybean pricing opportunities for fall delivery has been limited since July 18 where there was potential to cover total economic costs with a harvest CFC sale. As bids for harvest and January delivery have declined, there is limited opportunity to lock in a January CFC bid that would cover total economic costs plus the minimum storage costs. Managers considering early 2017 delivery should establish pricing objectives and monitor the market for opportunities to lock in profitable prices when they are available. Managers need to fully understand their per bushel costs to guide their marketing. Spot prices tend to decline into harvest so managers should determine the amount of production in excess of available on-farm storage and analyze pricing alternatives rather than selling off of the combine into the spot market at low prices. Topic 4. Comparing Storage Costs and Spot Price Appreciation from October to Spring and Summer It is worthwhile to compare the cost of storing corn and soybeans on-farm to the cost of off-farm storage through a delayed pricing (DP) contract. This analysis will compare the cost of each method for three different storage lengths to identify when one method may become more expensive than the other. 5

6 On-farm storage costs are estimated using research from Kansas State University (MF2474), the University of Illinois (farmdoc daily 4(179)), and Iowa State University (Edwards). It is assumed that 1% moisture is removed with the same drying cost on-farm as off-farm. Corn stored on-farm has a shrink of 1% plus 0.1% per month stored. The shrink for off-farm stored grain is 1.4%. The interest cost reflects the opportunity cost of delayed revenue. The corn crop could have been sold at harvest for $3.18/bushel with revenue used to pay debt or to earn a return elsewhere. A 5% annual interest rate is assumed with the opportunity cost compounding monthly from October until the sales date. Low-debt farms may have a lower opportunity cost. Conversely, farms with debt at interest rates greater than 5% have a higher opportunity cost. The opportunity cost is the same for on-farm and off-farm storage. The variable cost of on-farm grain handling and conditioning is assumed to be $0.10/bushel based on estimates from Iowa State. Perhaps this cost will be greater when corn is stored into late spring and summer as more aeration will needed to keep the grain in condition. However, this cost is kept constant for simplicity in this analysis. The off-farm storage fee is modeled by a DP contract. A flat fee of $0.40/bushel is charged from October until January 31, Then the additional charge is 0.04/month. This is based on conversations with elevators in Western Kentucky (Table 6). Table 6. Comparison of On-Farm and Off-Farm Western Kentucky Corn Storage Alternatives for 2016 October 2016 through January 2017 October 2016 through April 2017 October 2016 through June 2017 On-farm Off-farm On-farm Off-farm On-farm Off-farm Drying 1/ $0.035 $0.035 $0.035 $0.035 $0.035 $0.035 Shrink 2/ $0.045 $0.045 $0.054 $0.045 $0.060 $0.045 Interest 3/ $0.053 $0.053 $0.093 $0.093 $0.119 $0.119 Handling/Conditionng 4/ $0.100 $0.100 $0.100 Quality Loss 5/ $0.032 $0.032 $0.032 Storage Fee 4/ $0.400 $0.520 $0.600 Total $0.264 $0.533 $0.314 $0.692 $0.346 $0.799 Harvest Price $3.180 $3.180 $3.180 $3.180 $3.180 $3.180 Total Cost as % Harvest Price 8% 17% 10% 22% 11% 25% 1/ Drying cost is $0.035 per point removed for both on-farm and off-farm storage. 2/ Shrink of 1% per point of moisture removed plus 0.1%/month stored on-farm. Shrink for off-farm storage is 1.4% per point of moisture removed. 3/ Interest is 5% per year. For $3.18 corn, this is $ /month. 4/ Commercial storage is $0.40 until January 31 and is then charged an additional $0.04/month. On-farm handling/conditioning is $ / Quality loss for on-farm storage is estimated at 1% per bushel. Table 6 is a reminder that on-farm storage systems are both a great source of income tax depreciation as well as the lowest cost storage alternative regardless of when the crop is sold. The total on-farm storage cost for sales in January, April and June are $0.264, $0.314 and $0.346 per bushel, respectively. The opportunity cost is about 20% of the total storage cost when selling in January but is over 34% of the on-farm storage cost for the June sales date (Table 6). The opportunity cost of grain is an important, but sometimes forgotten, cost of storing grain. The off-farm storage cost is $0.533, $0.692, and $0.799 per bushel for the January, April and June pricing dates, respectively (Table 6). To make this storage method profitable, the price will need to appreciate by over 17% for January 2017 sales with up to 25% appreciation needed for sales in June 2017 to just cover off-farm storage costs. Table 7 reports the analysis of on-farm and off-farm storage alternatives for soybeans. Three sales periods are considered October through January; October through April; and October through June. Shrink is assumed to be 0.25% for on-farm storage and 0.5% for off-farm storage. The opportunity cost is calculated at 5% annual interest assuming a harvest price of $9.46/bushel and is the same for on-farm and off-farm storage. On-farm handling/conditioning is $0.10/bushel regardless of when soybeans are sold. The off-farm storage fee is modeled by a DP contract. The storage fee is $0.30/bushel from October through January. An additional charge of $0.04/month is charged after January (Table 7). As in corn, on-farm storage is the low-cost storage alternative (Table 7) by a wide margin regardless when the soybean crop is sold. The opportunity cost is a significant component of the cost of on-farm storage as it is about 42% of the storage cost for sales in January and increases to over 62% of the total storage cost for sales in June (Table 7). Table 7 provides the minimum price appreciation needed from the October price to just cover the budgeted storage costs. If storing soybeans off-farm to January 31, 2017, the soybean market must increase by 5% to 6

7 $9.96/bushel to just cover the budgeted storage costs. If storing soybeans off-farm until June 2017, the price appreciation must be 10% for a June 2017 soybean price of $10.36/bushel to just cover the budgeted storage costs. Table 7. Comparison of On-Farm and Off-Farm Western Kentucky Soybean Storage Alternatives for October 2016 through January 2017 October 2016 through April 2017 October 2016 through June 2017 On-farm Off-farm On-farm Off-farm On-farm Off-farm Shrink 1/ $0.024 $0.047 $0.024 $0.047 $0.024 $0.047 Interest 2/ $0.158 $0.158 $0.276 $0.276 $0.355 $0.355 Handling/Conditionng 3/ $0.100 $0.100 $0.100 Quality Loss 4/ $0.095 $0.095 $0.095 Storage Fee 3/ $0.300 $0.420 $0.500 Total $0.376 $0.505 $0.494 $0.743 $0.573 $0.902 Harvest Price $9.460 $9.460 $9.460 $9.460 $9.460 $9.460 Total Cost as % Harvest Price 4% 5% 5% 8% 6% 10% 1/ On-farm shrink of 0.25%. Shrink for off-farm storage is 0.5%. 2/ Interest is 5% per year. For $9.46 soybeans, this is $0.039/month. 3/ Commercial storage is $0.30 until January 31,2017. An additional $0.04/month is charged after January. Handling/Conditioning of on-farm storage is $ / Quality loss for on-farm storage is estimated at 1% per bushel. The other side of the storage-cost coin is analyzing the appreciation in spot prices from harvest into the spring or early summer to understand potential returns to storage. The past ten years have witness impressive appreciation in spot prices from the traditional October harvest-time low into spring and summer. This decade benefited from strong domestic demand for corn for biofuel and soybeans for export. This period also had three consecutive years with below-trend yields that contributed to persistently tight levels of ending-stocks. Figure 3 shows the average monthly spot price as a percentage of the October harvest-time price for Western Kentucky corn for the 2001 to 2015 corn crops. The spot corn price in January is, on average, 12% greater than the harvest price. Figure 3 shows that the maximum price appreciation tends to occur in June. Notice the difference in price appreciation for the 2014 and 2015 corn crops. The 2014 crop had spot prices consistently 24% or more higher than the October price throughout spring and early summer. In contrast, the 2015 corn price didn t strongly appreciate until May and June JAN FEB MAR APR MAY JUN JUL AUG Figure 3. Western Kentucky Corn Price Appreciation, Relative to October Price, for 2014, 2015 with Average. Figure 4 shows the soybean spot market price appreciation from harvest in October to January through August post-harvest. The maximum appreciation from 2001 to 2015 has tended to occur in June with the second highest month in July. For those that are not comfortable in waiting until late spring to price, the May soybean price has been about 18% higher than the harvest price from 2001 to Notice the importance of the South American weather market on soybean prices for the 2015 soybean crop as there was limited price appreciation until April. Also notice the limited price appreciation for the 2014 soybean crop which made it challenging to obtain positive storage returns. 7

8 JAN FEB MAR APR MAY JUN JULY AUG Figure 4. Western Kentucky Soybean Price Appreciation, Relative to October Price, for 2014, 2015 with Average. Topic 5. Corn and Soybean Storage Risk Management Alternatives to February 2017 Previous newsletters have focused on pre-harvest price risk management for corn and soybeans. As harvest is getting underway, we will switch the focus on the alternatives available in managing price risk for stored grain. We have already talked about cash forward-contracts for storing grain into January. Let s look at the alternatives available if corn and soybeans are stored to February The black dashed line in Figure 5 is the per bushel total variable cash cost + cash rent + on-farm storage cost from October through February assuming a harvested yield of 172 bushels/acre. These costs are based on the 2016 crop enterprise budgets for Western Kentucky with an emphasis on covering cash costs, cash rent and storage. Ideally you would strive to cover total economic costs plus provide a return for family living, debt payments, management and future business growth. Consider the black line at $3.69/bushel a minimum price needed to cover the cash costs of farming and storing grain. Cash CFC Futures Put TVC+Rent+Storage $5.25 $5.00 $4.75 $4.50 $4.25 Cash Price $4.00 $3.75 $3.50 $3.25 $3.00 $2.75 $2.50 $2.80 $3.00 $3.20 $3.40 $3.60 $3.80 $4.00 $4.20 $4.40 Futures Price Figure 5. Comparison of Price Risk Management Alternatives for Storing Corn from October 2016 to March Cash forward-contracts for February delivery (red line) are scarce on DTN but a few in the region were listed at an average of $3.45/bushel which would be a -$0.24/bushel return over the pricing objective. Similarly, a hedge with March futures (green line) at $3.47 would lock in a price at $3.57 assuming a basis of +$0.10/bushel in February. This hedge would lock in a return of -$0.11/bushel over the pricing objective. A just-in-the-money put option (orange line) with a $3.50 strike price costs $0.21 and would create a floor at $3.48/bushel and a -$0.21/bushel return. When 8

9 March futures are at $3.75, the put is better than the hedge and the CFC. The March put expires on February 24, 2017, so risk coverage ends on that date. Price risk management alternatives for soybeans are illustrated in Figure 6. The pricing objective of $8.97/bushel will cover the per bushel cash total variable production costs, cash rent and on-farm storage from October to February based on the state average yield of 51 bushels/acre. A few locations were offering a CFC for February 2017 at $9.74/bushel which would be a $0.77/bushel return (red line). Similarly, hedging with March soybean futures (green line) would lock in a price at $9.84 assuming a basis of +$0.10/bushel. The hedge would be a $0.87 return over the pricing objective. A just-in-the money put (orange line) with a $9.80 strike price costs $0.49/bushel and would provide a floor at $9.41 which is $0.44/bushel above the pricing objective. When March futures are at $10.13/bushel or higher, the put option is better than the hedge and better than the CFC. Harvest is a hectic time as you race to get the crops out of the field and into storage. It is important to not forget the pricing function of storage and to consider risk management protection that meets your pricing objectives whenever they are available. $12.00 Cash CFC Futures Put TVC+Rent+Storage Cash Price $11.50 $11.00 $10.50 $10.00 $9.50 $9.00 $8.50 $8.00 $7.50 $7.00 $7.00 $7.50 $8.00 $8.50 $9.00 $9.50 $10.00 $10.50 $11.00 Futures Price Figure 6. Comparison of Price Risk Management Alternatives for Storing Soybeans from October 2015 to March Topic 6. How Have Storage Hedging with March Futures and Puts Performed since 2000? A common theme of this newsletter is to demonstrate risk management opportunities and to evaluate the past performance of hedging with commodity futures or put options in managing revenue risk. In this period of lower commodity prices and tight profit margins, finding revenue opportunities through storage is foremost in manager s minds. Where does risk management fit into this equation of seeking higher revenue? The objective of risk management is to reduce the scope and frequency of bad outcomes in this case lower prices post-harvest. Fortunately for Western Kentucky grain farmers, price seasonality tends to limit the number of years where spot prices are lower post-harvest than at the harvest-time price in October. Table 8 compares the risk management strategies of hedging with March corn futures, buying the closest to the money March corn put option and the do nothing strategy of spot sales after harvest. The harvest-time price is assumed to be the October average cash price for Western Kentucky based on cash market data provided by the Kentucky Farm Bureau Federation. Table 8 shows the average change in the corn price from harvest through February. For the sixteen years being compared, spot corn prices have increased 14 of those years from October to January. The average increase in corn price for those 14 years was a $0.43/bushel increase from October to January. The average price decrease in the two years was $0.12/bushel from October to January (Table 8). Hedging with March corn futures will reduce the risk of lower spot prices but at the cost of a lower average return as compared to the do nothing strategy of spot market sales. The average increase in corn value with hedging from October to February was $0.14/bushel lower than the no-risk management strategy. Hedging with futures can reduce the downside risk. However, the average price increase with hedging is reduced. Managers should 9

10 consider if they have the financial capacity to absorb the risk of lower prices under the do nothing strategy. If not, consider hedging with commodity futures. Put options are easier to manage than hedges as the cost is known at purchase and puts do not have the potential cash flow problems of making margin calls as compared to hedging with futures. Option premiums have been expensive and purchasing expensive puts actually increases the frequency and size of lower net prices (Table 8). Table 8. Comparison of Western Kentucky Corn Risk Management Alternatives from 2000 to Change in Value from October to: NOV DEC JAN FEB Spot Sales - No Risk Management 1/ Average from 2000 to / $0.16 $0.24 $0.36 $0.47 Average in Years of Higher Prices 5/ $0.22 $0.38 $0.43 $0.64 Number of Years 5/ Average in Years of Lower Prices 6/ -$0.10 -$0.16 -$0.12 -$0.06 Number of Years 6/ Storage Hedge with March Corn Futures 2/ Average from 2000 to 2015 $0.14 $0.23 $0.28 $0.33 Average in Years of Higher Prices $0.16 $0.25 $0.28 $0.33 Number of Years Average in Years of Lower Prices -$0.10 -$0.10 $0.00 $0.00 Number of Years Storage Hedge with March Put Option 3/ Average from 2000 to 2015 $0.13 $0.21 $0.29 $0.39 Average in Years of Higher Prices $0.19 $0.29 $0.39 $0.51 Number of Years Average in Years of Lower Prices -$0.08 -$0.36 -$0.27 -$0.36 Number of Years / The average change in spot price from October to the deferred month without using any price risk management tools. 2/ The spot price in the deferred month plus any gain/loss from hedging with the March corn futures contract less the spot price in October. 3/ The spot price in the deferred month plus value of March corn put option less premium less the spot price in October. 4/ Average change in value from 2000 to / Average value in years when price appreciates after harvest and the number of years when price appreciates. 6/ Average value in years when price depreciates after harvest and the number of years when price depreciates. Table 9 provides a similar comparison for soybean price risk management strategies using March soybean futures and March soybean put options. The seasonality for higher cash prices has provided an average increase in spot price of $0.86/bushel from October to February. Of the sixteen years analyzed, three years did not have price appreciation with the average price decrease of $0.23/bushel (Table 9). Hedging with March soybean futures did reduce the number of times where the net soybean price was lower in January and February than at harvest. The size of the loss was also reduced from a $0.60/bushel loss to a $0.05/bushel loss for hedging from October to January. The average net sales price from hedging was a $0.36/bushel and a $0.52/bushel lower net price for January and February sales, respectively, as opposed to the do nothing strategy (Table 9). Again, managers should consider if they have financial resources to withstand a loss under the do nothing strategy. Put options had a larger average net sales price than hedging for soybeans. As in corn, the expense of the put premiums lowered the average net sales price by $0.20 and $0.27 for January and February, respectively, as compared to the do nothing strategy. The expensive put premiums also increased the number of years with a lower net sales price as compared to October. What does this mean for managers? Over the last sixteen years the strong seasonality has made the do nothing strategy one that has downside risk that is limited in frequency and size for corn. Soybean downside risk for the do nothing strategy is also limited in frequency but has the potential for larger per bushel loss. Using risk management blindly each year provides opportunities to reduce the downside risk. The cost of using futures or options does provide a lower average return over time. As you consider your financial strength, it is 10

11 worth comparing the potential benefit of using price risk management to lock in a positive return on a percentage of your stored grain whenever these opportunities are available. Those with greater capacity to absorb risk may be more comfortable with the do nothing strategy and trust in the likelihood of a seasonal price increase. Others may benefit from reducing the risk of lower post-harvest prices to preserve working capital. Table 9. Comparison of Western Kentucky Soybean Risk Management Alternatives from 2000 to Change in Value from October to: NOV DEC JAN FEB Spot Sales - No Risk Management 1/ Average from 2000 to / $0.27 $0.54 $0.71 $0.86 Average in Years of Higher Prices 5/ $0.46 $0.68 $0.80 $1.10 Number of Years 5/ Average in Years of Lower Prices 6/ -$0.28 -$0.42 -$0.60 -$0.23 Number of Years 6/ Storage Hedge with March Corn Futures 2/ Average from 2000 to 2015 $0.15 $0.29 $0.35 $0.34 Average in Years of Higher Prices $0.23 $0.34 $0.37 $0.34 Number of Years Average in Years of Lower Prices -$0.48 -$0.16 -$0.05 $0.00 Number of Years Storage Hedge with March Put Option 3/ Average from 2000 to 2015 $0.21 $0.39 $0.49 $0.56 Average in Years of Higher Prices $0.38 $0.48 $0.64 $0.81 Number of Years Average in Years of Lower Prices -$0.14 -$0.20 -$0.15 -$0.46 Number of Years / The average change in spot price from October to the deferred month without using any price risk management tools. 2/ The spot price in the deferred month plus any gain/loss from hedging with the March soybeans futures contract less the spot price in October. 3/ The spot price in the deferred month plus value of March soybeans put option less premium less the spot price in October. 4/ Average change in value from 2000 to / Average value in years when price appreciates after harvest and the number of years when price appreciates. 6/ Average value in years when price depreciates after harvest and the number of years when price depreciates. Topic 7. How Do I Get on the Distribution List to Receive this Newsletter? If you would like to receive each month s newsletter by , send an to todd.davis@uky.edu and request to be added to the distribution list. The Crops Marketing and Management Update is published monthly usually after the release of the USDA: WASDE report. You can find this issue and past issue on the UK Agricultural Economics Department s website at: Todd D. Davis Assistant Extension Professor Extension Economist Crop Economics Marketing & Management Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin. UNIVERSITY OF KENTUCKY, KENTUCKY STATE UNIVERSITY, U.S. DEPARTMENT OF AGRICULTURE, AND KENTUCKY COUNTIES, COOPERATING 11