For a farmer to be successful in using a hedging strategy, they must have an agricultural lender that understands and promotes hedging.  Many lenders are willing to finance margin accounts for bonafide hedgers since they understand that the farmer is reducing their exposure to pricing risk.  Some will also lend a larger percentage of the value of stored grain if it is hedged rather than held on an unpriced basis.  Lending 90% of the hedged value of grain is a common practice.  Good lenders will also help the farmer evaluate how various hedging opportunities will effect the financial condition of the farm and help determine an acceptable level of price risk.

Some agricultural lenders utilize a three-way hedging agreements between the farmer, broker and bank.  In this arrangement, the brokerage house will send the margin call to the bank.  The bank then automatically lends the farmer the amount needed to cover the margin requirement and the sends it directly the brokerage house.  In this way, the farmer is assured that the money is available to cover the margin risk.  If futures positions are liquidated, the profits are sent to the bank to be put into an interest bearing account for the farmer’s benefit.  These arrangements can help reduce the stress of receiving a margin call by the farmer.  The farmer will also get copies all transactions.

Before initiating any hedging strategy, check with your bank to see what type of hedging program they offer.  If the answer is none, either educate the bank or possibly find a new one that understands hedging.

 Most ag grain producers are able to lock in prices by using either a hedge or a forward contract.  Forward cash contracting involves a commitment to deliver grain to a grain buyer at a future time.  Both alternatives can be used to: price before and after harvest; establish a return for storage of grain; and reduce price risk.  Thus, deciding which alternative to use depends upon weighing hedging advantages and disadvantages in comparison to forward cash contracting.

Hedging Advantages vs. Forward Cash Contracting

• Hedging allows flexibility to later select the appropriate delivery point to take advantage of competing buyers for your grain.
• Hedging allows you to reverse a decision based upon changes in growing conditions, changes in price outlook and changes in the condition of stored grain.  Once a forward cash contract commitment is made, it is very difficult to change or cancel.  A position in a futures contract can be terminated almost immediately.
• Hedging allows the farmer to speculate on basis improving.
• Hedging generally lengthens the potential pricing period to 20 to 24 months, including about one year before and after harvest.  This can be longer than a forward cash contract.

Hedging Disadvantages vs. Forward Cash Contracting

• In hedging, you may not know the final price due to changes in the final basis as compared to the initial basis.
• Hedging is more complex than forward cash contracting.  To hedge successfully, a farmer must understand futures markets, cash markets and the basis relationships between the two markets.  They must trade in a futures market and involve a commodity broker and have a banker who understands and is committed to hedging.
• Margin money is required to maintain a futures position.  A forward cash contract typically does not involve margin deposits.
• Hedging involves commissions and interest on margin money.  These extra costs may average 1 to 2 cents per bushel.
• Since hedging generally involves using future contracts in either 1,000 or 5,000 bushel lots, the farmer is locked into these quantities to hedge.
• Basis levels may not gain as expected and can even widen more than expected.

Remember that hedging never guarantees a profit.  The hedging decision needs to take into account production costs and market outlook.  However, the good use of a hedging program can help the farmer prevent pricing indecision where the farmer “does-nothing-until-forced-to-sell-strategy” which normally leads to much lower prices.

 The idea for this blog was a glimmer in my mind at the end of 2008.  While surfing on the web, I found the Golden Practices web-site that listed different industry specific blogs.  This spurred me to action and with their help, we had a fully up and running blog site in the first quarter of this year.  Some of the experiences and reflections that I have for 2009 are:

• 1.  Our readers are a very geographically diverse group.  I expected to have most of my readers from the corn belt of the US, while this is true, we seem to have many readers from India, Australia, Canada, Europe and all over the globe.  I assume most of them read English and I hope they have learned a lot about US farming.

2.  Altough I am a CPA by trade, I grew up on a farm and farmers are business people first, and taxes and finance and accounting is just part of the equation.  I have tried to balance my posts with operations, marketing, accounting, taxes and trends. 

3.  I believe that the mega trends are and will continue to support farming as a great business going forward.  All of the world has to eat and this requires farm.  Horse and carriage was replaced by cars which may be replaced by some other form of transportation a 100 years from now, but we will still be farming at that time.  China and India other growing countries will demand better food with more protein as they mature.  Our American farmers will be there to provide a lot of this food.

4.  I have set an ambitious goal for myself to get some type of online “Farmers Tax Guide” up and running by the end of 2010.  I have several parts of it done, but to be fully operational and run the way I want it to may require programming skills that I do not currently have.  Also, with tax season for me rapidly approaching, not much will get done between now and April 15.

5.  The best thing about this blog are the wonderful people that I have met or communicated with that are doing similar blogs.   A couple that you should check out at “The Exuberant Accountant“, “The Roth & Company Tax Update Blog“, and “Legacy by Design“.  You can not go wrong by checking these sites out.

6.  I thought I would get more comments on the postings and for several months, I did not get any at all.  Recently, I have started to get more comments and e-mails and I really appreciate the feedback.

7.  I also enjoyed trying to work up “White Papers” or “Tax Bulletins” on subjects that my readers have questions on.  I have already done several of these and I am planning on putting them in a little better format and posting them to the site early in 2010.

Last, but not least, we want to wish everybody a prosperous New Year in 2010 and we look forward to seeing what the year brings.