I am a firm proponent of using hedges to lock in your cost of production when you can.  However, you must not just look at what your commodity price is trading at on the relevant exchange.  You need to determine what your basis is and how it compares to the historical trends.

Basis is the difference between what your local elevator, ethanol plant or other buyer is willing to buy your crop for and what the price is on the exchange.  For example, assume you can sell your corn locally for $3.85 per bushel and on the exchange it is selling for $4.25.  Your basis is in this case a negative 40 cents. 

For growers that are far away from the end user of the product, their basis is normally quite negative compared to other growers.  This is due to the cost of shipping the product to market.  A grower with several ethanol plants competing for product will normally create the best basis for corn growers (in many cases you will have substantial positive basis, while a wheat grower in Montana that has to ship his product by rail to Seattle to ship it overseas will have a very negative basis).

After determining what your basis is, you need to review how the current basis compares to the trends over the last several years.  This comparison of the deviation from the normal trend will give you data as to whether you expect it to narrow toward or away from the exchange price.  This can effect whether you want to put on a hedge or use some type of forward contract.

The Kansas State University has a great Crop Basis and Deviation service that they provide on an almost weekly basis.  They provide a map for several mid-west states showing the current basis and the deviation from a three year average.  If you are in one of those states, bookmark this site and watch how your basis changes over time.   

As you become familiar with your basis, you will make more informed decision when and how to sell your crop.

Agriculture Online has a good quick article on whether farmers will reduce their production levels in 2010 due to the large crop that was grown in 2009.  Corn has rallied about a $1 since early September and soybeans have gone up about $2. 

However, the government report on Tuesday led to limit down price moves in corn.  Surprisingly to the author, farmers seem to be upbeat this time of year compared to previous years.  It seems that the fundamentals of the world grain market may have changed to promote high levels of production since the demand is now starting to keep up with these levels of production.

I think you need to make sure not to rely on this, but rather, make sure you have marketed enough of your 2010 production to cover your input costs.  At these price levels, you should be able to still get good pricing to cover them.

 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.

 Most farmers are of an independent nature, however, in one area they may want to consider partnering up on is grain storage.  The decision to build on-farm grain storage can be very complex.  Farms that are mid-size or smaller usually find it cheaper to continue to bring their grain to an elevator versus storing it on their farm.

However, if their are several compatible farm operations in a central location, the idea of Condo Storage may make a lot of sense.  The benefits are that instead of each farmer having to spend the same amount on certain items related to the storage facility that cost the same whether they build 5,000 bushels or 500,000 bushels, they may be able to pool their money together and only spend it once. 

Most of these condo storage operations have employed a farmer-owned LLC.  The farmer buys shares in the limited liability company and receive rights to store grain in proportion to the amount of shares owned in the LLC.  The storage structures and equipment are owned by the LLC, not the farmers.  This provides liability protection for the farmer investors.  If somebody were to get injured (or even die) working in the storage facility, the only asset at risk are the assets of the LLC, not the farmers assets.

The LLC then depreciates the structure and equipment and passes the depreciation back to the owners based upon their ownership percentage.  Also, the Condo LLC may charge each farmer a per bushel fee to store the grain and then the net income or loss is allocated to the farmer owners.   If a fee is charged, this allows the LLC to offer its storage to other farmers that are not owners of the LLC.  This can either help it make a profit or reduce the overall cost to the owners.  There is typically a board of directors elected to govern the LLC and make decisions regarding the assets it holds.

If the farmers do not want to manage the storage facility themselves, they can contract with a local grain cooperative to manage and run the facility for them.  Long-term lease options are also available under this structure.  To entice a local cooperative to get involved, several hundred thousand bushels of storage will probably need to be committed to the condo program.

I believe that many mid-size farmers should look into this opportunity especially with long waits and long travel times to get to grain elevators these days.

This type of condo project probably has returned a much higher rate of return than buying a Florida condo in the last few years.

Crop insurance has been available to farmers for many years.  Until recent years most of this insurance was based upon Actual Production History (APH).  Insurance products based upon Crop Revenue Insurance (CRI) have been introduced to enhance and/or replace APH.

Marcia Taylor of DTN/Progressive farmer had a good blog on how one farmer in Ohio is utilizing Crop Revenue Insurance as part of his risk management strategy.   One interesting paragraph stated that on a nationwide basis, CRI is now insuring about $33 billion of potential corn losses versus $4.3 billion for APH.   If total corn production is 12 billion bushels at an average of $3.50 per bushel, approximately 89% of the total US corn production is covered by crop insurance.

There are many reasons for this.  I think the primary reason is that CRI allows the farmer to lock in a guaranteed revenue level per acre on a much more consistent and predicable basis than APH.  The Iowa State University has several Ag Decision Maker articles on how all of these programs work.

I think that all farmers should carefully review these available crop insurance options and work with your financial advisor, banker and insurance agent to determine which is best for you.  At a minimum , you should make sure to lock in your input costs .  Also, most bankers are going to require this to obtain an operating loan or renew one.

Many farmers do a good job of benchmarking their operations to other operations in the same state of region.  By doing this benchmarking, they are able to see where they are either behind or ahead of other farmers.  Some get discouraged trying to get out of the middle range into the top 20%.  Most think that it is too hard to get there.

What I would like farmers to key in on is what I call the 5 + 5 + 5 = Home Run concept.  This is obtained by doing the following:

• Increasing yields by 5%,
• Increasing the price received for your crop by 5%, and
• Decreasing total costs by 5%.

Lets see how these objectives would apply on a typical farm. 

Lets assume that the average corn yield is 150 bushels with average price of $3.50 per bushel and the farmer has total costs of $2.50 per bushel.  His current net income is equal to 150 bushels times his net margin of $1 equals $150 per acre.

If we increase the yield by 5% to 157.50 bushels, the price to $3.675 per bushel and decrease costs from $375 per acre to $356.25 per acre his total return per acre will equal 157.50 times 3.675 or $578.81 per acre of revenue less $356.25 equals net return of $222.56.  By doing these 5 + 5 + 5 adjustments, the return goes from $150 per acre to $223 per acre or an increase of $73.  This equates to an almost 50% increase in profits.

As you can see, it does not take a large change in the three major production centers to yield a large increase in net income.  I suggest you review your numbers and set these 5% targets and even if you only hit 2 of them, you will be many dollars ahead.  Good luck.

We had a good weather rally back in the spring when it was apparent that the come would be planted lack due to the rain in Illinois and other areas.  It appears that we might be having a weather rally due to the frost coming this weekend.

I would highly suggest that you review your marketing plans for this crop and the 2010 crop to see if you need to lock in some good prices that are coming now.  If the current prices compared to production costs provide a profit, do not be shy about locking 20-40% of them in.

Too many farmers get emotional when they see a rally start, think it is going higher and wind up with missing the whole rally.  Do not let this one go by with the same problem.

I am headed back to my farm in Missouri next weekend and plan on driving a John Deere combine very similar to the one shown in the picture.  I am hoping it does not rain and I get to cut some 60 bushel beans or 200 bu corn.  This is always my vacation this time and year and for a farm boy like me, there is nothing better.

First off, an update on why there have not been any posts for a few days.  I went on a four day backpacking trip into the North Cascade Mountains of Washington state.  This is some of the best scenery in the whole United States.  I went with a friend that was in my wedding many years ago and we had not done this type of trip for several years.  I had a great time, lost a few pounds and did not get bitten by too many bugs.

After getting back, I found out my computer’s hard drive finally crashed on me.  I had another computer to replace it, but it took several days to get it up and running and will probably take another few days to get it exactly the way I want it.

For the current post, Successful Farming recent September 2009 issue has a very good article on the six sucessful steps needed to be a good marketer of your grain.  This article was written by Alan Kluis, who usually contributes a monthly article to the magazine.

The six steps are as follows:

1. Know Your Break-Evens – A good marketer will know exactly what is break-even point based upon price and yield.  They are willing to make sales when they get to a price level that works.
2. Be Consistent – A good marketer is consistent.  They sell about 40% – 60% of their crop in the key April-to-June period when seasonal trends are usually the best.
3. Make Sells on the way Up – They are willing to make incremental sales as the market is going up and keep making them.  I see too many farmers try for the exact top and by the time they determine what the exact top is, the market is 10 % – 20% lower and it is too late.
4. Be Disciplined – They are willing to sell when the market is bullish.  They have a sense of history and know when to sell and will pull the trigger to sell.
5. Use Seasonal Odds – These farmers tend to not sell in the low seasonal periods, but rather, wait until the normal seasonal high periods to sell.  They take advantage of new crop hedges, cash sales or put options to lock in these prices.
6. Use a combination of tools - They use a combination of risk management tools.  The majority of them take advantage of CRC or RA insurance.  They will tend to insure their “A” bushels which is the core crop yields and use put options to get price protection on their “B” bushels.

All-in-all, this is a very summary of what all farmers should try to obtain in their marketing efforts.

As the global economy turned south a year ago, the Food and Agricultural Policy Research Institute at the University of Missouri decided to revise their projections of food prices and production over the next five years.  This was done early in the year and many commodity prices have changed direction in the last several months.  FAPRI has issued an updated report as of August, 2009 give new updated estimates.  Has the outlook gotten better or worse?

Although prices have fallen from the 2008 peak, many of the major commodity prices remain above pre-2007 levels.  FAPRI is predicting that petroleum prices will increase over the next five years, however, they will not get back to the high levels of 2008.  Also, this will lower the demand for ethanol and bio-diesel which will lower the pricing for corn and related products.  The offset is that the cost of petroleum and fertilizers will be lower than peak pricing.

Corn Update – Corn acreage will climb steadily from 87 million to about 90.4 million in 2014.  FAPRI is estimating a new crop record of about 165 bushels per acre, however, this extra production will be offset with additional use for Ethanol.  It appears that the average price of corn will remain under the $4 level between now and 2014, however, it will still exceed pre 2007 baseline levels.  Net per acre returns before cash rents are expected to average around $300 per acre.

Soybeans Update – Acreage will remain steady at around 78 million acres till 2014 with yields steadily climbing to around 43.2 bushels per acre.  FAPRI is predicting pricing to remain in the $9 to $10 range.  For each year, carryover is projected to average around 220-230 million bushels.  This means that if there is any weather scares or disease issues, the price could increase dramatically.  Net per acre returns before cash rents are expected to average around $240 per acre.

Wheat Update- Acreage will decline from the peak acreage of 55.7 million acres in 2008 to around 49 million in 2014.  The yield is expected to climb slightly and the pricing appears to average between $5 and $5.50 between now and 2014.  Net per acre returns before cash rents are expected to average around $90 per acre.

Cotton Update – Cotton acreage during these years peaked out in 2007 at 10.2 million acres.  It is expected to remain level at the high 7 million acres between now and 2014.  Pricing is expected to increase from the bottom of 49 cents per pound to about 61 cents per pound in 2014.  Net per acre returns before cash rents are expected to average around $140 per acre.

Livestock Update – The beef herd is expected to continue its liquidation trend until about 2012.  This will reduce the herd by about 2 million head to 30 million total.  Pricing is expected to expand from the current 85 cents per pound to over a dollar for an average 1,100 – 1,300 pound Nebraska steer.  Net returns are expected to become slight profitable next year and then top out in 2013 at about $70 per head.

Swine Update – Some liquidation will continue over the next couple of years, with production starting to increase in 2012.  Pricing should firm from the drastic lows of last year and this year to around the high 50 cents per pound for barrows and gilts starting 2011 and beyond.  Returns will remain negative this year at around $8 per head and trend up to a perhaps $8 per head in 2011 and 2012, however FAPRI expects returns to drop to zero in 2014.

I came across a good marketing company be watching Agday the other day.   Alan Brugler was discussing the corn and bean market and I decided to go check out his web site.  He is located in Omaha, Nebraska and has a very good short guide on how not to be a marketing lemming.

I will highlight the 12 steps to not becomming one and you can read the full article to get more details.  The twelve steps are:

1. Find a method that works for you and stick with it.
2. Don’t gather data that inevitable contradicts.
3. Remember that the market satisfies need, not greed.
4. Don’t demand consistently high returns.
5. Beware of your success threshold.
6. Make your own final decisions.
7. Isolate emotion from order time.
8. Don’t argue your position with friends.
9. Avoid highly leveraged positions.
10. Remember that your current market position is never perfect.
11. It doesn’t matter why, it matters which way.
12. Make marketing a habit.

I would strongly suggest reading this memo several times and try to determine where your marketing strategies fit within this.  Remember that a lemming only goes one way eventually and that is down.