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A Letter to Farmers

February 26, 2010
By: Bob Utterback, Farm Journal Columnist
 
 

I was recently asked by a grain producer: "What are the attributes of a successful grain farmer of the future?” I told him I wanted to give it some thought and would put it on paper. Here's my response.

Dear Producer,

When I thought about your question, I felt it came down to improving management in three key areas: production, price risk management and stabilizing input costs.

1. Production

Your product must be the superior quality that buyers want. The classic lesson taught in business school revolves around the story of the Edsel. A lot of market research was put into building the car that the market said it wanted. After Ford produced the lavish car, consumers did not respond. While consumers liked the concept on paper, what they really wanted was cheap transportation. The moral of the story for producers: While consumers say they want organic food, what they really want is "green” produce—high-quality food that is cheap!

Yields must be high enough to provide profit. Some economists suggest producers should push technological advances until the last unit of expense is equal to the revenue generated. This implies that there are three big areas for future improvement: control of diseases in high-yield populations; an effective use of water, especially in the Western states; and fertilization practices for optimum production in light of potentially more stringent runoff regulations.

In addition to producing superior quality, the product must be held until the buyer wants it. Producers will need to store on-farm to take advantage of basis and carry incentives. As many on-farm storage units approach the size of a modest elevator, I see a couple of problems developing. First, the farmer uses the grain bin as a substitute for selling inventory early. The logic is to get the grain in the bin and market it later. As many old-time elevator managers will tell you, the quickest way to go broke is taking unnecessary flat-price risk exposure. Second, in 2009 many producers learned that just because you have the storage space does not mean you have the dryer capacity to keep the combines running. As units get bigger, necessary management skills increase exponentially, not linearly.

Bottom line: Producers who continue to improve product quality along with yields and storage management will be the ones in position to take advantage of opportunities as they present themselves.

2. Price risk management

We all want to get the most from our production but at what risk? Is it prudent to have the chance to lock in $150 per acre profit but risk it for another $20 to $50?

As difficult as it is, take advantage of profits when the market offers them and then defend against unknown bullish price events. Granted, there will be periods (such as 2008 and 2009) of high prices when a perfect storm of unexpected demand (such as ethanol) merges with tight stocks and aggressive fund buying by outside money. In the end, prices were pushed way too high and we are now seeing the fruits: increased production not only in the states but on a global basis, as well.

3. Stabilizing input costs

This is the part of the management equation that producers have to work the hardest on to find ways to price in advance. One of the biggest problems in 2008 was that even though producers knew that selling expected 2009 and later corn production at $6 was a home run, they were paralyzed
because of the uncertainty about hedge management, cash rents and input costs, such as fertilizer.

To become a more effective manager of risk—in order to forward sell expected inventory when opportunities develop—focus on interest rate management, fertilizer cost control and land management.

Interest rate management. Now is the time to focus on strategies to lock up long-term interest rates. Producers have been spoiled by a 27-year trend of declining interest rates. The stage is being set for rates to increase, probably by late 2011 to early 2012, to help offset significant government debt. I suggest the following ways to prepare:
 

  • Get away from one-year variable rates and move as much debt as possible into long-term structure.
  • If you must maintain short-term debt, know the publicly traded interest rate instruments and consider selling them to offset future upside interest rate exposure.
  • A working relationship with your banker proves to him or her that you know how to manage market risk. Should you ever decide to sell two years' of expected production of corn at $4.50, for example, your banker will want to be comfortable with your hedging practices.


Fertilizer cost control. As demonstrated in 2008, when fertilizer prices exploded, it was difficult to pull the trigger on 2009 corn sales and beyond. I suggest that you take these steps:
 

  • Buy natural gas on seasonal weakness to protect expected 2011 and 2012 nitrogen price exposure.
  • Buy crude oil or gasoline on seasonal corrections to protect expected 2011 and beyond gas and diesel needs.
  • Think out of the box when trying to stabilize fertilizer costs, but don't jeopardize yield or crop quality in the meantime.
  • Establish a long-term relationship with livestock operations to secure availability of manure.
  • Stockpile phosphorus and potas-sium when prices are lower, rather than annual purchases.


Land management. Land control is always a key concern. It can be a serious problem to lose a cash lease when you bought equipment, invested in storage facilities, etc. Keep in mind:
 

  • Buying land is better than cash renting at this time because of current low interest rates and the expected inflationary influences that will force prices up over time.
  • If forced to cash rent, try to negotiate a longer-term lease. Three years is the absolute tightest time period to consider; five years gives you a little more breathing room. To get the longer-term cash rent agreement, you may have to agree to higher payments to the landlord in exchange for a consistent cost that allows greater confidence in making multiple-year sales when opportunities develop.
  • In the end, it comes down to your preference. Would you rather have an income trail where one year you make $300, then $200, then $100, then $50, then $100, or a five-year pattern of $150 year after year? Call me crazy, but I want a boring profit curve, one that is solid and consistent, rather than an inconsistent pattern from extremely high to extremely low.

The information provided is believed to be reliable. There is a risk of loss associated with trading futures and options. Anyone acting on this information is doing so at his or her own risk. Consult your Risk Disclosure Statement before trading. To comment on Outlook, e-mail Outlook@farmjournal.com. For information on risks and strategies or to subscribe to Bob Utterback's Internet site or e-mail service ($400 per year), call (765) 339-7704 or e-mail bob@utterbackmarketing.com. You can read daily comments from Utterback after markets close at www.farmjournal.com.
 

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FEATURED IN: Farm Journal - Mid-February 2010

 
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