The Real Cost of Marketing
As the market sought to balance record corn and soybean crops, widely varying world wheat crops and ever-growing usage over the past two years, we saw wide, sometimes wild, fluctuations in basis (the difference between futures and cash prices). Next year promises to be more of the same.
Adding to farmers' stress in the summer of 2008, major buyers, at a time we needed them most, stopped contracting, citing difficult markets and excessive hedging (margin) exposure. Those who did buy widened their basis significantly. My northern Illinois corn basis, traditionally –35¢ to –45¢, widened to –65¢ and soybeans, usually –40¢ to –50¢, ranged from –$1.25 to –$1.60.
Yet it took only six weeks for the rally that so worried corn buyers to soar from $6 to $8 and back down again to $6—a $2 margin call, but for a very short time. The 20¢ widening of basis during that time to "pay" for the phantom cost of hedging was excessive indeed.
Many producers also refused to dig into their pocketbooks for money to margin high-priced corn that got higher-priced, and bankers were reluctant to loan $2/bu. to margin profitable hedges, either because they don't understand hedging or are unwilling to approach it as an investment rather than an expense.
Where Costs Really Lie. I have long been a proponent of hedging (using futures and options) at least 60% of one's production and being selective on advance cash contracts on the remaining 40%. Here's an example of what hedging versus forward cash contracting corn in March 2009 would have wrought.
A futures hedge would have netted a 14¢ gain in futures and a 30¢ gain in basis, for an overall net price of $3.70 ($3.56 September cash price plus .14 hedge) versus the $3.40 my elevator offered me on March 2.
Had one cash contracted 25% of a 200-bu. corn yield, the buyer would have placed a hidden tax of 30¢/bu. (basis)from March to September—about $15/acre. The cost of a hedge, on the other hand, would have been the interest on the margin requirements of about 50¢/bu. at 6% for six months (less than 2¢/bu.).
Even more disturbing was soybean basis: –65¢ in February versus +70¢ to +$1.10 on Sept. 1. That meant a $1.35 to $1.75/bu. gain by hedging, or a $50/acre average difference.
It has never ceased to amaze me that we will complain about the cost of herbicide or fertilizer or a prime steak dinner, but readily kiss away $50,000 on 1,000 acres of soybeans by not using the tools of marketing.
Tight Margins. This benefit is most important during times of lower profit. If we are making $1/bu. on corn, for example, it isn't so bad to give up some of the gain for convenience, but when profits are tight, as they may be for some in the marketing year ahead, leaving 30¢ to 40¢ on the corn table may mean all the profit goes to the handlers and merchandisers.
Equally important to me for the past 25 years has been the ability to store at least 100% of a year's production so as not to be forced to accept harvesttime quality and test-weight discounts, not to mention high commercial drying costs. Plus, I may be able to capture a good market carry (often 40¢ in corn).
Couple the investment in storage and "investment" in the capital required for a hedging program, and as a producer you have two separate profit centers—growing the crop and marketing the crop. Both are necessary to compete in the volatile and uncertain ag world we are asked to compete within. Convincing your banker that a line item on your budget should be treated as an investment and calculated as a return to that investment may be more difficult than it looks, but your viability and success depend on it.
Jerry Gulke farms in northern Illinois and North Dakota and is president of Gulke Group Consulting at the Chicago Board of Trade; contact email@example.com or (312) 896-2080.
Top Producer, November 2009