Sharpen Your Business Plan
Last year, the decision to plant corn/soybeans or wheat was often based on which crop would yield the most net profit. This year, the decision may very well be which will lose us the least.
In just seven months, our world has been turned upside down. Gross returns for corn have dropped by $500/acre and soybeans, $150 to $200.
Given the implosion in worldwide financial markets, the big question is which will we destroy faster—production or demand? Speculation on price improvement based on the fact that "the world has to eat" is not advised!
Lack of capital and third-party risk concerns will change what and how much the world grows, eats, and consumes.
Crop choice. The cash-flow shock is likely hitting home this month. Total cost of production doubled in two years, while gross income is nearly half of what it was seven months ago. The estimates in the table do not include land costs and are a moving target depending on futures prices at planting time and who will blink first—farmers or seed/fertilizer/chemical suppliers.
Corn at 150 bu. does not compete well with 45-bu. soybeans. Anything less than 180-bu. corn or 50-bu. beans may mean returns insufficient to cover land rent. Unfortunately, a deflation-focused market may not care about the relative price difference between crops.
What to do. Focus on maintaining ownership. A well-thought-out capital-requirement business plan can pay huge dividends of perhaps $50 to $100/acre while keeping control of your financial destiny.
I have long advocated that the cost of managing price risk be a line item on your budget. Note that in 2008, the cost (interest on margin) to hedge $6.50 corn lasted only about six weeks. Corn hedged last year at $6 eventually required a $2/bu. margin payment. Interest at 6% for two months is about 1¢.
Granted, the initial margin may have doubled as well, requiring an extra $1,500 per 5,000-bu. contract of corn. But that is a short-term "investment"; only the interest cost of the extra margin is an increase in expense.
Yet the basis at my elevator in northern Illinois last month was –70¢ for fall delivery (40¢ worse than normal), ostensibly because of elevators' margin risk. I‘d leave that on the table if I contracted (not to mention the ability to capture 50¢ to 60¢ market carry after harvest).
The plan. If you are a typical U.S. corn farmer, your yield was about 154 bu./acre (perhaps 200 bu. in the main Corn Belt states). For starters, the portion of the crop not covered by revenue insurance (about 20% to 30% of adjusted production history) should be hedged. In addition, another 20% should be under self-management, leaving 50% to be sold under the wide basis offered by cash contracts, if you so desire. I would prefer 90% to 100% under self-management, but that may require an understanding banker with money—an oxymoron in today's world.
Because of insufficient storage and/or capital, we have left money on the table through lack of flexibility in marketing and the inability to maintain beneficial interest. Lack of capital will get worse this year. Do the math and work with a banker who understands what managing risk is all about, or get another banker.
The world of agriculture has changed, and not being held hostage to changing times gives "Freedom to Farm" a whole new meaning.
Jerry Gulke farms in northern Illinois and North Dakota and has a consulting office at the Chicago Board of Trade. Contact Jerry at firstname.lastname@example.org or (312) 896-2080.
Top Producer, January 2009