Outlook: Lock Up Fuel and Knock Down Debt

January 23, 2016 05:00 AM
Outlook: Lock Up Fuel and Knock Down Debt

Many start the year with big resolutions and dreams of better times ahead. This year I have to admit the equities and commodities have started off with about as bearish of an attitude as I’ve seen in the market at this time of year. Essentially, the public is starting to panic. The funds have pushed open interest to record net short levels for many of the grains and oilseeds contracts. The sky is falling at exactly the time bears want to take profits and bulls start slowly accumulating for a trend reversal.

This places me in an unusual situation of trying to argue that most of the bearishness of macro fundamentals and big inventories is already factored into the grain and oilseed complex. I’m not suggesting the grain markets can’t dip a little lower in February or March on aggressive South American harvest pressure in soybeans, but I’m here to say now is not the time to panic!

Let’s focus on two components a farmer should examine during this time of negative price action.

Lock up fuel cost for a multiple-year program at 12-year lows. The ultimate lows in crude oil will come in the first quarter of 2016 when Iran oil hits the market. The pace of recovery will depend on how fast oil rigs are shut down and the global economy bounces back from it’s current weakness. 

In some cases, a farmer’s fuel needs can be locked up by a local distributor, but most are reluctant to go out more than a year and the premium charged is more than the carry in the market. I suggest figuring out how much fuel you use in a year and scale down buy  lead-month crude oil contracts. 

A large contract is 1,000 barrels or 42,000 gal., while a mini-contract is 500 barrels or 21,000 gal. It seems about one mini-contract per 1,000 acres is what most farmers would consider a fully hedged position. Focus on using the smaller contracts so you can scale into and out of the contract. There are various other contracts more specific to heating oil, natural gas and gasoline. But I’m more comfortable staying with the crude oil contract in the lead month. 

When the contract comes to the delivery time period, roll it forward a quarter at a time to reduce commission activity. At press time, there’s a big carry in the market that suggests buying nearby rather than deferred contracts.

Get your borrowing exposure insulated against any unexpected changes. We have seen interest drop from record highs in the 1980s to record lows now. This implies the bond market is going to come under pressure in 2016 and beyond as the Federal Reserve strives to raise interest rates to keep the risk of inflation in check. 

It is going to be a losing battle, but some time in the future the fear of inflation will trump the risk of higher interest rates. Subsequently, if farmers have a lot of short-term borrowing capital, they risk significant exposure in the next 24 to 48 months. If you can, aggressively move from a short-term to long-term borrowing strategy. Specifically, if you have land that is paid off, borrow against this asset and reduce your short-term borrowing needs. However, do not let short-term capital debt accumulate. 

If this alternative is unattractive but you want to protect yourself, look at being short the bond market to protect interest rate exposure. Since many don’t have a lot of experience in this sector, move slowly and focus on 10-year or 30-year contracts. The bond market can be volatile so don’t overplay your position. 

As we start a negative 2016, these points are two solid steps toward improving long-term profitability and protecting ourselves from policy changes as a new executive administration enters in 2017. 

Any opinions expressed herein are subject to change without notice. There is a significant risk of loss in trading futures and options, and trading might not be suitable for all investors. Those acting on this information are responsible for their actions.

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Spell Check

Ionia, MO
1/25/2016 01:41 PM

  In the 80's interest went from 10 to 18% in a short time less than a year making it very hard to make any payments. Good advise to lock up low interest A3FCC9

Kearney, NE
1/25/2016 07:14 AM

  "pay down debts",.... doesn't that require profits first Bob? One can't pay back anything when you lose money, and current prices don't allow for much, if any, profit. Also, the tiny amounts that interest is going to go up should be the least of our worries. ZIRP and QE have been, and will continue to be, disasters for Agriculture. Only ignorant "economists" can't see that.

Western, NE
1/25/2016 09:10 AM

  Just what I need, another few futures contracts to monitor on a daily basis. When should I expect to get my work done? What Bob is saying about oil is what we were told to do with commodities. Elevators in my area ceased doing long term futures contracts after 2008 when they had so much tied up in margin calls they couldn't operate. Hence the farmers conundrum too, how much to tie up in margin money? The commodity markets are forcing the farmer to become full time hedge fund managers. That's just not going to happen.


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