Power Hour: Does It Pay to Lock in a Loss?

December 6, 2013 09:00 AM

With December 2014 corn futures hovering in the $4.50/bu. range much of this week, locking in price protection on at least a portion of expected new crop production might just be the best business decision you make for the year ahead, even if it’s barely at or even below your cost of production, some analysts suggest. "A smaller loss is better than a larger loss," says Corinne Alexander, ag economist at Purdue University.

"Admittedly, it’s hard to pull the trigger in this new environment of resetting expectations. It’s tempting to speculate," she says. But why Alexander and others recommend that risk-adverse producers consider locking a portion of expected 2014 production near current levels is this: December 2014 futures could decline from about $4.60 today (December 6) to $3.80 come June if the crop this spring gets off to a good start and no major weather problems plague South American corn and soybeans.
"Eighty cents would make a big difference on the bottom line," Alexander says. She adds that using a negative basis of 30 cents, the potential of $3.80 turns into a cash farm price of $3.50. That would chew up a lot working capital except for lowest-cost producers. That makes today’s new crop farm price of about $4.30/bu. (with basis of 30 cents) look not so bad, by comparison.
"The market will work its way down slowly," predicts Chad Hart, ag economist at Iowa State University. He sees the likelihood of $4.30/bu. futures on January 1 and closer to $4 by summer, assuming the most likely set of market fundamentals. "I think we’ll see some pressure." For the 2014 marketing year, he thinks the downside potential is $3.25/bu., with upside potential as high as $5.25 to $5.50. "New crop prices in June could have a $3 in front of them," Hart says. That assumes 92 million acres and no major weather events either here or in South America. "I think that what’s most likely, however, is for average new crop prices to be close to the cost of production," he says. Hart and others acknowledge that breaking even on corn and soybeans in 2014/15 would represent a significant victory. Besides marketing, key to that is cost control, trimming breakeven levels.
Because he gives a return to higher prices low odds, Hart says setting a price floor on unprotected bushels makes a great deal of sense. One strategy he suggests is $4 out-of-the money put options whose premium is relatively inexpensive, or even a $4.25 put if producers want additional downside protection, although a strike price at higher levels comes with additional premiums. Hart is quick to add, however, that the 2014 corn crop is still months away from even getting in the ground, so it’s important for producers not to box themselves in. Weather events and demand could spur at least short-term blips in prices and create market opportunities, he notes.
More bullish than most analysts is Frayne Olson, ag economist at North Dakota State University. "I put the December 14 corn futures range between $4 and $5/bu. Odds favor higher rather than lower corn prices. It will take an unexpected set of events to get prices below $4." Because of that, he does not recommend pricing now, particularly if prices are below the cost of production. Olson thinks that because so much could happen to crops before next fall, occasional price spikes are likely. "But if producers can get 20 to 40 cents more, they’d better take advantage of it and quickly and aggressively. Such spikes aren’t likely to last long."
What makes Olson more optimistic? Corn acreage of just 90 million to 91 million acres, less than most, due to acreage cutbacks in the outer reaches of the Corn Belt, and a stronger U.S. and global economy that will spur more meat demand and in turn demand for more feed grains. Because of that, Olson looks for stocks-to-use for the 2014/15 marketing year to be 14.5%, the same as 2013/14. Others look for the number to increase for the next marketing years. For 2007-11, stocks-to-use was 11% and 7.4% for 2012. At the same time Olson admits to being more of a bull than a bear, he nonetheless says it’s possible that December 2014 corn futures could even dip below $3/bu. "But I don’t give that more than 5% to 10% odds." What would it take for sub-$3 corn to occur? Olson says it would take weak demand from feed, ethanol and exports; higher than trend-line yields, and more corn acres than he is looking for.


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