Protecting prices in down market

Ray Mueller
Now Media Group


Wherever one looks in the worldwide commodities markets, prices have been in a significant downturn in recent months.

Because this also applies to the agriculture sector, farmers ought to think seriously about 'pricing your commodity before you produce it,' commodities marketing adviser Chris Atten told attendees at a 'Managing the Margin Squeeze' program sponsored by Investors Community Bank.

Atten, who is a principal in Atten Babler Commodities at Galena, IL, reminded farmers that they are 'at the mercy of prices' and in effect are 'price takers' rather than price makers for themselves. Atten's firm, which also has a satellite office at Visalia, CA, emphasized taking a hedging position in the marketplace is a way to create a floor on prices while, at no more than the cost of premiums, leaving the topside open in case of price increases.

With such an approach, one's net risk is reduced and 'what direction the price moves does not matter,' Atten remarked. He finds that too many sellers of agricultural commodities are caught in a 'panic and fear marketing' pattern instead.

Because he owns 1,500 acres of cropland in Lafayette County along with irrigated cropland in Texas, Atten noted he has first-hand experiences with the pricing patterns and challenges that all crop, dairy and livestock farmers face. At a minimum, 'have a plan for 2016' and beyond, he urged.

'Be more than a producer,' Babler advised. He said an alternative answer — although not palatable to most producers — to today's low prices in the agriculture sector is 'to plant less acres' of corn and soybeans and 'to kill cows.' Another possibility is a repeat of the 2012 drought which triggered two years of record high corn and soybean prices, he said.

What constitutes success in a commodities market is matching one's price exposure risk with hedging positions that include the buying of put options (protecting a floor price), the selling of call options (removing price caps) or the devising of more complex strategies such as 'fencing,' Atten explained.

For his 2016 corn to be grown in Lafayette County, Atten has calculated that he needs a breakeven selling price of $4.11 per bushel — a price not available in the current futures markets. Depending on what yields they are able to achieve this year, many corn growers are likely to lose $40 to $60 per acre on their 2016 crop, he warned.

In such a scenario, they need to be alert for any pricing opportunities and take advantage of them, Atten stressed. Given the world's projected carryout of 208 million metric tons of corn at the end of the 2015 crop marketing year and the $3.80 to $4.80 per bushel breakeven prices that most growers in the United States are likely to face this year, he calls for having 'a strategy with a plan or within a plan.'

Consider buying put options on close to 100 percent of one's anticipated 2016 production in the December 2016 futures for, at recent rates, premiums of 16 or 21 cents per bushel plus transaction costs at $3.60 or $3.70 per bushel, respectively, Atten said.

Another possibility is to buy a put option at $3.70 per bushel and selling a call option at $4.70 for a net premium of 12 cents per bushel plus transaction costs, Atten said. He noted that the call position would require margin payments should the price top $4.70 per bushel.

Dairy sector outlook

A similar scenario exists in the dairy sector, if only because its pricing seems to have a down cycle every three years, Atten observed. As it stands, many dairy farmers can expect to operate at deficits during all or most of 2016 — losses they could limit to 50 to 70 cents per hundred of milk in many cases with the price protection tools that are available, he promised.

Given 'the burdensome global supply' of milk and the reduction of dairy product imports by both China and Russia, the price outlook is 'not rosy,' Atten warned. He cited the anticipated annual 4 to 5 percent milk production increase within the European Union, which was already producing 61 percent more milk than the United States does.

As he noted that Atten Babler Commodities does 50 percent of its business with dairy farmers, Atten called attention to the continuing month to month and year to year increases in dairy cow numbers and milk production in the United States. One of few bright spots at the moment is the lower cost of dairy ration feeds, he added.

In addition to the three-year drought, milk production in California has fallen because landowners are finding it more profitable to have the land converted to growing pistachios, almonds or nuts, Atten said. Those who intend to remain in dairying prefer to relocate to the Upper Midwest or Northern Plains.

Wisconsin's dairy farmers should not be surprised if they gradually lose a large portion of the premiums that they have traditionally been paid for milk quality or shipment volume, he predicted. To cope with squeezes on margins, whatever the cause, he suggested that dairy farmers look at buying put options or consider enrolling in either the federal milk margin protection program or the livestock gross margin insurance.

Livestock sector woes

While dairying tends to have a three-year price cycle, the livestock sector is suffering greatly at the start of its typical 10-year downside cycle, he said. Cattle feeders already lost about $5 billion in 2015 — about $600 to $700 per marketed animal in many cases — and that some are surviving only because they had a hedging strategy in place.

As with the other commodities, Atten urges livestock sector entrepreneurs to identify their point of economic risk and to buy put options on live cattle prices.

During a period of low prices, he advises relying on minimum price strategies and avoiding capping or locking in prices.

For soybean growers, Atten pointed to November 2016 futures on which put options could be purchased at 16 cents per bushel at $8 or 29 cents at $8.40 plus the transaction costs. As with the other commodities, base a strategy on the anticipated breakeven with production costs, he added.