Corn production and market risk management
Todd Davis and Charles E. Curtis, Jr.
The profitability of corn is often directly related to how well the farmer manages production and price risks. Decisions made in the selection of soils, fertility scheme, variety, pest management practice(s), tillage system and row spacing can all impact costs, final yields and profits. Information in this guide gives details about how South Carolina farmers can make good choices. The following is a discussion of production and price risk management in the context of enterprise budget analyses for corn.
What are the enterprise budgets?
Enterprise budgets are prepared as a reference for the farmer and are a record of the anticipated costs and returns for a particular set of production practices for the crop(s) considered. Farmers, lenders and others use these budgets as a means to evaluate the economics of production.
Of course, producers will need to adjust the figures given for the cost inputs for their operation. Enterprise budgets are prepared by the Clemson University Department of Applied Economics and Statistics which can be accessed on the web at the following Internet address: http://cherokee.agecon.clemson.edu/crop_bud.htm
Variable costs are those that are incurred each year the crop is produced and are basically the out-of-pocket expenses for seed, chemicals, fertilizer, labor, machinery and interest. These may vary from year to year, field to field and farm to farm. This is why producers must be aware of their average expense figures for each cost component.
Fixed costs are those incurred even if a crop is not planted. Such things as depreciation and taxes on equipment are fixed costs. A particular farmer may choose to ignore the fixed cost component for a year or so when planning the farm's crop mix.
However, over a period of several years a farmer needs to be able to cover total costs to maintain an economically viable cropping system. Farmers are urged to consider various production and market risk management scenarios to try to capture the highest profit possible.
2009 estimated costs and returns for non-irrigated corn
The estimated Return over Variable (production) costs for non-irrigated corn for 2009, based on Clemson University Enterprise budgets, is described in Table 1. Total production costs are estimated to be $340/acre with fertilizer/lime costs accounting for 42% of the total cost per acre (Table 1). In addition, seed, hauling, and tractor/machinery expenses account for 15%, 14% and 8%, respectively, of the total cost per acre (Table 1).
The harvest cash price, based on the value of the December 2009 Corn Futures contract of $4.24 and adjusted by an estimated harvest-time basis of -$0.10, is estimated to be $4.14 per bushel (Table 1). Given the revenue and cost estimates, the Return over variable costs for non-irrigated corn is estimated to be $157 per acre (Table 1).
Table 1. 2009 Non-Irrigated Corn (Conservation Tillage) Estimated Costs and Returns ($/Acre)1/.
1/ Detailed enterprise budgets for agronomic crops are available at: http://cherokee.agecon.clemson.edu/budgets.htm
or from your local Clemson University Cooperative Extension office.
2/ Corn price based on December 2009 Corn Futures price on January 12, 2009 with a local harvest-time basis of -$0.10/bu.
Understanding the Increase in Production Costs for Non-Irrigated Corn
For long-term profitability, producers must continue to control costs. The production costs for non-irrigated corn from 2002 to 2009, based on Clemson University Extension enterprise budgets, are reported in Table 2.
Variable costs have increased $137/acre since 2002 with 54% of the increase occurring since 2005 (Table 2). As you would expect, the largest increase has been for fertilizer with nitrogen costs increasing 30% since 2002 (Table 2).
The increased cost of fertilizer and lime accounts for 45% of the cost increase since 2002. Another large increase has occurred in hauling expense which has increased by $30 per acre since 2002 (Table 2). The increase in hauling expense reflects the increase in the oil markets since 2003. Seed costs have also increased by $25 per acre since 2002 (Table 2).
This cost information will help managers understand which cost items have increased the most and, in turn, which items to focus on when monitoring costs. It is important to remember that it is important to cut the non-necessary expenses and to use inputs in a way to get the biggest return for the cost of the input. Therefore, sound management practices should be used when managing costs. For example, soil tests can be used to determine fertilization rates and increased scouting for weeds and insects can be used to monitor pesticide costs.
Table 2. Budgeted Production Costs from 2002 – 2009 for Non-Irrigated Corn with an Estimated Yield of 120 Bushels/Acre.
How Risky is Non-Irrigated Corn in 2009?
Another question managers should consider when evaluating a crop enterprise is the risk of not covering variable costs. The Total Variable Costs for non-irrigated corn are estimated to be $340/acre (Table 1). At an expected yield of 120 bu./acre, the break-even price for non-irrigated corn is $2.83 per bushel. At this break-even price, there will be just enough revenue to pay for the variable costs listed in Table 1. However, the break-even price of $2.83 does not pay for the cost of rented land or provide a return to fixed costs and management.
Table 3. Return over Variable Cost for Various Prices and Yields for Non-Irrigated Corn (120 bu./acre Expected Yield) 1/.
1/ Total Variable Costs are estimated to be $340 per acre.
2009 Estimated Costs and Returns for Irrigated Corn
The estimated Return over Variable (production) costs for irrigated corn for 2009, based on Clemson University Enterprise budgets, is described in Table 4. Total production costs are estimated to be $461/acre with fertilizer/lime costs accounting for 38% of the total cost per acre (Table 4). In addition, machinery/irrigation, hauling and seed expenses account for 17%, 14% and 13%, respectively, of the total cost per acre (Table 4).
The harvest cash price, based on the value of the December 2009 Corn Futures contract of $4.24 and adjusted by an estimated harvest-time basis of -$0.10, is estimated to be $4.14 per bushel (Table 4). Given the revenue and cost estimates, the Return over variable costs for irrigated corn is estimated to be $201 per acre (Table 4).
Table 4. 2009 Irrigated Corn Estimated Costs and Returns ($/Acre) 1/.
1/ Detailed enterprise budgets for agronomic crops are available at: http://cherokee.agecon.clemson.edu/budgets.htm or from your local Clemson University Cooperative Extension office.
2/ Corn price based on December 2009 Corn Futures price on January 12, 2009 with a harvest-time basis of -$0.10/bu.
Understanding the Increase in Production Costs for Irrigated Corn
For long-term profitability, producers must continue to control costs. The production costs for irrigated corn from 2002 to 2009, based on Clemson University Extension enterprise budgets, are reported in Table 5. Variable costs have increased $195/acre since 2002 with 55% of the increase occurring since 2005 (Table 5).
As you would expect, the largest increase has been for fertilizer and lime increasing by $67 per acre since 2002 (Table 5). The increased cost of fertilizer and lime accounts for 35% of the cost increase since 2002.
Machinery costs, especially the cost of irrigation, account for 19% of the increase in production costs since 2002 (Table 5). Another large increase has occurred in hauling expense which has increased by $40 per acre since 2003 (Table 5).
Table 5. Budgeted Production Costs from 2002 – 2009 for Irrigated Corn with an Estimated Yield of 160 Bushels/Acre.
This cost information will help managers understand which cost items have increased the most and, in turn, which items to focus on when monitoring costs. It is important to remember that it is important to cut the non-necessary expenses and to use inputs in a way to get the biggest return for the cost of the input. Therefore, sound management practices should be used when managing costs. For example, soil tests can be used to determine fertilization rates and increased scouting for weeds and insects can be used to monitor pesticide costs.
How Risky is Irrigated Corn in 2009?
Another question managers should consider when evaluating a crop enterprise is the risk of not covering variable costs. The Total Variable Costs for irrigated corn are estimated to be $461/acre (Table 4).
At an expected yield of 160 bu./acre, the break-even price for irrigated corn is $2.88 per bushel. At this break-even price, there will be just enough revenue to pay for the variable costs listed in Table 4. However, the break-even price does not pay for the cost of rented land or provide a return to fixed costs and management.
Table 6 describes the Return over Variable Cost for alternative prices and yields. Managers can use Table 6 to evaluate the risk of not covering variable costs of producing irrigated corn based on their own price and yield expectations. For example, at the price of $3.50/bushel, there would be revenue available to pay for all production expenses with yields of 140 bu./acre or greater (Table 6). Similarly, at a yield of 110 bu./acre, all variable costs will be covered with prices of $4.25/bu. or greater (Table 6).
Table 6. Return over Variable Costs for Various Prices and Yields for Irrigated Corn (160 bu/acre Expected Yield) 1/.
1/ Total Variable Costs are estimated to be $461 per acre.
Controlling market risks
The best means of controlling market risk is to have a proactive market plan. Specific marketing plan approaches will vary from farm to farm. There are, however, common components that will be included in virtually any viable plan. They are:
1. Know what you need from the market to be "successful." This is accomplished by knowing the true production costs of the enterprise on your farm. Further, one must account for family living expenses and long-term financial goals. An assessment of "successful" is the key to this step. However, this important concept is one that varies substantially from farm to farm.
2. Know where the market is now. This requires access to and the ability to correctly interpret corn price information. The best starting point is knowing the current Chicago Board of Trade (CBOT) futures price for the month in which one plans to sell.
Prior to harvest, the CBOT December futures price is typically the best gauge for what the market thinks next year's crop will be worth at harvest. This price should be further adjusted by your basis estimate that you expect to prevail at harvest. If considering storage, one must further account for the physical and interests costs of storage.
3. Know what the available marketing alternatives are. While there are numerous cash market and futures based marketing alternatives, each with their own risk management properties, the available alternatives fall into three broad categories:
a. Do nothing now: This clearly is the most often followed strategy. Whether through simply avoiding the marketing or pursuing this as an objective strategy, this assumes that the price captured later will be better than today. If this fails to materialize (i.e. prices fall) then there is no downside protection. Strategies that fall into this general category include unpriced production, unpriced storage and delayed payment contracts.
b. Fix the price today: If the market were currently offering a price at which one would be "successful" then one would be wise to accept it. However, prior to harvest when yields are unknown, it is not advisable to obligate the entire expected crop for sale. Contract penalties can occur if a producer over-contracts a volume of production and prices rise.
Further, this approach carries the implicit assumption that the price captured now will be better than it will be in the future. Strategies that fall into this category include cash forward contracting, hedging (partial), Hedge-to-Arrive contracting (partial) and basis contracting (partial).
c. Fix a price floor but leave the ceiling open: This approach to market risk management allows for the best of both of the above while avoiding many of the potential drawbacks. Through the use of put option purchases, call option purchases in conjunction with cash forward contracting, buying call options instead of storing, or by seeking minimum price contracts, producers can protect their operational revenues from subsequent price declines while leaving open the possibility to benefit from future price rallies. Clearly, this approach is one worth exploring.
4. Assess the risks and returns from the available marketing strategies. Knowing the conditions set out above, combined with observation of current market fundamentals, is critical in selecting the best market approach. The above strategies have various risk abatement attributes, particularly with regards to how they handle futures price and basis risk. Do you expect the basis to improve later? Do you expect the price to improve later? How much of your crop can you comfortably sell now? These and other questions need to be explored.
5. Seek the unbiased opinions of others. Other farmers, agricultural lenders and Extension personnel (among others) can often help you weigh the alternatives you are considering. It is important to stay grounded in the reality of market risk management and not move into the realm of speculation. Seeking opinions can help sort through the complexities ... but remember the final decision is yours!
6. Make the decision and follow through. The best-laid market plans avail us nothing if the "trigger isn't pulled" on placement of the strategy. This is easier said than done. But if the above steps are taken, then one should feel confident in the knowledge of risks to be transferred or retained.
7. Review the plan and adjust as needed. Because of the dynamic and ever-changing markets for corn (and other agronomic crops) it is important to review periodically the plan that is in place. For example, let's suppose at planting you observed a good price but only felt comfortable with pricing 25 bushels per acre. Suppose now its late August and you're much more certain of your yields. You need to revisit your plan and review the necessity for leaving the remaining crop unpriced. The risk environment has changed, so your plan requires reviewing and updating.