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Neill McKinstray
Anderson Inc.,
Maumee, Ohio
The Changing Nature of
Crop Marketing and Risk Management
(Slides 1, 1a)
During other portions of this seminar, you"ve heard references
to the evolutionary factors affecting agriculture. I have a few
points to add which relate to crop marketing and risk management.
Undoubtedly, these factors will pose an increasing challenge
to successful risk management at the individual farm level. In
my view, improved risk management is an opportunity but it is
not a choice. This is one message we need to deliver.
However, improving risk management is just part of the solution.
The message must be to realize that virtually every segment of
the farm business may, in some way, be under attack. Everyone
has heard that farming is a way of life. This statement has
allowed many people farmers, lenders, government, and others,
to look at and treat agriculture differently from other usinesses.
I believe we need to encourage all of our farm customers to realize
that farming must be managed as a business, or it cannot be a
way of life.
In this seminar, we re talking about lots of risks but not
all of them. The message must be to really zero in on all elements
of the business, including accounting systems, capital structure,
production management, and inventory control just to name a few.
I mention these specifically, because they are among the first
things I seek to understand and encourage as I attempt to assist
a producer with marketing. My experience has been that it will
be very difficult to help him better manage marketing and other
risks, if management control around these other issues is not
integrated and already in place.
The Crooked Rows of Agricultural Marketing
(Slides 2, 2b, 3)
In addition to the new and evolutionary factors challenging
farm risk management, and the other less prominent challenges,
my experience has found a number of existing practices that seem
to be present and get in the way time and again. The extensive
list may give you the impression that I think things are much
worse than they really are. This is not the case, as a great
many farmers are top notch managers. However, because these issues
exacerbate marketing problems, and make appropriate management
of farm risk just that much tougher, I d like to share them with
you. I call these the Crooked Rows of agricultural marketing.
Perhaps a few of these practices apply to your clients, or,
in your trade area. If none apply, that s fantastic. These operators
are already poised to address the global and specific challenges
affecting risk management. These operators are probably already
doing a fair job of marketing and are likely ready to consider
new concepts and techniques.
However, my guess is that you know at least one operator who
has a couple of crooked rows in his risk management field.
Getting attention focused on these will make the marketing challenge
much easier.
Question: What does all of this have to do with the marketing
of corn and soybeans?
Answer: unless the crooked rows are dealt with, and their
management integrated with the marketing-decisionmaking process, long term marketing success is unlikely.
Axioms and Objectives (Slides
4, 5, 6)
For expediency sake, let s assume that we now have straightened
our crooked rows, and that we are ready to move on to the practical
side of managing risk related to the marketing of cash corn and
soybeans.
First, I need to share with you a few axioms that I think are
key to successful farm business and crop risk management:
A crop marketing program will not be successful in the long
term if built solely upon emotional decisionmaking, or speculative
price forecasting.
A long-term successful corn and soybean marketing program must
be based upon financially-informed, balanced, and objective decision
making.
Objectives of a successful marketing strategy should seek to
obtain marketing balance, where profitability assurance, catastrophic
loss insulation, and upside opportunity are provided.
Moving producers toward accepting these concepts is the first,
and, perhaps most difficult part of crop marketing. Perhaps this
is because they usually imply significant change, and sometimes
move the producer to doing some things that he is not so comfortable
with.
However, as you work with your clients, I suggest you keep
these points in mind. Again, accepting these statements, and
committing to changing the approach are the first steps toward
lessening the effect of emotion in the marketplace, and overcoming
the crooked row biases that impede successful marketing.
At The Andersons, we attempt to do this through education,
information, analysis, and gradual introduction of concepts and
tools involving the risk management issues discussed at this seminar.
Obviously, this process also involves an investment in time,
and a commitment to improve.
Achieving Marketing Balance
(Slides 7, 8,9 )
I hope I don"t make this sound too simple. Actually, even
if the rows were straight, and the producer was objectively oriented
and willing to change, real marketing balance was tough to achieve
until recent years. Luckily, Uncle Sam filled the void with acreage
controls, deficiency payments, and disaster relief. Also, until
recently, the tools were too complicated, or too expensive to
provide practical access to profit protection, catastrophe avoidance,
and upside opportunity.
In this respect, producers only had an either/or decision
as it relates to crop marketing decisions. For example, until
1984, they could choose to lock in a flat price, or choose to
remain fully unpriced on any portion of their crop. This forced
a continual flat price bias in marketing decisions. Marketing
tools consisted of variations of flat price management tools in
the form of contracts in the cash market; commodity futures-no
options; and old-time crop insurance. Each had considerable weaknesses;
they didn t work well together; and they didn t provide balance
to the risk/reward tradeoff. Luckily, the government was there
with the loan, disaster relief, deficiency programs, PIK, CRP,
reserves, set asides, etc. It was common to see a case where
deficiency payments accounted for more than 100% of the net farm
income.
While many of the cash marketing tools were simply variations
to this either/or price risk management question, the tools definitely served a function. Generally, they were designed to
provide flexibility, and to separate other decisions relating
to flat price, basis, cash flow, tax, quality, and physical movement
of the grain. Examples of these variations are flat price forward
contracts, basis and HTA contracts, delayed price, and storage.
While providing certain value, they still required the producer
to make a firm priced or unpriced decision based upon a guess
for flat price direction.
To further make my point about any real and practical ability
to predict price, let's look at historical corn and bean charts.
What do these charts tell us?
1. No repeating pattern of timing of highs or lows.
2. No pattern of degree of highs or lows.
3. No new plateau.
4. Lots of volatility and uncertainty. (things not needed
in objective business management)
I"ve been able to extract only a few really useful and general
insights from these charts, which speaks to my disdain for building
a marketing program based solely on price prediction and/or speculative
decision making:
1. Try not to sell corn under $2, or beans under $5.
2. Get costs of production under $2 and $5, respectively.
3. Get objective about pricing decisions.
4. Use some means to assure, and insure revenue, as the
market will not provide any guarantees.
5. Usually the market provides an opportunity to lock in
profitable values at some time during the marketing cycle.
Unfortunately, there are many out there who wish to convince
the farmer that speculative price prediction is marketing. This
has led many farmers into the bait and switch cycle of marketing
management.
Traditionally, if they chose to price in an attempt to lock
in profit, they had very limited flexibility and no opportunity
for gain in a rising market. Worse, if they priced, and had production
problems, their suffering was likely doubled-potentially leading
to catastrophic loss. This lead to the two primal fears of
crop marketing - fear of lack of production and fear of higher
prices.
I spoke earlier about my sense that the producer has resorted
to speculative price risk management and/or has become a reluctant
seller because he has been unable to find practical ways to reach
the marketing objective. Each of these approaches has caused
marketing imbalance and/or missed opportunity. I would further
suggest that this extreme variability has further encouraged some
of the Crooked Row techniques.
Survival was accomplished in many cases only due to the safety
net provided by the government. In my view, this is not risk
management in the sense of today's opportunity and tomorrow's
need.
Marketing Strategies (Slides
10, 11)
Luckily, just as much of the direct help from the government
is going away, marketing tools and strategies are evolving to
where the producer has a chance at marketing balance. Tools exist
today that offers a reasonable means to lock in profit, insulation
from catastrophic loss, and an upside opportunity.
Since we re limited by time, I d like to go into detail about
a couple of strategies to illustrate this point. Hopefully, as
greater understanding is gained, the producers may be able to
spring from this trap of imbalanced risk management, speculative
price forecasting, and reliance on the government, and be poised
to manage overall risk more objectively.
I would like to illustrate two techniques that producers might
use to better manage certain risks, but when combined, can come
very close to achieving our objective of balanced marketing:
1. The simple MPC or minimum price cash grain contract. In
its simplest form, in exchange for the delivery of bushels, the
buyer guarantees to pay the farmer a minimum cash price, with
upside price opportunity related to the movement of the underlying
commodity futures price. If the underlying futures price subsequently
rallies, the producer has the right reprice at the higher level.
Let's look at an example from earlier this summer.
The MPC risk management strategy accomplishes the following.
It:
Another benefit that is real, but less tangible, is the time
provided by this strategy. This time gives the producer the opportunity
to maintain price flexibility while crop and market conditions
become more clear. Perhaps this will allow for earlier pricing
decisions at more favorable values.
One other very important thing the MPC strategy provides is
marketing courage. This will help overcome the reluctance to
sell, avoid missed opportunity, and overcome the primal marketing
fears. You may not find many producers who will confirm this,
but a study of price history and actual producer sales confirms
that more dollars have been lost by not pricing when favorable
values were offered, than by pricing, followed by crop losses
or a further price rally (e.g., realization of the primal fears).
The absence of marketing courage has been seen very recently.
For example, very few producers took pricing action earlier this
year when new crop corn futures were $3 and higher, and new soybean
prices were over $7.
The problem with the MPC strategy is that it functions only
as a price insurance concept. It does not insure against a production
risk, or thus, farm revenue. Limited production at a great price
still equals limited revenue. Therefore, from an overall business
perspective, we still haven t reached our objective of marketing
balance.
2. CRC Marketing. In the previous session, Crop Revenue Coverage
insurance was discussed. This product, and its cousins, revenue
assurance and income protection, have evolved greatly from the
old MPCI. They potentially take us another step closer to where
we ultimately want to be. They re cost effective because the
government greatly underwrites the cost. The problem with a stand
alone insurance approach is that it still misses the target of
marketing balance.
For example, with CRC, coverage is limited to 75% of the price/yield
calculation. That's like insurance on your home with a high deductible
and no replacement cost coverage it s definitely not painless
if you have a claim.
Given that CRC utilizes a spring or fall value, this insurance
product does provide insulation from catastrophic loss, but does
not truly protect profits. Adding to the potential coverage
gap from this strategy is the fact that the price components
are established during the portion of the growing season that
is typically less volatile.
About half the time, prices rally significantly, only to fall
to a price between the two pricing windows. Thus, our objective
of upside opportunity is essentially unavailable unless the insurance
product is used in conjunction with a marketing decision.
For example, in 1990, Ohio had a reasonably good crop certainly
not a disaster. Yet, between March and July, the corn market
rallied and retreated 50 cents per bushel! This is the window
that we need to close! We"ve got to figure a way to give producers
the confidence to grab that value and close the gap between catastrophic
coverage and profit assurance!
So, while the new insurance products provide insulation from
catastrophic loss, they are limited in their ability to provide
the kind of profit assurance that is needed, and without a marketing
decision, there is only speculative upside opportunity.
For a more balanced and integrated approach toward managing
revenue and marketing risk, and to take yet another step closer
to our balanced objective, the producer could utilize a crop insurance
product in conjunction with a minimum price cash grain contract
strategy.
Absorbing this combined concept is a little more difficult
to understand. It begins to integrate the management of production
risk with the management of price risk, but doesn t necessarily
take a problem to contribute benefits, because the payout
comes from the market. This moves us closer to a true loss indemnification
function that also provides real profit assurance, catastrophic
loss insulation, and upside revenue opportunity.
To see how this might work, let's look at this year. Let's
assume that the producer knows that he needs $225 per acre to
cover all crop production expenses based upon his accounting and
information management systems. At the Feb. average price, and
his APH, he can lock in a CRC minimum of $233 ($2.59 X 120
X .75 = $233), so he signs up for CRC. But, we are not farming
to break even! This step provides only the catastrophic loss
insulation in the event that actual production and spring/fall
price combine to deliver less than $233 per acre! (1)
Realizing that market values could move lower, he also locks
in his MPC value at $2.57 per bushel or $308 per acre (CZ7 $2.80
put @ $-.18, less .05 basis equals $2.57 at a normal yield of
120). Thus, with a normal yield, he has locked in his profit
at $83 per acre ($308-$225). (2)
As quickly as April 8, new crop prices have rallied significantly
from the Feb. average. He contacts his elevator and elects to
reprice his MPC at $2.83 (CZ $2.90-.18+.16-.05) If he has a
crop problem, he is assured $233 per acre. If he has normal production,
he has locked in his profit, and he's captured the upside opportunity
of $340 per acre, ($2.83 x 120 = $340) which gives him the potential
for a profit of $115 per acre.
There are other tools and strategies that move even closer
to full indemnification of revenue, and integration of these concepts
into one package. For example, the Area Yield futures and options
contracts conceptually have the ability to be integrated into
cash marketing concepts that achieve marketing balance. Additionally,
we re hopeful that agricultural trade options will be legalized
to allow even more cost competitive, simplified, and individually
tailored products to be developed utilizing other combinations
of insurance, regulated exchange, and cash market concepts. Finally,
the RMA and private insurers continue to work on other concepts
that allow for even greater objectivity and balance in producers
crop marketing programs.
Summary (Slide 12)
My hope today was to give you something to think about relative
to a focus upon:
Farming as a business
- Evaluating the various risks as an integrated package and
- Managing the risks for more dependable profitability and long term farm success.
I"ll close with this quotation that sums up my attitude toward
this process, and take any questions or inputs you might have.
"... If a man look sharply and attentively, he shall
see Fortune; for though she is blind, she is not invisible."
Francis Bacon 1561-1626 | 
