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Extension > Agricultural Business Management News > April 2014

Wednesday, April 30, 2014

Returns to Corn Farming and Ethanol Processing

by Doug Tiffany, U of M Extension Educator, Agricultural Business Management

As corn farmers fine-tune their equipment and head to the fields, many have concerns about the costs of production and prospects for profitable price levels. Through the winter many have crunched the numbers to determine their corn production costs, including fuels, fertilizer, herbicides, seed, depreciation, anticipated repairs on equipment and land rent. The 2013 crop season was one fraught with production uncertainty in the form of meager soil moisture and continuation of adverse weather conditions; but in the end, a huge crop of corn with price-depressing effects was produced. Over the past long winter, there have been a series of demand-supply reports that have shown increasing levels of corn exports and greater use for ethanol production, offering some increases in prices. For tenants, corn prices still hover close to costs of production, depending on land rent.

Corn markets in the winter months are tempered by the understanding that the Upper Mississippi River is frozen, stopping the flow of corn to our most important export port, New Orleans. Rail movements of corn during the winter took the 2013 corn harvest from the Midwest to the West Coast for export to Asia and to domestic poultry and livestock feeders in SE United States and other areas. Truck traffic moves corn to ethanol plants and Midwest feeders; however, beef cattle on feed are fewer than in past years due to dry pastures and high hay prices over the last few years. With the opening of the Upper Mississippi and the price dampening effects of Southern Hemisphere corn production now understood, attention of the corn trade has shifted to the corn acreage intentions and field conditions faced by Midwest corn farmers. Those two factors will be dominant from this spring to the fall harvest.

In contrast to corn farmers, feeders of livestock, both domestic and foreign, and dairy producers are rejoicing at the cheap corn prices through the winter and going forward. Another group of corn consumers are ethanol plants, who have enjoyed excellent margins since the harvest of 2010. Many corn farmers are also stockholders in ethanol plants, so this is a great time to review the history of profits for corn farmers and corn ethanol plants.

The Agricultural Marketing Research Center (AgMRC) consisting of Don Hofstrand, Robert Wisner and Ann Johanns at Iowa State University has maintained a very useful series of data on costs of production of corn in Iowa as well as modelled profits for typical ethanol plants since 2005 using farmer budgets and ethanol plant techno-economic models. Their data and analysis are regularly displayed in the Renewable Energy Newsletter.

Appearing in Figure 1 below is a graph produced by AgMRC that offers historic perspectives on profits of ethanol plants from 2005 to the present. Here one can see corn at the cost of production for the farmer, not the market price. This graph represents a period of dramatic changes in the ethanol business as that industry expanded rapidly in 2006-08 following the high profits that started at harvest time in 2005 as a consequence of Hurricane Katrina, which bottled up the Mississippi River and shut off corn exports through the Gulf of Mexico. Another effect of this natural disaster was to raise prices of ethanol and other petroleum products after damaging refineries and natural gas infrastructure on the Gulf Coast. Cheap, plentiful corn that couldn't be moved to export markets set the stage, along with for higher ethanol prices, for profits of $1.00 per gallon of ethanol produced for certain periods of time. By assuming the yield of 2.75 gallons of ethanol produced per bushel of corn, profits of $2.75 profit per bushel of corn processed resulted. However, good times rarely last for long in industries based on agricultural commodities.

Ethonol Production Tiffany article.jpg

Excellent profits between $.50 and $1.00 per gallon of ethanol remained until harvest of 2007 corn was delivered. In 2008 high ethanol prices kept ethanol plants very profitable until the financial crisis that started in the fall of 2008. Profits were zero or negative for ethanol plants from the harvest of 2008 until the harvest of 2010. Energy demand and ethanol demand were weak as the general economy staggered through this period that witnessed the bankruptcy and idling of about 10% of installed ethanol capacity in 2009. There were periods of losses in 2010 for ethanol plants before recovery to profitable levels with harvest of the 2010 crop. From the fall of 2010 until the present, margins have generally been positive for ethanol plants, with excellent returns since the harvest of the 2013 crop.

Appearing in Figure 2 is AgMRC's allocation of monthly supply chain profits for corn farmers and ethanol plants from 2005 to the present. The profits of corn farming and ethanol production run counter to each other because corn is by far the largest input in ethanol production. This modeled history shows how farmer investments in financially sound, well-managed ethanol plants can offset times of poor profits or losses in corn production, exactly as value-added enterprises are supposed to perform, overall. Profits in both corn farming and ethanol production require care at each step of each process. Corn farming requires the operator to manage weather, pest and market risks and still produce competitively priced crops. Processing of corn to ethanol requires plant management to manage substantial marketing risks in the procurement of corn and natural gas as well as the sales of ethanol and the by-product feed, distillers dried grains and solubles. Substantial efforts and vigilance are needed to monitor and coordinate performance of enzymes, yeast, centrifuges, evaporators, dryers, and distillation columns at top ethanol plants. Figure 2 confirms the historical wisdom of farmer investments in value-added enterprises that move and process their production toward the consumers.

Allocation of Ethanol Profits Tiffany article.jpg


Tuesday, April 29, 2014

Improve Your Farm Profitability in 2014 and Beyond

By Don Nitchie, U of M Extension Educator, Agricultural Business Management

The decline in median Minnesota Net Farm Incomes for 2013 from 2012 was 78% according to the Center for Farm Financial Management at the University of Minnesota. By enterprise, crop production enterprises decreased most significantly where earnings were 80% lower than in 2012. This was due to much lower inventory values of stored grain and costs that have steadily increased over the last several years. Livestock enterprises also declined significantly.

Crop prices that remained at record levels for several years while costs of production were lower but steadily increasing made for several years of record profits in crop production. Some experts would argue that a period such as we have just gone through can lead to some managers becoming too casual about managing profit margins and preparing for changing times. So, are there profits to be made when the average farm's breakeven costs are at the average market price available today?

MOVING FORWARD-TESTING FUTURE SCENARIOS; Testing the "average" 2013 farm in the Southwest Minnesota Farm Business Management Association (SWMFBMA), it appears there are significant opportunities to improve profit margins, even now. Using the income, cost and asset valuation shocks the authors applied to the average SWMFBMA farm, the financial ability to absorb these shocks is strong for the near term. Liquidity and solvency would remain in very strong positions although profitability would obviously suffer. The caution would be that for the near term on crop farms, operating expenses and term debt payments would demand an increased portion of revenues. Working capital would have to be drawn down to pay these obligations in some cases.

The last page of a new section of the annual report entitled; "The Impact of Projected Profitability and Financial Shocks" contains the results of shocks on the average 2013 farm. The last column titled "2013 Improved Margin Management" demonstrates real opportunity-what we call "good news" back home. Those calculations show that by just improving gross income by +5% (yield and/or selling prices) combined with lowering costs by -5%, together just about doubles the 2014 profitability for the average 2013 association farm. This does not imply that it is the smart choice to cut costs 5% across the board. Be strategic in your choice of which costs to take a hard look at. Those costs that you suspect have not always be returning $1 in return for the last extra $1 of expenditures-should be the first to be reduced. You may need to look hard at 4-5 or more cost items to come up with a 5% overall cost reduction. You may come up with even more. This information can be found in the full report at http://www.cffm.umn.edu/ under the "publication" tab.


Sunday, April 13, 2014

Extension releases info series on 2014 farm bill

Kent Olson, Extension Economist

MINNEAPOLIS/ST. PAUL (April 14, 2014)--A series of fact sheets on the Agricultural Act of 2014 - the farm bill - is available to help the agricultural community prepare for changes introduced by the recently passed federal legislation.

University of Minnesota Extension economist Kent Olson prepared the six-part series, which emphasizes changes in programs and rules affecting crop commodities.

"Passage of the farm bill removes uncertainty about what farm programs will be for the next five years," Olson said. "Farmers will have to make choices, but the rules are different compared to the old farm bill."

Gone are the Average Crop Revenue (ACRE) and Counter-Cyclical Program (CCP). In their place, farmers must decide between new programs: the Price Loss Coverage (PLC) or the county- or individual-based Agriculture Revenue Coverage (ARC).

The fact sheets are on Extension's web site at www.extension.umn.edu/agriculture/business/farm-bill/. They cover details on the new crops programs, including comparative information designed to help farmers choose their best option. Other information focuses on updating payment yields and reallocating base acres.

"There is also an important warning: Farmers have to act. If farmers and landowners fail to make a unanimous election of the program in which they enroll, the bill says that no payments can be made to the farm for the 2014 farm year and the farm will be deemed to have elected PLC for the 2014 through 2018 crop years," Olson notes.

The farm bill information sheets are offered through Extension's Agricultural Business Management program. Olson and his colleagues connect farmers and other industry professionals with University research-based information on farm management and marketing. More information is available at www.extension.umn.edu/agriculture/business/.

For more news from U of M Extension, visit www.extension.umn.edu/news or contact Extension Communications at extnews@umn.edu. University of Minnesota Extension is an equal opportunity educator and employer.

Friday, April 4, 2014

Hedging in Times of Production Uncertainty

Bret Oelke, Regional Extension Educator, Agricultural Business Management

With the recent concern in the swine industry about Porcine Epidemic Diarrhea Virus (PEDV) and record high futures prices for lean hogs at the Chicago Mercantile Exchange (CME), discussions have occurred about how farmers can take advantage of high prices while protecting themselves in case hogs are not be available to market. This issue is not unique to the swine industry; crop producers face the same type of scenario in a drought year. While revenue based crop insurance provides some protection in the case of crop production, livestock producers don't have the luxury of a product exactly like the crop insurance products. There are however, exchange based tools that can be used to provide price risk management without obligating delivery of live hogs as a packers' forward contract would require.

If a hog producer is interested in locking in a future price on a portion of his production he would traditionally either sell a futures contract near the anticipated deliver month or enter into a forward cash contract with a packer. In the current environment, with the risk of disease causing abnormally high mortality for a period of weeks, the producer may not be able to deliver hogs to the packer under the forward contract which in most cases is delivery obligated. Growers need to be aware of the non-delivery penalties that are written into the contract if spelled out. In some cases, the grower would be responsible for acquiring enough hogs from another source and delivering them against his contract, regardless of what has happened to the price since the contract was written. If supplies continue to be tight due to the production problems associated with disease, and the price has increased, a significant market loss would take place.

In the case where the producers used a CME futures contract to manage price risk, delivery is not obligated. Under normal circumstances the grower would sell (or go short) a futures contract and hold that contract until delivery into normal marketing channels were to take place and a cash price for the hogs was offered. At that time, the futures contract would be bought back. If the price had dropped, the grower would realize a gain in the futures market which would be added to the cash price to the marketed hogs. If the price had gone up, the grower would realize a loss in the futures market, but would have realized a higher price in the cash market which would offset the loss in the futures contract. If the hogs were not able to be delivered due to a disease outbreak, the grower could buy back the futures contract and realize a gain if the futures price for lean hogs had dropped. If, however, the futures price had increased, a potentially large loss on the futures contract would result with no offsetting gain from sales of lean hogs.

The potential for large market losses in addition to the already potentially devastating disease losses associated with a PEDV outbreak might cause many hog producers to decide not to hedge future production at record or near record futures prices for lean hogs. There is a strategy that growers can use to manage price risk with limits on the potential market price loss in the event of continued increasing prices if delivery were unable to occur. The grower could purchase put options, which are contracts that give the buyer the right, but not the obligation to sell lean hog futures at the selected strike price. The grower then has the right to sell hogs at the strike price or can allow the put option contract to expire if the price has gone up. This strategy doesn't come without a cost however. Recently July 2014 CME lean hog futures traded at $124.00 per hundred weight. An at the money put option (strike price $124.00) had a premium cost of $5.10 per hundred weight, resulting in an equivalent futures price of $118.90 per hundred weight. This is relatively expensive and may not appeal to many producers. There is another strategy that may work better for hog growers, that is to buy put options as a floor on price and holding them until the pigs have reached a stage of growth where a disease outbreak would not impact them as it would when they were younger. At this point the put options could be bought back, hopefully with a minimal loss, and a futures contract could be sold to hedge the price of the hogs to be marketed later. A packer forward cash contract could also be entered into at this time and the futures contract would be unnecessary.

In times of production uncertainty, farmers and ranchers shouldn't ignore price risk management when we have tools that allow them to manage price risk without obligating delivery in case of production losses.


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