“Don’t pull a VeraSun.” Illinois Extension Economist Scott Irwin’s warning is for growers who may teeter on economic catastrophe if they pay high prices for fertilizer or other inputs without matching them with corn or soybeans sales. His reference to the bankrupt biofuels company – which apparently failed to hedge against grain it purchased – illustrates the enormous financial risks farmers take. “The mistake you can’t afford to make is to lock in high input prices and not lock in corn prices,” Irwin stresses.
Too many farmers don’t follow through on both ends of the spectrum, even though fertilizer prices have consistently followed corn prices up and down since 2006, Irwin says.
Lance Unger, Carlisle, Ind., takes a different approach. He heeds that advice of Irwin and other farm-management specialists who recommend not doing one without the other.
“It’s the only true hedge in the market,” says Unger, 24, who farms with his father and mother, Del and Tammi. They work about 5,500 acres, 75% of which is in corn, with the remainder in winter wheat that’s double-cropped with corn or soybeans.
“Matching input purchases with corn sales insures that you’re likely going to make a profit and cover your risk,” he says. “It does no good to buy your inputs and not sell grain.”
In early September, with corn and soybean prices still at bin-busting levels and fertilizer costs below what they were last winter and in the spring, locking in both prices and inputs for 2013 production should have been in the plans for many growers, Irwin believes.
The latest budget forecasts by the University of Illinois farmdoc management program call for reasonable returns for corn and soybeans, even when using a medium of $6/bu. corn price and $12.50/bu. for beans. Irwin says that excluding land costs, returns are pegged at more than $650/acre for corn and $400/acre for soybeans across high-production areas of central Illinois. Similar returns should be expected for high-yielding areas in other Corn Belt regions, he says.
But if your budget is set and you’ve locked in your fertilizer costs without making sales – beware. Corn could easily turn tail and hit $4-$5 and slash your expected returns. “You’re setting yourself up for disaster.” Unger says.
Alan Miller, Purdue University economist and farm business management specialist, recommends working with your input retailer or elevator.
Unger and family consults with their local co-op, Ceres Solutions, as well as a regional ag marketing service, Blue Reef Agri-Marketing, Morton, Ill. For 2012, the Ungers made early corn sales at $6-$7 before the end of 2011 on about half of their crop. “We also locked in our basis at about 30¢-over through July.
“Shortly afterward we also locked in our anhydrous ammonia in the $800/ton range. That price was up to 10% below what it was a few months later. We saved close to $75/ton.” That’s about $7-$10/acre in savings for applying 180-200 units of N/acre preplant to produce a more than 200-bu. corn yield on irrigated land.
Early 2013 action included making corn sales and securing fall fertilizer needs in mid-summer. “We sold some $6.40 hedge-to-arrives (HTAs) for September (2013) delivery and some $6.50 HTAs for delivery the following March (2014),” Unger says.
That was on 25-30% of their projected 2013 production. “At the same time, we locked in about 30% of our fall fertilizer needs,” Unger says. “DAP was at about $600/ton.”
Those transactions were through their co-op elevator, with advice from their marketing consultant. Unger says they will also lock in ammonia needs early next year and make further sales at the same time.
“You may not think about one end when you’re conducting business on the other. Getting the timing worked out may not be easy.”
Along with fertilizer, the Ungers lock in diesel early. In the spring, it was about $3.20/gal., compared to about $3.80 or higher later on, he says. “That was through our co-op. They’re trying to provide a break on diesel for guys who’re being aggressive.”
Irwin says more growers are interested in booking inputs and sales simultaneously, with growers often more comfortable buying than selling, “even though the input markets are far less transparent than corn or soybean markets.”
Adam Dyer, Unger’s marketing consultant, says the old thorn in the side of not knowing total cost of production can lead to mistakes in an input/price management program. “Know your true cost of production before locking in inputs and selling grain,” he says. “True cost of production takes into consideration all costs of doing business, not just direct input costs of cash rent, seed, fertilizer and chemicals: don’t forget principal and interest payments, drying, storage, machinery depreciation, family living expenses, owners’ draw.”
Miller says a major mistake “is the failure to consider all of the risks involved when you lock in the prices. “There are more tools available for locking in the commodity than the inputs,” he says.
“There’s also the counter-party risk. Check out whom you are buying from. If you’re buying ahead, make sure you can take delivery.”
Farmers should know how reliable the supplier is, Irwin adds. “Know what happens if you make a favorable contract and the local fertilizer contractor goes belly up.”
Still, failing to makes sales when inputs are bought is the biggest blunder a grower may face. “Given the correlation of fertilizer with grain, particular with corn; and because inputs are so much more expensive, I would recommend recalibrating and rethinking about scale-up strategies for fertilizer and corn sales,” Irwin says.
“If you buy N at $1,200 and don’t sell corn at the same time – you’re pulling a ‘VeraSun.’ They went bankrupt locking in input prices and letting the output price go unhedged. You can also get into trouble by locking in high cash rents and not hedging corn or bean prices, which helped cause the higher rent prices.”
Unger is still learning the ropes with a lot of direction from his father. “We’re not fool-proof,” he says. “We can lose money. It can be hard to haul $6 corn to the elevator when the price is $8.
“Also, with these high prices, some guys get short-sighted. They sit around and think grain prices are going higher. But they also paid high prices for fertilizer. If grain prices go down, they’re in trouble.”
Seek Help
One of Dryer’s regular farmer clients, Lance Unger, Carlisle, Ind., regularly matches input purchases with grain marketing. He says growers should explore how to enhance their ability to do both. “Talk to your elevator reps,” he says. “Their job is to watch the markets and give advice on what they think they’ll do. Talk to Extension and go to meetings in your area, which may be emphasizing input management.”
Alan Miller, Purdue farm management specialist, encourages growers to seek out people in the fertilizer or seed industry. “If someone comes to an Extension meeting from the fertilizer industry and is knowledgeable of that industry, try to develop a relationship with that guy,” Miller says. “You can’t have too much information.”
Since 2006-2007, fertilizer prices have nearly mirrored corn prices, meaning profit margins require more than just hedging corn or soybeans sales at an attractive price.
“In the past, if you wanted to lock in a margin, you just worried about the price of corn,” says Scott Irwin, U of Illinois Extension economist. “Now, you have to be concerned with timing on inputs and output. Corn might go to $8, but if N goes to $1200, it eats your profit.”
Adam Dryer, consultant for Blue Reef Agri-Marketing, Morton, Ill., an introducing broker for FC Stone, says FC Stone graphs (see graphs) show how prices for UANand anhydrous ammonia have tracked corn regularly in recent years.
“Growers can use this knowledge to help determine when to lock in their inputs as well as corn prices,” Dryer says.