Jan

18

The Commodo, by Scott Brooks

January 18, 2007 |

George has asked for a "grain maven" to shed some light on the corn/bean situation. I'm no maven at beans/corn … but I'll try and shed some light on the subject … with a ground level perspective … hopefully some of you will find this helpful.

The farmers that sold some of their '07 crop already aren't thinking of this as a carnage … they're pretty happy.

My farmer expects to average 145 bushels/per acre for corn over a four year period. He expects to average 45 bushel/acre for soybeans over the same period of time. At these corn and bean prices, I'd give some serious consideration to selling half of my '07 … a crop that won't even be planted until mid April for corn and May or June for beans.

He should still be able to insure himself to a break even point at that level if there is a crop disaster, i.e. drought, hail, disease, etc., but may want to sell only 25% of his expected '07 crop to be on the safe side.

This is a huge opportunity for farmers that capitalize on this, as long as they are quality farmers who work hard at getting the job done, and furthermore, if the weather cooperates.

There is also a lot of risk associated with this course of action. If there are wide spread crop failures, he'll have to pay dearly to buy back his futures contracts. For a farmer, they want steady stable performance over time. They don't want too much risk. Their lives are fraught with risk … the worst kind of risk, too … risk that they have absolutely no control over … the weather! No matter how good a farmer is and no matter if he does everything right, if it doesn't rain, then he ain't got squat!

Here's a refresher on some of the economics on farming for the list (I've shared these numbers before).

It costs around $125 - $200/acre to plant, grow, harvest and sell corn. The wide range in price is due to many factors … mainly depending on the quality of the land and the quality of the farmer. I believe my farmer has told me that it takes around $145/acre on my place. Then my farmer has to pay me my rent for the land he's farming. That's another $100/acre. His break even is $245/acre. When corn was down around, it's usually $2 - $2.25/bushel, he would have to get around 110 - 120 bushels/acre to break even … well, that's not completely true … the government has a subsidy formula for my land that is called "the basis." This amounts to around $25/acre that the government pays on the land for the "basis subsidy." The farmer gets this money.

Based on the futures prices right now (approximately $4.20/bushel), if my farmer were to sell all his crop at the current prices, and he grew his average expected crop, he would stand to have a stellar year. Based on the expense numbers above and him getting the approximate average price of corn (around $2.10/bushel) he would make about $84.50/acre. Based on the same expense numbers above, and getting $4.20/bushel, he would make around $389/acre … so as you can see, when the price doubles, his profit potential more than doubles!

But it's not realistic to expect that he would make this money. Here's why.

There is no way a prudent farmer is going to sell his entire '07 crop in advance, let alone this far in advance. There is way too much risk. If there is a drought, prices are likely to spike from here and he could be financially destroyed.

If he's smart and he takes the conservative route and only sells part of his crop, and we don't have a drought, then prices will likely moderate and/or fall from here. As a result, he'll sell the remainder of his crop at a lower price.

If someone would like to see the numbers for beans, I'd be glad to do that in a later post.


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1 Comment so far

  1. J Goodman on January 18, 2007 3:43 pm

    I suggest your farmer (and bearish speculators) take a look at the July Corn puts. For a premium of about 6%, he could hedge his entire crop and relax. Arbitrageurs may wince at buying 33% implied volatility, but the nominal premium is about 25 cents per bushel … which is one day’s limit move … and less than the amount that the contract has rallied in the past five sessions.

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