Uncertainty Prevails

Weather and market factors are difficult (sometimes impossible) to predict and this uncertainty produces risk that must be managed. While uncertainty is normal in agriculture, it seems there is more uncertainty than usual to manage this year.

Weather risk is always significant. The production season is starting out dry. The Drought Monitor (April 15) map shows drought or dry conditions over Kansas, Nebraska, Iowa, South Dakota, Minnesota, Wisconsin, Michigan, most of Illinois, Northern Indiana and most of Missouri. These early dry conditions are "two edged." Dry soils speed field operations, allowing early and rapid planting. For example, as of April 13, the Missouri corn crop was thirty percent planted-5-days ahead of the 5-year average. Rapid planting progress often results in more acres getting planted. This early planting gets the crop off to a good start, along with possibly more acres, and could mean higher yields and large production. However, the lack of soil moisture also means that even short "dry spells' could seriously reduce yields and production. Which will it be? Early planting and large production or dry weather shortened crops? Dry conditions make the outcome very uncertain.

What about acreage? USDA's March Prospective Plantings Report provided some surprises. Most expected sizeable increases in corn acreage and a significant reduction in soybean acres. Instead the report showed acreage of both crops only slightly below last year's plantings. Will weather conditions and/or disappointing prices cause other acreage changes along with more or less production of either crop? Even if actual planted acreage remains the same as intended acreage, rapid planting and good weather could produce larger crops than last year.

A number of demand surprises have surfaced in recent months. Corn exports have been disappointing and USDA has reduced export projections in each of the last five monthly Supply and Demand Reports. Some analysts are beginning to believe that the last cut (April 10 Supply & Demand Report) was too much. China has been subsidizing corn exports to reduce relatively large stocks they were believed to be holding. It appears they have accomplished this, which suggests they will eventually have to slow their pace and open up opportunities for U.S. corn exports since World supplies are relatively tight. In contrast to slow exports, domestic corn ethanol use continues to grow. With strong domestic use, a turn around in exports would change the demand outlook significantly. But when will exports turn around?

Soybean demand has been the opposite of corn. Domestic crush has been reduced, but exports continue strong even with a record South American crop beginning to move into the market. The stronger than expected exports have reduced U.S. soybean supplies to low levels. Many analysts believe that U.S. exports will exceed current USDA projections, in part because it appears that slow movement of South American soybeans to export may have shifted some additional export business to the U.S. However, the record Southern Hemisphere crop will come to the market in the next few months and may eventually depress prices in spite of strong World demand.

Grain supplies are relatively tight in the U.S and worldwide. Year-end carryover of corn is currently estimated near 1-billion bushels, down almost 600 million bushels from last year. Soybean estimated ending stocks would be the 2nd lowest in more than 25-years. Additionally, World ending-stocks of both corn and soybeans are expected to decline. While tighter than usual, supplies appear adequate and any supply increases would be negative to prices. However, any additional demand surprises or poor production weather could quickly create a situation where these tight supplies would need to be rationed with sharply higher prices.

What are the price risks? About the only thing market analysts agree on is that the potential price range could be wide. Trend line or better yields, with no demand surprises, are likely to result in corn and soybean prices below loan price levels at harvest time. In contrast, continued strong soybean demand and improved corn exports coupled with any widespread production problems could see corn prices above $3.00 and soybeans well above $6.00!

The government program is designed to provide protection in the low price scenario with good production. Fixed payments plus counter cyclical payments (CCP), triggered by low prices, provide offsetting revenue. The loan program's market loan gain (MLG) or loan deficiency payments (LDP) would be available on all program crop production, effectively establishing a price floor near loan price. Short-term storage could provide the opportunity to capture basis gains and market carry and, with the program price support benefits, potentially generate satisfactory returns from higher-yielding production.

The problem with the government program provisions is that they don't provide protection in the high price/low yield situation. There is nothing to protect against the loss of revenue from reduced yields. Prices might be very good, but producers wouldn't have many bushels to sell. Only the fixed payment would be available, there would be no CCP or LDP to offset lost revenue form low yields.

One strategy, for corn, to deal with this situation is to purchase call options. Corn call options have generally been reasonably priced. The call option provides the right to purchase corn futures at a specified (strike) price. If weather problems send corn prices sharply higher, the call could be exercised. The gains from higher futures prices would offset lost revenues from lower production and reduced government program payments.

Strategies for soybeans may be more difficult. Soybean option premiums have been expensive. Out-of-the-money calls that are reasonably priced may give up considerable price gain potential. Soybean yield risk, especially for the indeterminate varieties of Northern Missouri, is often considered less than corn during dry periods and production costs are lower than corn. Higher prices on limited yield losses might still generate decent incomes. So the high price/low yield risk may be somewhat less for soybeans than corn. However, soybean-marketing decisions will require close attention to deal with the uncertain price and yield prospects-especially if prices move above CCP trigger prices.

Production and price uncertainty prevail this year. The risks need to be recognized and understood. No strategy completely eliminates risk, but some offer opportunities to mange some of the negative impacts.