Supply/Demand or Weather?

The grain markets usually first anticipate and then react to supply and demand as reported monthly by USDA. For the past three months, along with suggesting some tightening of supply and demand, these reports have contained some surprises and contradictions.

In May, USDA used the acreages from the March Planting Intentions Report (79 mil. ac. corn and 73mil.ac. soybeans) and trend line yields of 137.9-bpa corn and 39.7-bpa soybeans to estimate production. While these acreages were somewhat in line with market expectations, eastern corn-belt planting delays began to raise concerns. However, most analysts accepted that rapid progress in the western corn-belt offset these weather delays.

The June Supply and Demand Report brought some surprises! USDA lowered the corn acreage (78 mil. acres) used in the production estimates and increased soybean acreage (73.6 mil. acres) due to eastern corn-belt planting delays and expected acreage shifts from corn to soybeans. USDA also adjusted trend line yields for delayed corn planting to 135.8-bpa and left soybeans at 39.7-bpa. While somewhat surprised, many analysts agreed that these acreage and yield changes probably had occurred.

USDA and everyone else are facing difficulties assessing the impact of this year's weather on supply! The next surprise came with the Planted Acreage Report later in the month; corn (78.9 mil acres) and soybean (73 mil. acres) planted acreages were back to nearly the same as the intended acreages in the May Supply and Demand Report! Apparently weather and planting delays didn't reduce corn acreage or cause a shift to soybeans.

While the questions raised in June were about acreage, yield appears to be the focus in July. USDA, now using the higher corn and lower soybean acres, did not change yields-sticking with the previous trend line yield adjusted only for late corn planting. These represent the 4^th largest corn yield (135.8) and the 2nd largest soybean yield (39.7) in history. Reports that dryland crops are gone, along with heat/moisture stress in irrigated crops, suggest that western corn-belt yields will be reduced. Many areas of the eastern corn-belt crops are also in trouble, having been planted late under wet conditions that have turned dry resulting in considerable plant stress. Rains have been spotty and some crops look very good, but each week's crop conditions report suggests crop prospects are deteriorating.

Weather and crop conditions are keeping the markets on edge. While the market pays attention to crop condition reports, most still remember that last year's poor summer crop conditions still turned out large crops! Even the weather forecasts are uncertain, changing daily, as some forecasters predict more hot/dry conditions while others bring in chances of rain and more moderate temperatures. Time may be running out, but weather and crop conditions could still improve. This could allow crops to recover and produce yields approaching USDA's July trend line production estimates.

Hopefully USDA's August Production Reports, which are the first to use survey data, will provide a clearer picture of production and supply. Until then, continue to expect market upswings with dry weather and down at even the hint of rain. It may not be over then either, with many acres of late planted crops, there may be frost worries later on. All in all, it's a difficult situation in which to try to make marketing decisions!

Volatile Markets and Selling Opportunities?

The government program marketing loan provisions and LDP effectively provide price protection in the form of a "price floor" at county loan price. Assuming harvest time basis levels are similar to recent years, it will take a December corn futures price of approximately $2.45 and $5.40 November soybeans to produce fall cash prices near county loan price. Once prices are above loan price, other marketing strategies are needed to capture and/or protect higher prices.

Soybean prices are in an up trend since making a low in January. November Soybean prices have posted gains of more than $1.00 per bushel from the $4.28 low to $5.38 (7-16-02). December corn prices have ranged upward nearly forty-cents per bushel from an early spring low of about $2.15 and recently have traded near $2.45 (7-16-02). These futures prices should produce harvest cash prices near loan price and are among the best prices we've seen in over three years-a signal that we should be preparing to make sales.

Forward contracting or hedging with futures are among common tools used to capture favorable prices that are above loan prices. If weather conditions improve soon and prices decline seasonally into harvest, this could produce prices that are again well below loan price. The hedged or contracted price could then be "enhanced" by the LDP resulting in a net price that is even higher than the contract price. Waiting too long to make sales could miss this opportunity since weather markets often collapse rapidly when the weather improves. However, if weather conditions don't improve and/or the sale is made too early, prices may continue to increase well above current levels. In this situation the hedged or contracted price ends up less (maybe much less) than market price at the time of delivery. There would be no LDP and maybe no CCP along with the possibility that poor weather may have reduced yields--producing the "double hit" of below market prices and less grain to sell! These risks make the selling or hedging decision difficult in volatile weather markets.

Put options or minimum price contracts offer methods of capturing higher prices that can produce "win-win" strategies in volatile markets. As prices move higher than loan price, locking in a price with minimum price contracts or put options provides downside market price protection. If prices decline, there may again be an opportunity to "enhance" the minimum price with the LDP and receive a significantly higher net price. If market prices continue higher, the put option or minimum price would expire and the crop could be sold at higher prices. A problem with this strategy is the option premiums (cost). Volatile markets increase risk and this increased risk is reflected in higher option premiums-sometimes making them costly and reducing net price received.

Another option strategy is to purchase call options to offset hedges or forward cash contracts, possibly using lower premium (cost) out-of-the-money call options. Actually, this strategy works better at a much lower premium cost if it is in place before the market begins to rally; See the December 2001 issue of Decisive Marketing, "Price Insurance for Pre-Harvest Sales." An out-of-the-money call also can produce a win-win scenario as market prices increase and approach the option strike price where the crop can be sold with a forward contracted or hedged with a futures sale at prices above loan price. Then, if prices decline, the hedged price may be "enhanced" with the LDP. If prices continue to rise after the crop is hedged, gains on the call option will offset losses on the hedge or forward contract. As with the put strategy, option premiums in volatile markets can be costly. Had this strategy been put in place last winter for November 2002 soybeans, premium costs would have been ten cents per bushel or less and the option already would be showing gains.

None of the option or minimum price strategies completely eliminate risk or difficult pricing decisions. If put options or minimum price contracts are used, the decision must be made at some point to price the grain. If call options are used to offset hedges or forward contracts, the decision about when to exercise or liquidate the call and collect gains also must be made. These decisions may still be difficult in a volatile market. However, whatever the decision, the net price should be much higher than most sales that are made too early in the rally and price protection is in place if the rally falters.

Value Added Price Risk!

Producers with value added enterprises and livestock producers, particularly those using commodity grains as production inputs, should be making risk management decisions for price protection in the volatile and uncertain weather markets. USDA expects 2002-03 (new crop) grain and oilseed carryover supplies to decline worldwide. If dry weather in much of the corn-belt continues, lower production and sharply higher prices are possible. Grain users should already have in place risk management strategies in the form of pre-purchased supplies, contracts for delivery or long hedges. Additional protection using these strategies or call options should be considered, especially if drought conditions persist.

Recent year's low prices have encouraged use that is already expected to exceed U.S. new crop corn and wheat production along with only a relatively small increase in soybean carryover. Much higher prices to ration supplies that are already tightening up may occur if production is reduced. This is a somewhat different situation than what occurred in the past few years and could have dramatic impact on value added or livestock operations that based their expectations on continued low grain prices. While improved weather and production prospects could again send grain prices well below government program loan prices, the current risk warrants risk management strategies to protect profits.