Why Marketing Your Crop Matters: Q&A with John Miller
The 2017 crop year will present tremendous challenges for U.S. producers. However, if history repeats itself, opportunities for profitable pricing will also exist. To take advantage, producers must be proactive. For a firsthand look at how, I caught up with John Miller, owner of Caldwell, Texas-based Southwest Agribusiness Consulting.
John Duff: Tell me a little about Southwest Agribusiness Consulting.
John Miller: We assist producers in developing individualized price risk management plans and executing these plans with discipline. We also help producers find the right elevator, access cross-country buyers and brokers, use a trading account to reduce reliance on cash markets, build storage to better manage harvest and selling opportunities as well as vertically integrate. We feel there is more risk in doing nothing than in making profit-oriented decisions utilizing sound risk management principles.
JD: I completely agree with your sentiment on the risk of doing nothing. Farming is risky enough without adding price swings. Any marketing strategy carries a certain amount of risk, but with the right advisor this can be minimized.
JM: Absolutely. A key benefit to our approach is peace of mind. Our producers can concentrate more intently on their businesses knowing we are monitoring commodity markets with their best interests in mind. They do not have to do it alone.
JD: So you are helping producers be more proactive instead of reacting to market moves?
JM: Yes. It is important for producers to think through their risk management approach and emphasize price risk tools that focus on long-term profitability. We believe risk management is most successful when based on profitability and not the hope of outguessing the market.
JD: Price is only half the story when it comes to profitability. December corn futures have rallied to profitable levels three summers in a row, and producers who knew their per bushel costs were able to lock profits in an otherwise down farm economy. Do you consider costs and the level at which producers can market profitably when you help develop risk management plans?
JM: Having a sense of production costs is a foundational requirement for any marketing plan. It is often difficult to assess costs since input prices are always changing, tillage and chemical use can change from year to year and ultimate yields can vary. However, having that cost number in mind frees producers up to approach the market more confidently. I can attest producers with a good understanding of their costs are much better prepared to step through a risk management plan.
JD: Tell me about your producers’ risk management plans.
JM: We begin developing marketing plans for an upcoming crop year as early as harvest. Global communication and commodity funds’ speculative behavior seems to make futures markets more forward looking all the time. For example, traders historically discussed upcoming crop acreage scenarios at the start of each new crop year. Today, acreage is a topic written about as early as the prior summer.
JD: In other words, producers must start thinking about marketing well in advance instead of reacting or selling exclusively at harvest.
JM: Yes. A challenge is the difficultly associated with predicting input costs six or even eight months before planting. However, we begin working with our producers to develop price targets as much as a year in advance given the unpredictability of today’s commodity markets. We base these targets on costs, price seasonality and profit goals, and once we have them in place we work with futures and options advisors as well as potential buyers on hedging and sales projects.
JD: How early are your producers locking a portion of their price or even guaranteeing bushels?
JM: It is not uncommon for producers to have futures—and basis in some rare cases—set on a portion of a crop a year in advance. To sell that early, however, producers typically seek a premium from the market. After that first sales decision, the focus turns to acreage, yield potential and evaluating price rallies for opportunity.
JD: The biggest fears most producers have are being unable to deliver on contracts and missing topside during rallies. These fears are understandable, but tools exist to manage these risks as well.
JM: We use these tools frequently. If production potential is uncertain, we advise using put options. Put options are preferable for many of our producers since their risk is calculable and limited to the option premium. If the producer purchased call options in the early stages of the marketing plan (which we often recommend), he or she can sell futures and have at least some protection against margin requirements as long as the call option is in place.
JD: Many producers avoid using futures contracts to hedge because of margin requirements. Your producers use them but often purchase options to cover margin risk as well.
JM: Correct. We do have producers who use futures contracts alone and simply finance margin requirements during price rallies. The challenge is maintaining these requirements in the case of a crop failure. We typically recommend a blended approach for this reason. Even a blended approach that ultimately results in a price lower than a rally high is better than no price risk management strategy at all.
JD: Producers should definitely consider using all the tools at their disposal and lean on advisors for assistance if necessary.
JM: We communicate with our producers frequently to evaluate their yield potential and the level of sales aggressiveness with which they are comfortable. Based on this we help blend forward sales with futures and options contracts so our producers can avoid being short on cash contracts. These are often costly and can occur at the wrong time, so it is important to stay up-to-date. Our approach means our producers are always up-to-date.
JD: Shifting gears, how do your producers manage basis risk?
JM: Basis is the most important piece of the marketing puzzle. The difference between the cash price and the futures price—a value known as basis—is the only negotiable part of a sales contract. Futures market volatility sometimes allows producers to manage basis strictly by monitoring the flat price, using hedge-to-arrive (HTA) contracts with trusted buyers or even locking basis early and selling futures market rallies. A strong understanding of historical basis can be of real benefit as well since certain pockets of grain country seem to exhibit seasonal patterns.
JD: Talk about the key features of each strategy.
JM: Each strategy has its own challenges. With the flat price approach, all upside is removed and the producer must guarantee delivery. With HTA contracts, a set quantity is committed to a given buyer’s basis quote, and again the quantity must be guaranteed. Locking basis means upside is removed and futures risk remains unless the producer sells futures contracts.
JD: Managing basis has its advantages though.
JM: Absolutely. If basis is favorable (knowing history is important here), all three strategies are advantageous. For producers fearful of production shortfalls or of foregoing basis upside, using futures contracts and put options to set a price floor is the most straightforward approach. Again, we typically advise using a blend of risk management approaches given the crop, time of year, production risk and producer attitude.
JD: Many areas of the Sorghum Belt see their worst basis levels at harvest, so knowing when to lock and avoiding the typical fall downside is important. However, keeping some opportunity in place in case of rallies is not unwise. What portion of their crop do your producers leave uncovered?
JM: When using put options or futures contracts, we rarely recommend hedging more than half the crop before harvest season, particularly for non-irrigated producers. This is partly due to the fact we have likely made some forward cash sales. Additionally, we do not want to add inordinate risk to our producers’ businesses by having them spend too much on price protection relative to the size of their crop. For irrigated producers, we might recommend the hedged percentage go as high as two-thirds.
JD: How much of their crop do your producers sell forward?
JM: It is not unusual for our producers to have one-third to one-half of their crop sold in the cash market at the start of harvest with another third protected with put options or futures contracts. Some years call for more aggressiveness, especially if early crop development is going well. Selling more than half the crop before harvest is a strategy typically reserved for irrigated producers or producers who purchase call options early in the season to help fund production shortfall buyouts.
JD: We are a few months away from beginning the most economically challenging crop year in a generation. What advice would you give to a producer looking to manage for a better price?
JM: Right after developing good communication and a balanced marketing approach, my advice based on 17 years of experience is to maintain marketing flexibility and transparency. This is why we do this work. We have a strong desire to help producers understand each component of their price risk management plan. Whether we are aiding in cash sales or advising on futures and options contracts, we strive to give our producers flexibility and control over pricing decisions at every step.
John Miller can be reached at 979-219-1864 or jmiller@agconsult.net.