Ep. 13 Mississippi River Transport Disruptions and Commodity Market Impacts

[00:01] Intro/Outro
Welcome to Relevant Risk from the Fryar Price Risk Management Center of Excellence presenting conversations and Analysis about Risk and Risk Management for food and agriculture, supply chain decision makers from farmers to consumers and everyone in between. This is Relevant Risk.

[00:19] John Anderson
Hello, this is John Anderson, director of the Fryar Price Risk Management Center at the University of Arkansas, with another Relevant Risk podcast; here today with a couple of familiar guests, Andy Mackenzie. Andy, how are you today?

[00:30] Andy McKenzie
I’m good. Good to be back with friends talking about an important issue again.

[00:33] John Anderson
Absolutely. And Hunter Biram. Hunter, Hunter first joined us only about a week ago for his first podcast and already got him put back to work. Hunter, how are you today?

[00:42] Hunter Biram
Doing great. Long time no see.

[00:45] John Anderson
Yeah, absolutely. You’re joining us by Zoom from Little Rock. So using … making maximum use of our technology here, we hope that it all holds together for us. Got an interesting topic today, a great risk management topic and one that I think we’re all excited to bring in. Not that it’s necessarily a pleasant topic, but Andy, we have talked for I don’t know how many times in the past six months about the drought and effects of the drought. Very difficult production year. And we’re sitting here now about halfway through the month of October and we’re still talking about dry weather. But there is a different dimension of this of this weather challenge for us to talk about today. And that is the fact that it has become so dry across the country that the Mississippi River is running at a very low level, close to historic lows from what I see in the news. And that is affecting barge traffic. So let’s start just with the kind of the most direct impacts of of this disruption of barge traffic: freight rates. What’s going on with freight rates on the Mississippi River?

[01:54] Andy McKenzie
Yeah. So this has been a problem really beginning back in July when water levels have started to go down. And what that really means in terms of getting barges down the Mississippi is that we would have lighter loads coming down on the barges that are still traveling and less barges in the tows which are coming down. So overall, that just means less supply coming down the river. And what that fuels then is a higher cost of getting grain from interior markets down the river to New Orleans for export. And so freight rates have gone way up to a … to account for that extra cost there.

[02:31] John Anderson
Yeah. Hunter, you had some information, I think specifically about what freight rates had done.

[02:36] Hunter Biram
Yeah. So freight rates are at about $75 a ton right now, which is up 257% from or over the three year average, 172% over last. this time last year and just 63% over last week.

[02:53] John Anderson
Oh, wow. So they’ve gone up a lot just within the last few days.

[02:56] Hunter Biram
Just in the last few days, over 60%.

[02:58] John Anderson
So this situation has as has escalated, obviously, the drought has been building for a long time, but the situation with shipping on the Mississippi River has escalated pretty rapidly in recent weeks. And we care a lot about this in the agricultural world, right.  Because a lot of our product moves down the river. And Andy, I would say as as as people who work in commodity risk management, there’s probably no topic nearer or dearer to our hearts than basis.

[03:35] Andy McKenzie
Yes. Basis, which is, formally the definition of it is a local cash price, less the futures price. And it’s important to farmers and grain elevators, merchandisers. Everybody up the supply chain has to deal with basis.

[03:51] John Anderson
And so let’s talk about what these higher freight rates do to basis.

[03:56] Andy McKenzie
Well, one of the one of the factors is … one of the major components of basis, that differential between futures and cash is transportation, or freight, costs. So when you get an increase in those, that’s going to make the basis get wider. And in effect, from a farmer’s point of view, the basis goes more negative and there are cash prices that they get to sell at are lower in comparison to the futures.

[04:22] John Anderson
Okay. So we talk a lot about determinants of basis. So those things that affect the spread between cash and futures prices. And you know what, I’ve … you’ve taught this material for a long time. I taught this material for a long time. One of the things that I would always say to students is that basically anything that impedes the flow of product, especially at harvest time, is going to show up as as a bigger spread between cash and futures prices or to, to use the appropriate terminology here, a weaker basis.

[04:52] Andy McKenzie
Yeah. I mean, if you think about it from a grain company’s point of view, the cost to get it down the Mississippi River, that’s going to be directly incorporated into their bids to farmers. So if freight rates go up, they’re going to lower their bids on what they’re willing to pay farmers. And that has the direct impact of giving you a more negative or a lower basis.

[05:12] John Anderson
So let’s talk about what basis has done lately along the Mississippi River. You’ve got some numbers or, Hunter, you have some numbers on that?

[05:23] Andy McKenzie
I got some. I mean, I was looking at it just today, and I was looking at some river market locations, and I was seeing something like a dollar to a dollar 30 under the futures right now.

[05:33] John Anderson
So, on soybeans.

[05:34] Andy McKenzie
On soybeans.

[05:35] John Anderson
So that would mean that the cash bids for current delivery are a dollar, what did you say a dollar 30? A dollar 30 lower than…

[05:44] Andy McKenzie
The futures.

[05:44] John Anderson
…the futures price right now?

[05:45] Andy McKenzie
Uh yeah, the November futures price. And also I think similar numbers even for corn. I was seeing it as well, even a dollar 30 under for corn as well.

[05:53] Hunter Biram
Yeah, I was seeing 115 under at Helena and 130 under for West Memphis on corn.

[05:58] John Anderson
Okay. So that’s again, to use the terminology, that’s a weaker or a wider basis than normal. The spread between the cash and the futures is a bigger spread than it is normally at this time of year.

[06:12] Andy McKenzie
That’s right. I mean, if you think about it just in terms of selling today in the cash market, again, what that means is farmers are going to be getting a lower price relative to the futures on what the basis is doing right now. And if they’ve actually, ahead of time tried to use the futures market to hedge their positions, then their effective price that they end up getting at the end of the hedge is weaker or lower too, because the basis has gone against them.

[06:37] John Anderson
And so let’s come back to that in a second, because I do want to ask this question of, you know, okay, who cares? The basis is wider, but prices are still really high, so farmers are okay. I think there’s a couple of things to unpack in that. One is those cash prices, those cash price bids are much lower than they were just a week or two ago. They are much lower than we would normally expect them to be relative to the futures market, although we’re still at a fairly attractive price point for the most part. But another issue here, in addition to, okay, prices deteriorated over the last couple of weeks; we don’t like that.  The widening of basis reduces the effectiveness of the risk management strategies that farmers put in place.

[07:19] Andy McKenzie
That that is correct. And what we’re also seeing, though, interestingly, is if you look at some later delivery periods, say for the post-harvest periods, I’m talking about November or January, then the basis is actually being offered at higher levels for those delivery periods by these same river elevator facilities. And so what they’re really saying is these facilities: hey, we don’t need the beans, right now. We can’t even move them and get them to export, but we’ll take them in a month or two’s time and we’ll give you a better price for them at that point.

[07:50] John Anderson
Right. So the return to storage should be pretty significant over the next couple of months. If if if farmers have storage available.

[07:59] Andy McKenzie
If you have storage available, you can make some returns on that storage; you’re right, John. And similarly, even we’re talking about basis here, but even in the futures market itself, we’ve seen recently over the last week, the soybean futures prices for the deferred contracts. So I’m talking March, January, March and May futures versus the November contract for harvest. They’ve, the March one has probably gone up about $0.20 over the last week the May about $0.30 a bushel; the January a little bit less, maybe up to about $0.10. But again, what that’s saying is the market is telling people, I’ll pay you more if you wait and store the grain for me and give me at a later date.

[08:42] John Anderson
Okay. So the market is saying, we don’t need it now because we can’t move it. We’re hopeful that we’ll be able to move it later and so bring it to us later and it’s worth more.

[08:53] Andy McKenzie
That’s exact … I mean, the market is really an interesting beast. It tells you … or gives you signals on what to do. And that’s what the signal is right now.

[09:02] John Anderson
Yeah. Yeah. So one thing that I wanted to talk about related to this is, let’s think specifically about beans. If farmers have priced their beans, they’re probably not that concerned about this situation. They’ve got a price established or they locked the basis in and pulled the trigger on a on a price at some point in the in the in the growing season. This is really a bigger issue on unpriced grain. The beans that they’ve produced that they didn’t have booked already. And I’ve talked to our colleagues, Scott Stiles, who has joined us on the Relevant Risk podcast several times before, and unfortunately couldn’t be with us today. Scott estimated that, you know, 40 to 60% of beans in the Delta had been priced and the rest were un priced right now. And so were subject to this deteriorating price situation that we’ve seen. And that actually seemed like, given the strength of prices through this growing season and the good opportunities to price, that seemed like a fairly low percentage as we’re sitting here at the end of the year. But there’s a reason that farmers would have been reluctant to price grain this year.

[10:12] Andy McKenzie
Yeah, that’s right. I mean, if we look at the options on how you can lock in a price ahead of time, you can go to the futures market directly and do it through that. But another way and probably more common for farmers is to book a forward contract with their local co-op or elevator. The problem with that is if they don’t make the production, then they’re going to get penalized by the elevator for all of the bushels they aren’t able to deliver on their contracts. And that’s where you’re hitting the nail on the head, John, because we had all of these drought related weather effects and people are really scared about maybe not making good yields and getting the bushels.

[10:52] John Anderson
So there was a lot of concern about overbooking and then being stuck for that difference between what I could actually produce in a drought affected year versus what I had booked and had to deliver… was on the hook to deliver.

[11:04] Andy McKenzie
That’s exactly right. And I think this is the sort of perfect storm this particular year, because we did have very high prices. So we had the opportunity to book ahead of time. But by the same token, we did have these weather related events in terms of drought, which made people a little apprehensive to not overly book ahead of time.

[11:24] John Anderson
Right.  Now, Hunter that’s where I want to bring you into the conversation on this, because, you know, you do a lot of work with crop insurance, as we talked about on the last podcast, actually. And, you know, one of the intents for the crop insurance program is that it it protects farmers against the financial impact of those short crop situations so that they can book with greater confidence, maybe book more aggressively. That is, crop insurance is supposed to be a complement to their other pricing strategies and allow them to to to price more earlier than they might otherwise would. Could you unpack that a little bit, explain kind of how that’s supposed to work at least?

[12:06] Hunter Biram
Maybe I’ll start with just revenue protection, insurance. So in in crop insurance and the programs that RMA administers and rates, there’s going to be two primary types of revenue insurances and that’s going to be revenue protection, so RP; there’s going to be revenue protection, harvest price exclusion. And so the key difference in the revenue protection and harvest price exclusion is that you get to essentially roll the dice on the prices twice with R, so there’ll be projected price versus harvest price — and I’ll talk about that in just a second. And then with the RP, the guarantee will be determined by only the projected price rather than either the predicted or the harvest price. So the way the RP works is there’s going to be a guarantee, it’s going to be calculated by the APH, which we talked about last week, the actual production history. So it’s going to be some… it’s going to represent some expectation of yield, some expectation of production.

[13:00] John Anderson
So that’s the yield level that the producer can insure.

[13:03] Hunter Biram
That’s right. Yes. And so there’ll be some expected yield times, either the higher of the projected price calculated by RMA or a harvest price calculated by RMA. There’s your yield times price times some coverage level that is chosen. We talked about coverage levels last week. So the projected price is going to be calculated in some period in the winter time or spring time.  For Arkansas, for for corn and for beans that projected price period’s going to be somewhere, it’s going to be mid, mid, mid-January to mid-February. And the harvest price actually for soybeans is being discovered, so to speak, right now. And so that’s from October 1st to up to October 30th. Corn is odd crop out. It’s August 15th through September 14th. So depending on which one of those prices, either the harvest price at planting or essentially the har… the the the sorry in the futures price at planting or the futures price at harvest depending on which one of those is higher can give you a higher revenue guarantee and that’s on RP. But RP-HPE, it’s only going to be whatever that projected price was.

[14:11] John Anderson
So the key the key difference between those two products is the harvest price exclusion sets your revenue guarantee before planning when the insurance purchase decision is made. And that guarantee doesn’t change.

[14:24] Hunter Biram
That’s right.

[14:24] John Anderson
With the RP product, if price goes up through the growing season, you get the benefit of that higher price in that it adds to your guarantee and your guarantee adjusts to that higher price point.

[14:37] Hunter Biram
That’s right. And so you’ll have essentially more price protection with RP in that you’re going to be protected more from price volatility. The RP- HPE, you don’t really capture that, you know, growing season price volatility in between planting and harvest. So, you know, bringing this back to the original question like, why is this important and how is this important for being more aggressive with forward contracting? Well, you know what little I do know about marketing is that if you don’t have grain to to take some way that grain elevator, grain elevator needs to be compensated and they need to be compensated for the value of that crop. So what revenue protection would allow you to do is depending on which coverage you purchase, you may be able to replace the value of the crop the was lost due to weather, drought, and use that indemnity payment to go to the elevator and essentially pay them for the value of the lost crop.

[15:39] John Anderson
Right. So that that mitigates the risk that the producer would would would have to cover any shortfall out of their pocket.

[15:47] Hunter Biram
That’s right.

[15:48] John Anderson
The indemnity would be there to cover that. Now, obviously, nobody wants to have to give their indemnity up to that. But that’s better than having to pull it out of your pocket.

[15:56] Hunter Biram
That’s right. And I mean, think about this. If you know, if you have some July or August price that you can book out for, you know, September, October delivery that is very favorable. And, you know, that’s normally about the about the time of the season where where we’re seeing those prices being the highest. You have more confidence to go ahead and book that higher price. And between the higher price that you booked and revenue protection, you may be better off than what you would originally think.

[16:28] John Anderson
But all of that assumes that the APH, the yield that that is insurable to you as a producer is a pretty accurate reflection of what you expect your production to be. And it assumes that you’re getting a coverage level that’s high enough that that you could book that additional volume.

[16:46] Hunter Biram
That’s right. There are so many moving pieces and coverage level is one of them is one of them. And yeah, we have to assume that the APH, given that there’s even enough yield history to calculate an accurate yield yield APH. If you’ve only got four years of data versus ten years of data, you may not… that that four years isn’t hardly going to describe what your actual yield, you know, distribution, so to speak, is going to be or what your possible yield might be for that growing season. So, yeah, there’s this, you know, is APH representative or not and that’s I think that we can go down that road later if we want to. But then there’s also the coverage level part of this. And so in my discussions with farmers that I’ve had this… it sounds to me like about 70, 75% coverage is the most popular and that is verified by RMA summary of business data. That’s what I’ve seen pretty much since the beginning of summary of business data from ‘89 forward. We’re saying mostly 70, 75%; 65% being very popular, but not a whole lot in that 80, 85%, which are the highest two coverage levels.

[17:54] John Anderson
Right. Right. So a lot of complexity to this. A lot of I think some important caveats about about, you know, how close that coverage can be established to a farmer’s actual expectation. But a key point here that these risk in… risk management tools do interlock and overlap in some important ways for farmers.

[18:18] Hunter Biram
Yeah. And you know with with our piece, something else that I want to that then I want to go ahead and reiterate on that talked about last week is and there’s an individual trigger there. So we’re looking at farm yield trigger for that revenue protection. And as you know, we’re not focusing as much on like for ARC, for instance, has the county trigger now ARC’s going to be under the commodity programs, that’s not crop insurance. But still you have… well, you’re eliminating your basis risk that we talked about last week by signing up for RP because you have this farm level APH that you’re going to be using to insure with.

[18:52] John Anderson
Right. So let’s let’s think a little bit about what this implies for for farmers and the decisions that they’re making right now. And usually when you’re in the middle of a of a of a circumstance like this, it’s it’s too late to change decisions very much. But, Andy, what what are some things that farmers could think about doing in response to this really weak basis situation that we’re looking at.  It’s too late to go back and buy a higher level of crop insurance coverage. But what can we do now?

[19:26] Andy McKenzie
Well, I mean, they could look at other interior market locations which maybe are paying a higher basis than the river, but they’d have to factor in their own trucking rates to get it to those locations. And, you know, depending how close they are, that might not be feasible. The other alternative is to actually store the grain themselves and try to capture that return to storage that we talked about and maybe try to hit those later delivery periods. I think that’s something if you have the storage space in that capacity, that would be a good thing to think to do.

[19:55] John Anderson
Now, my guess is this .. the situation where the interior elevators, the country elevators, aren’t reflecting as weak a basis as the river elevators —  that won’t last very long, probably, will it?

[20:10] Andy McKenzie
It won’t. All these markets are interconnected. And, you know, we talk about how basis ripples through the whole country, in effect. It’s almost like the CIF NOLA market at New Orleans is a key market because it’s the main export market for soybeans. And when, say, demand goes up at that New Orleans market, there is an increase in basis reflected there. And it’s like throwing a pebble into a pond. It ripples through the whole country and you get that increase in basis gradually. Well, I say gradually. How fast it happens just depends on a bunch of different things, but it’ll increase throughout the country. And so you’re right, John, those interior market locations right now maybe have a higher basis, offering farmers a higher price than the river. But once those guys start to fill up, if you know, the supply goes there, they’re going to start lowering their bids. They don’t need the beans anymore. It’s going to come back to the river again when hopefully water levels start to rise again. So all these markets are interconnected and it’s really freight and cost between different locations which separate those prices.

[21:16] John Anderson
Yeah, yeah. Those signals propagate through the system pretty quickly. But to the extent that the interior elevators have space … now, I could see a situation where as more people try to go to those elevators for the more attractive basis, there are bottlenecks there with delivery and all kinds of other issues that that end up showing up, maybe not only as weaker basis, but also as higher cost as you factor in time and fuel and all those other things, so…

[21:41] Andy McKenzie
That’s that’s right.  I think this whole situation is really compounded that it’s happening when it’s happening, right, right around harvest time. Because I’ve I’ve looked at this as a research question before and I know that there’s seasonality in the barge freight rates and they tend to be at their highest levels during harvest. No surprise, because that’s when there’s greatest demand for barges. And so it’s sort of compounding that effect.

[22:03] John Anderson
From the standpoint of Arkansas agriculture, it’s … there probably couldn’t be a worse time in the year for this to be going on, I would guess.

[22:10] Andy McKenzie
Yeah, I think that’s right.

[22:11] John Anderson
Because we really are really getting into the heart of soybean harvest and soybeans are the main crop that’s going down the river. Almost half the crop is being exported. A lot of that’s going through the Mississippi River system. Now with corn. We send a lot of corn down the river and obviously basis has been affected. But we’ve got other marketing channels for corn compared to soybeans.

[22:34] Andy McKenzie
Yeah, that’s right. And so if you have other alternatives, then obviously you can use those alternatives and get the higher basis level those those other locations.

[22:42] John Anderson
So we may see on corn that’s not going down the river, but instead coming up to northwest Arkansas to poultry feed mills, maybe it’s a different situation.

[22:49] Andy McKenzie
That’s right. That’s right. I mean, you’re going to go where the biggest buck is, right?

[22:53] John Anderson
Absolutely. So an interesting situation. As I said, Andy, I know guys like us could sit down and talk about basis all day, but most of our listeners probably don’t have the tolerance for it that we do. So I think that’s probably enough for one podcast. So I want to say Hunter Birum. Thank you for joining us.

[23:12] Hunter Biram
Well, thank you for having me. It was a lot of fun to sign on from Little Rock.

[23:16] John Anderson
Absolutely. And Andy, thank you again for for joining us, as always. And we will sign off for this Relevant Risk podcast. Thank you.

[23:27] Intro/Outro
Thanks for listening to the Relevant Risk Podcast, a production of the Fryer Price Risk Management Center of Excellence in the Department of Agricultural Economics and Agribusiness within the University of Arkansas System. The Fryer Price Risk Management Center of Excellence carries out teaching activities through the Dale Bumpers College of Agricultural, Food and Life Sciences at the University of Arkansas in Fayetteville and research and Extension Activities through the University of Arkansas System Division of Agriculture. Visit Fryer Dash Risk Dash Center dot USDA dot edu for more information. Thanks for listening.