Ep 23. Crop Market Update and Pre-Harvest Risk Management Considerations

[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 of Excellence with another Relevant Risk podcast and we have a special guest today, Associate Professor and Extension Economist Aaron Smith with the University of Tennessee, Knoxville. Aaron Smith, thank you for joining us today.

[00:36] Aaron Smith
Any time, John. Glad to be here. It’s always good to reconnect with my alma mater.

[00:42] John Anderson
Yeah, well, I’m glad you brought that up because I want to get, you know, get out there at the outset, a little plug for our program. Aaron is an alum of our Ph.D. in Environmental Dynamics at the University of Arkansas through the AG Economics Department. Is that right?

[00:56] Aaron Smith
Yeah, that’s right. Dr. Mike Popp and Lanier Nalley were my two primary advisors, but they basically walked me through kind of a unique Ph.D. program, but one that served me very well in my career. And obviously, there’s still several faculty there that I was at one point a student in their class, including Dr. McKenzie, who also is heavily involved with this podcast.

[01:22] Aaron Smith
But no, it was one of those ones where the department really did prepare me well for what I do in terms of extension programming and my programming and risk management marketing and domestic foreign policy. So.

[01:36] John Anderson
Well, we’re very proud to have you as an alum. Aaron is one of the top extension crop marketing economists in the south and really across the nation. And you’ve been at Tennessee since you finished your Ph.D., right? That’s kind of been your first landing spot?

[01:53] Aaron Smith
Yeah, it’s been great. I got out here in 2013, the year I finished my Ph.D. and moved the family to Knoxville. And we’ve loved it out here a lot. Lots of traveling, moving east to west across the state. But it suited me and my wife and kids very well. So it’s something where University of Tennessee has been a fantastic experience for us.

[02:17] John Anderson
Good. I’m glad to hear that. And that is a great institution. We’ve got a lot of good collaborations with faculty there and I have had over the years and very happy to have you joining us today. And Aaron, I know I feel like I need to apologize to you in advance before we even get in this podcast.

[02:34] John Anderson
And let me set the date a little bit for the listeners who’ll be hearing this in a couple of days. We’re sitting here on July 11th recording this, which is a day before the July WASDE comes out, which is in my experience as a crop marketing economist is the absolute worst time for somebody to ask you what’s going on in the market.

[02:52] John Anderson
So first of all, I just want to give you my sincere apology for booking you to do this the day before the July WASDE and thank you for being willing to do it. But in light of that timing, I really want us to focus a little bit more on kind of the longer run fundamentals that are at work in this in the market as we’re sitting here kind of mid-season taking stock of what’s going on, kind of looking ahead to the things that are going to happen, that are going to kick in and set the stage for the marketing year to come.

[03:24] John Anderson
What’s going on with some of these longer run issues and to maybe get the conversation going? Obviously, it’s not news as we sit here right now because a lot of people have kind of already digested the acreage report. But the acreage report was a big kind of change in the fundamental picture in these markets. Is that a fair statement?

[03:42] Aaron Smith
Yeah, absolutely. I mean, you know, when we look at the acreage report that came out on June 30th, there was pretty big shock. In particular the corn and soybean numbers with corn pointed at 94 million acres, soybeans at 83 and a half and cotton and 11.1 million acres. You know, we’ll have to walk the wait and see if there’s not revisions down the road on that.

[04:04] Aaron Smith
It’s something we’re always look towards. The USDA early release of the FSA crop data is as a confirmation or one of the one of the methods of confirming what’s going on there. And then there might be some additional changes that that might end up occurring through that. But we may make decisions based on the current information. And if there’s there’s additional revisions, we’ll have to go from there.

[04:25] Aaron Smith
But what it does end up doing is it does kind of recalibrate where we are right now in terms of what we know. And I’ll talk a little bit about some of the yield stuff that that is going to potentially play an important role. But just to give an indication of how big that report was in terms of the dynamics between corn and soybeans, I did some back of the envelope numbers on that.

[04:52] Aaron Smith
And right before that report released the harvest, corn to soybean price ratio on the futures market was 2.39. And the day after that was 2.74. And while that doesn’t maybe sound like a huge move, that was the largest single day move in the last over 12 years.

[05:10] John Anderson
So, wow, that is a big move.

[05:12] Aaron Smith
So again, it’s one of those ones where I think it really does have some implications that will end up creating potentially  some greater uncertainty in in certain crops than than others for sure, as they move forward.

[05:27] John Anderson
So we took a lot off of corn there, that change in that ratio. We took a lot off of corn and added quite a bit of soybeans on that change in fundamental expectations. And acreage, obviously a big the big factor there with that report coming out at the end of June, I’m starting to hear a lot of people talk about kind of the natural progression, I guess, as we go through the year.

[05:51] John Anderson
Okay, now we’ve got that acreage number. Now let’s start talking about yield. And we’re also at that time of year when summer weather is really becoming a factor in a lot of places, and particularly in this year, the heart of the Corn Belt is actually getting pretty dry. So what’s the buzz out there about yields kind of recognizing that at this time of year everybody’s got a different opinion on what yields are going to do, but how do you see that playing out as we kind of roll into, say, the August WASDE when people are really starting to get itchy about having a farm yield number, what do you think is going on?

[06:26] Aaron Smith
Yeah, it’s really challenging this year when you look at it across multiple states and geographic regions to really get a handle on that. I think everybody’s well aware of when we look at the drought monitor and some of the soil moisture mapping that is put out there, that it has been very dry across a big chunk of the the Corn Belt.

[06:45] Aaron Smith
But from conversations I’ve had with several people, there’s a lot of uncertainty in terms of how some of these rains have potentially impacted in terms of geographic area. So when we think about it, some of the spotting of some of these showers, I think is really going to end up creating some havoc or uncertainty is a better way to put it in terms of what those yields are ultimately going to be. When you’re looking at it in terms  from the crop progress report the USDA puts out, you know, there’s a lot of emphasis right now on on Illinois and then some of the northern Corn Belt states, including Michigan and Wisconsin.

[07:23] Aaron Smith
And then the kind of the epicenter of the drought has been kind of more on the western southwestern side of the Corn Belt in that area. And so those are going to be be very closely watched. And so, you know, one of the things that I’m checking on, on a daily basis as we end up looking through this is looking at some of the forecasting in terms of the five and seven day precipitation.

[07:45] Aaron Smith
And then also what we ended up realizing in terms of alleviating some of those drought concerns. But it’s a really challenging year to get a handle on what’s going to end up happening in terms of yield. Another one that I hear a lot of from from consultants and brokers that I end up speaking to is how good some of our genetics are, were we able to end up seeing some of our corn and soybean crops withstand some of this stress that we ended up getting.

[08:13] Aaron Smith
And what’s the what’s the implications in terms of long term yield? The one consensus that I have had or I haven’t heard anybody that said that they think that this yield is still targetable is the initial estimates that were released back in the May WASDE 181 bushels per acre for a national corn yield. I think we’ve kind of taken the top off that.

[08:34] Aaron Smith
The question is there’s a lot of room between there and where we might end up. So the question is, where are we in terms of those numbers once we get to that August time period?

[08:44] John Anderson
Right. And by the time we’re releasing this podcast, we will know if USDA made a yield adjustment in the July report. And I think for the reasons you just outlined there about the general uncertainty at this time of year and maybe particularly this year with some of the spotting of the rain, USDA has always loathed changing yields in July, but they will do it sometimes.

[09:07] Aaron Smith
Yeah, I agree. I think that they likely will punt. But given the dramatic nature that we’ve seen in terms of those acreage shifts and what we’ve seen in terms of some early season drought, it would not be entirely unsurprising if they ended up modifying that a little bit. The question I guess would be if they do choose to modify, what do they end up doing in terms of how big of a modification they end up providing?

[09:36] John Anderson
Right. Right. You know, again, we’ll see how right I am before this podcast even comes out. But it takes a pretty powerful push. Something pretty big has got to be going on a pretty clear for USDA to make a July yield change. They are a lot more inclined to stay in path until August when it really starts to matter and they’ve got more objective data to go on.

[10:02] John Anderson
But that’s something the market’s going to be watching for sure. So other issues, Aaron, what do you see coming down the road again, as we kind of looked to get into the market year, you know, as you’re talking to your stakeholders in Tennessee about planning for the upcoming marketing year, you know, what kind of fundamental factors have you got your eye on other than what we’ve already talked about?

[10:28] John Anderson
And give us your kind of elevator pitch of what you’re telling stakeholders about risk management plans for the coming marketing year.

[10:38] Aaron Smith
Yeah, I’ll circle back to the risk management plans here in a bit. But I mean, I look at three are looking at three real key different things when I’m talking corn, soybeans and cotton. The first one is reasonably new because of the June acreage report that 94 million acre number. It’s going to be real important to see what we actually get in terms of harvested acreage.

[11:00] Aaron Smith
Now that can come in a bunch of different capacities. If there are some crop losses out there for multiple reasons in terms of lost acreage. But since we do have that size of acreage that’s embedded in our initial estimates, that yield for corn is going to be really crucial if we’re somewhere north of that 175 national average yields, then you’re talking a pretty substantial carryover into the next marketing year based on current USDA assumptions about exports and domestic use in that market.

[11:35] Aaron Smith
And so that yield number for corn is one that I think is really important. When we look at soybeans, the one that I’m really interested to see how USDA addresses it. And again, this circles back to the importance of that June acreage number of 83 and a half million acres planted. If you end up having a yield of somewhere around that 50 bushels per acre, they’d actually have to end up dropping the export sales number from where it is based on current production levels.

[12:01] Aaron Smith
And so my big thing is it depends on when we see what the soybean yield is, if it continues to end up sliding downward a little bit, what we’re going to see is continued revisions to that export sales number. And so when we talked about those price ratios, yeah, we’ve seen soybeans end up jumping up substantially relative to corn.

[12:22] Aaron Smith
But we do always have to think about this, not just in the vacuum of the U.S., but what’s going on with our neighbors to the south and what will end up potentially happening. I think we’ve discussed it a lot this year and the size of Brazil’s soybean crop. So if we start seeing our prices domestically continue to run, they’re obviously going to get the price signal to end up increasing their production for the upcoming year, and then they still have a substantial amount in reserves.

[12:49] Aaron Smith
So there are some limitations that are that are embedded there. So the big one for me on the domestic side of things is looking at that soybean export rank. It’s a real important number. And then when we shift to cotton, cotton, once we start getting into August, we get an idea of what that abandonment is going to be in the Southern Plains.

[13:07] Aaron Smith
There are some of the longer-term weather forecasts that do have a potential for active hurricane season, which can play into what some of those production estimates are. So those are kind of the three main things that I’m looking at in those markets in terms of what’s really going to kind of drive price direction as we move forward.

[13:30] John Anderson
Alright. That’s a pretty good summary. The export numbers for soybeans, I want to dig on that a little bit. I mean, that’s the implication of that is if I’m interpreting what you’re saying. Right. The implication of that is of some fairly durable price support in that because  that rationing of exports doesn’t just happen.

[13:54] John Anderson
It happens through the prices going up or at least holding up to encourage people to find other sources. And you mentioned South America. Obviously, that’s a big one, but that implies fairly strong, barely strong fundamentals, support in that market.

[14:11] Aaron Smith
Yeah, in the domestic market, definitely. And so when we think about it and the reason why I was talking about having revisions down in that export number is because of where that acreage number came in. Even if you use a trend line yield, I think it was right around that 50 to 52 bushels per acre. If you plug that in based on current domestic crush, which you can make a pretty strong argument that will potentially increase with some of the the new crushing capacity that’s came online.

[14:45] Aaron Smith
We really don’t have the beans held in reserve to end up expanding that. And so it just becomes a plain and simple fact that when we restrict the amount of production that we have based on that acreage and then potentially revisions in yield, it’s going to come out of that export sales numbers where it’s going to come. And so I think that ends up having two implications potentially as we look at kind of a risk management strategy in beans.

[15:11] Aaron Smith
The first one that I tell a lot of the guys that I work with is we have to end up disassociating our futures price from our basis price. I think that’s really key under these circumstances, both for corn and soybeans and trying to look at how do we mitigate the risk in the futures market. Well, maybe leaving some flexibility on the basis side, we are in a bit of a different set of circumstances in terms of our demand side on the corn side when we’re in the south relative to the the heart of the Corn Belt.

[15:42] Aaron Smith
And then when we look at soybeans, I think, again, there’s going to be a real strong domestic demand for the soybeans that are out there. So I think we need to factor that in as we make our risk management marketing decisions for this year.

[15:55] John Anderson
So what do you do? What do you say to somebody? I’ll put you on the spot a little bit here Aaron because I know crop marketing economists love to be put on the spot with questions like this. Let’s say you’re dealing with let’s say you’re a corn producer in western Tennessee, eastern Arkansas, and you’ve been kind of holding back on your bookings because of production uncertainty.

[16:18] John Anderson
And now you’ve seen this fundamental this erosion in the fundamentals support in your market and you’re sitting here woulda coulda shoulda, what’s the best play moving forward from here? How do you address somebody here at an extension meeting in May and they ask you that question what’s your what’s your response? What’s the strategy from here forward?

[16:39] Aaron Smith
Yeah, you know, it’s one of those ones where you can talk in some generalities and I will a little bit. But, you know, you really have to look individually at where you are. What do you have priced at this juncture in the market? How is that priced? One of the big ones, if somebody just came up to me and I didn’t know them and said, okay, well, what should I end up doing?

[16:57] Aaron Smith
The first question I have is do you have the capacity to store the production that’s coming this fall? Right. What is your production estimate? How much of that can you can you store? Because then all of a sudden you’re looking at different or potentially different contracts and different mechanisms on how you might want to end up approaching it.

[17:15] Aaron Smith
One of the ones that I think works well under under the current circumstance, and I’ll use the corn market is example because soybeans you would use a little bit something different is if you have the ability to store that crop. I like looking at that March contract, but I like looking at it through options rather than just using futures.

[17:33] Aaron Smith
And I think there’s a real benefit to getting a floor under that. Whether you want to offset the premium cost by another strategy that can be, I guess, debatable as to whether you want to end up doing that. But to me, based on the corn acreage number and some of the uncertainty we’ve seen in weather, if you can store that crop, you can take some of that price risk off the table for the crop in storage.

[17:59] Aaron Smith
I think that’s something that is worth considering for sure. I do like the options because it does provide you a little bit of flexibility. I think one of the biggest mistakes I consistently see in using option markets is that they carry the option too long. Rather than unwinding that position and being able to recoup some of the premium that’s still potentially available after you’ve covered off some of that risk.

[18:24] Aaron Smith
And so again, I think I think that’s one that works pretty good. And I’ll just give you a quick example. I was jotting down a couple of notes earlier this morning. So some of these numbers might have changed a little bit. But using the March contract, you could buy a 450 put option for $0.11, etc., for 39 futures floor and then sell a $6 call for $0.11 to recoup that premium.

[18:47] Aaron Smith
Right. And so what you’re looking at is kind of putting in protection on the downside. You’re maybe foregoing some of the upside in the futures market, but I like it for two reasons because it doesn’t fix your basis. So you still have plenty of negotiating room as you work through the winter season. And again, since you are using an option, you can end up exiting a position and recouping potentially a portion of that premium.

[19:08] Aaron Smith
If you do end up seeing prices move in a positive direction for you. So that’s just an example of something that you might want to look at some of those options, ones are options contracts. If that’s something that works, you can make them more simple. You can just buy a put option or you can add additional complexity. There’s a lot of different ways you can look at it, and then obviously you can look at multiple strike prices right?

[19:31] Aaron Smith
So yo have to have an understanding of what you’re looking at in terms of strike prices. What’s your appetite for premium and kind of counter off that direction.

[19:41] John Anderson
So I hear you basically saying a store with a short hedge, some sort of option, construction of a short hedge, basically to put a price floor in use in the March contract. The idea being you’ve got a worst case scenario established. And and you know, when in a good positive outcome would be that over that period of time you maybe get some basis improvement so that you benefit from that before you liquidate that crop and unwind that position.

[20:12] John Anderson
Is that about what you’re saying?

[20:14] Aaron Smith
Yeah. I mean, I think in the corn market, just because of that acreage number and kind of where we’ve been trending, I do like getting the floor underneath it. I know when we end up constructing our cost of production budgets and I recognize there’s a whole spectrum of different, different cost of production for producers. And it does highlight why you should know or have good estimates as to what your cost of production is on a per unit basis.

[20:40] Aaron Smith
But most of those are coming in, you know, just under the $5 range for a lot of our guys. So if you have a a floor near that for 50 plus, you can tack a basis number on there in March and January through March in Tennessee, we are we are blessed by having a pretty strong, predictable basis in corn markets because of our strong distilling and poultry and livestock industries in addition to ethanol.

[21:07] Aaron Smith
And so it’s something where, again, if you can start penciling in some profit on there. Well, covering off that downside, I really like a play that gives you some upward mobility, but protects you from losses moving downward.

[21:22] John Anderson
Yeah, that makes a lot of sense. That’s good advice. Let’s kind of look at the other side of that coin to finish up here, Aaron. What about on the soybean side of the market? So now we’ve got this this the fundamental situation that has improved, looking like a strong market. We just talked about kind of this look like a reasonable expectation that will have fairly durable fundamental support in that market.

[21:46] John Anderson
Where do you pull the trigger to take that risk off the table if that’s your game?

[21:53] Aaron Smith
Yeah. You know, this this is a tricky one for for soybeans because you’re right, I mean the trend is definitely moved to a strengthening market. So the thing that just worries me tremendously because of the amount of soybeans we export in the competition is provided by South America, is we’re going to run headlong when we’re completing our harvest into that South American plantings.

[22:18] Aaron Smith
And so all of a sudden it adds another dynamic to it that is going to create a massive amount of uncertainty. So the further we see these markets on the soybean side continue to strengthen, the more of an incentive we will see in terms of Brazil again, increasing their production. And then the other one that I think we always have to recognize for the past year is, everybody remembers how strong the drought and the implications were for production down in Argentina.

[22:49] Aaron Smith
If you stack Brazilian production, then on on top of Argentina in production, looking out until January, March, when they’re going to be harvest, there’s a substantially larger chunk of risk there than when we’re potentially looking at having sales this fall. And again, so I think the key to me for for soybeans is you’re going to have to pick your price points.

[23:13] Aaron Smith
I really like once you end up establishing that that futures price to see what what’s available in terms of in terms of basis. But I would be a little bit concerned carrying a lot of production unpriced into into the new year based just on on the fact that we’re going to potentially have substantial competition coming from our Southern counterparts.

[23:35] John Anderson
Yeah. So the price situation here will incentivize big production there and that becomes a downside risk when we get to roughly the end of the calendar year.

[23:44] Aaron Smith
Yeah, and I mean, to add on that, I mean, we do have to remember that when we are delivering to some of the crushing facilities that are in our locations, there’s probably going to be some pretty good competition. So again, I would not ignore that basis component, but I really think that, you know, the bulk of your risk is going to come from the futures market.

[24:05] Aaron Smith
And the way that I always position it at my extension meetings is, you know, your futures market, that’s your sundae, your basis is your whipped cream and your cherry on top of it. Right. And so when you’re looking at that, can you end up expanding kind of maybe a bit of that whipped cream in the cherry? But don’t ignore that the sundae has to have that protection because when you look at breaking it down into percent intervals in basis, just by definition is going to vary across multiple locations.

[24:33] Aaron Smith
But I always like to end up sitting down and running numbers in terms of, okay, here’s your cash price. What percentage of that is based is based on futures, and then what percentage of that is based on on a basis offering? And normally what you see is in Tennessee or somewhere between 85 to 92% of it is the futures market price risk.

[24:54] Aaron Smith
And then the remainder is the basis component now that changes a little bit and there’s always exceptions to the rule. But again, you want to have that core risk management that is protecting you in the futures market and then maybe have a little bit more flexibility in the basis market, particularly in my location on on the East side of the river here.

[25:15] John Anderson
Right. That makes sense. Aaron that’s a good summary and really good information. I appreciate you sharing with us. Any parting thoughts before we wrap it up?

[25:25] Aaron Smith
Yeah, You know, I think the only thing that I will say is there’s still a large amount of uncertainty in what this crop is really going to look like nationally. And I think that really makes it challenging. You know, we always want to end up being cautiously optimistic, but being cautiously, cautiously optimistic shouldn’t lead you down a path where you’ve got massive amounts of downside exposure.

[25:51] Aaron Smith
We all know that most people will use crop insurance as kind of the base of their risk management plan. So one of the ones I when I work through kind of step by step process as to what you’re looking at in terms of in-season crop decisions or crop marketing decisions is where are you in terms of your crop insurance protection, what type of trigger yields are you looking at in terms of when an indemnity might end up being paid?

[26:16] Aaron Smith
What is your current production looking like on your individual fields or farms? What can you store versus what will you have to sell at harvest? Because that will really dictate what you want to end up doing in terms of potentially looking at the contract that you’re you’re using. And then where is your comfort level in terms of pricing the amount, a certain amount of production prior to harvest?

[26:42] Aaron Smith
And so, you know, if you have most of your corn acreage, for example, in irrigation, that would be a very different production risk than if you are dryland farming and you don’t want to end up potentially overexerting and switching that price risk for production. So this kind of systematically working through it, seeing where you are in terms of what your pricing is and going from there.

[27:07] John Anderson
All right. I like that. That’s I think that’s something we should probably talk more about is that kind of holistic view of of of how to manage risk across all of the different risk management components that a person has access to the crop insurance, the futures and options, the contracting that the on farm storage and optimizing you’re talking about optimizing a pretty complicated system.

[27:31] Aaron Smith
Yeah, well, and the other one too, that is lingering in the back and I know I’ll give a plug for for Southern AG today because I know we’ve had a few articles on this. One of the things that is different, even compared to last year in terms of storage costs, is the interest rates that we we face. Right?

[27:49] Aaron Smith
When you have borrowed money. But I would make the argument borrowed or non word you’re still you still got a cost associated with that capital. But when all of a sudden you start looking at eight and a half percent operating loan interest, holding that grain is an additional cost that we haven’t over the previous several years had to really worry substantially about that.

[28:11] Aaron Smith
But I would encourage people to really look at that as well, too, in terms of what their marketing strategy is looking at.

[28:18] John Anderson
Yeah, good advice. Aaron and that, you know, that kind of prompts me when we when we get down to harvest time, I’d like to have you back to maybe step through kind of the storage decision. If you’d be willing to do that with us. I’d love to have you back for a detailed discussion on that.

[28:36] Aaron Smith
Yeah, no, absolutely. I know we’ve we’ve been doing some work in a bunch of different storage systems, plus some of the drying systems. There’s a lot of guys that are looking at harvesting at various moisture contents that I think plays into the storage decision. And then we’ve also had a few producers that have really gravitated to some of those storage bags, which I know a lot of producers either love them or hate them, but those that love them can really find a real powerful use for them in their marketing program.

[29:10] John Anderson
Hmm. Interesting. Yeah, that’s a that’s a topic for another podcast, and we’ll definitely have you back to talk about that. Aaron Smith, Associate Professor and Extension Economist with the University of Tennessee. Really appreciate you joining us for the Relevant Risk Podcast and we look forward to having you again another time.

[29:27] Aaron Smith
Any time. Thanks, John.

[29:28] John Anderson
All right. Thank you.

[29:30] Intro/Outro
Thanks for listening to the Relevant Risk Podcast, a production of the Fryar Price Risk Management Center of Excellence in the Department of Agricultural Economics and Agribusiness within the University of Arkansas system. The Fryar 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 fryar-risk-center.uada.edu for more information. Thanks for listening.