Ep. 25 Crop Markets and Risk Management Considerations

[00:00] 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.

[00:20] John Anderson

This is John Anderson, Director of the Fryar Price Risk Management Center of Excellence at the University of Arkansas, here with another Relevant Risk podcast. Joining me today, a guest we’ve had before, Aaron Smith with the University of Tennessee. Aaron, you were with us back in the spring, wasn’t it?

[00:37] Aaron Smith

Yes, early summer, I think…

[00:38] John Anderson

Early summer.

[00:39] Aaron Smith

When we last spoke.

[00:41] John Anderson

And I promised at that time we’d bring you back after harvest or around harvest. We’re a little bit later than I would like to be, but Aaron actually is on site with us today. He and his family are in Arkansas enjoying a little vacation time. And I was able to coax him into doing a little bit of work on vacation.

[01:00] John Anderson

And we’re try not to hit it too hard today. But, Aaron, I appreciate you taking time away from your family on vacation to sit with us today here on campus.

[01:06] Aaron Smith

Yeah, no, it’s been great so far been haven’t been back to northwest Arkansas for a while. And so, we wanted to take the kids back to where we lived for four years and really enjoyed our time when I was doing my graduate work up here, I got to drive through pretty much all of Tennessee and all of Arkansas.

[01:25] Aaron Smith

So, we got to see a lot of what’s going on in terms of harvest and how things were progressing. So, it’s been good.

[01:30] John Anderson

Yeah, and that’s a good reminder. I just want to make sure our listeners are aware Aaron is an alumni of our department and we’re very proud to have him as an alum and he does great work there at the University of Tennessee. And so, yeah, happy to have you kind of back home, your adopted home at least.

[01:46] Aaron Smith

Yeah, it’s been it’s been great so far. The area has changed a lot, but it’s great to see some friendly faces and spend time up on campus here. It’s a beautiful campus.

[01:55] John Anderson

Well, we’re happy to have you and Aaron, so this time of year, what’s on everybody’s mind is, is markets and commodity markets. And I know you just got back from an outlook conference that our extension colleagues around the southern region do. I know you keep up with these markets closely all the time. Kind of give us a little summary of what’s going on with their Mid-South crops as we kind of come around the harvest being wrapped up?

[02:16] Aaron Smith

Yeah, it’s been a been an interesting year when we start looking at what’s went on in terms of crop markets, you know, when you look at some of the factors that have really been influencing market direction, you can kind of break it. I always like to break it into two different components. Obviously, there’s the futures component and then there’s the basis component and both of them are very important, but you get more of kind of obviously the global and national influences that are affecting futures markets.

[02:42] Aaron Smith

So, if we look at something like soybeans, which is a very important crop for both Tennessee and Arkansas, obviously a lot of the market focus right now is down on South America. They’re planting season and it looks like there’s a high likelihood that we’ll see the potential for another record Brazilian crop. And then also a rebound from the drought-stricken crop in Argentina.

[03:05] Aaron Smith

If we think back to the last production year, I had a colleague of mine from Argentina who came up and visited this past summer and he said last year during their production year, their soybean production was about half of what was anticipated based on their plantings because of the severity of that drought. And so, when you think about this in terms of how that affects producers in the Mid-South, the challenge is, its market direction between now and early 2024 is going to be largely dictated by how those crops progress down there.

[03:36] Aaron Smith

And so, there’s a lot of uncertainty that’s going to be embedded in there. You know, one of the challenges that we do have is we kind of have two major differences in supply and demand for soybeans. We have kind of the domestic picture where we’re actually pretty tight on stocks. We’re going to have probably another yield drop here on the next WASDE because of the delayed impact of the dry conditions that crept into a good chunk of the production area.

[04:01] Aaron Smith

So, you know, it’s kind of almost a bit of a bullish picture on the on the domestic front, but that’s getting dramatically overshadowed by what’s going on down in South America. And so those two factors on the supply side, I think, are the important components. And then the other one that I think is really important to watch is what happens in terms of the export demand side of things.

[04:23] Aaron Smith

So, it’s one of those ones where, you know, a lot of that’s going to revolve around China. But you know, what we try to end up looking at is where they are in terms of purchasing behavior. And what I mean by that is you can break export sales into those that are shipped. So those ones that have left the port and those that are commitments.

[04:41] Aaron Smith

And the commitments is where you get kind of a bit of a gray area because those can be washed out financially rather than delivered. And so that creates some uncertainty in those markets.

[04:51] John Anderson

Right. So, what do you see in terms of those commitments? I mean, compared to what we think of as normal?

[04:58] Aaron Smith

Yeah, we’ve actually been behind, you know, entering into this marketing year. Soybean marketing year, you know, starts September 1st and we’ve been behind, but we’ve been we’ve seen some pretty good sales recently. And so, you know, a lot of that, I think they’re concerned about, you know, maybe having a few more adjustments to the U.S. crop.

[05:16] Aaron Smith

And then there’s just a tremendous amount of uncertainty. Anytime you’re just planting a crop in South America, you really don’t know what you’re going to get, right? I mean, it could be another bin buster, or it could be one of these ones if you get, you know, a drought or you get some type of production disruption, then they’re scrambling to get beans.

[05:33] John Anderson

Yeah, Yeah. And that’s the game our buyers play is how much how aggressive are they on commitments, thinking that there’s probably going to be a big South American crop but that’s pie in the sky right now to some extent.

[05:46] Aaron Smith

It is and I mean, one of the other challenges that you look at, one that we track very closely when we’re looking at market outlooks is who’s holding the reserves. And that’s a really important factor. And so we have tight reserves in the U.S., China has actually got a high over the last six years in terms of current reserves.

[06:05] Aaron Smith

And what that allows them to do is just to end up being a little bit more flexible or a little bit more discretionary in terms of when they’re making their purchases and from whom. They can kind of pick their points. And the way that we track that, and we’ve got a couple of presentations that we’ve done on this is the number of days on hand, right?

[06:22] Aaron Smith

It’s a quasi-stock to use ratio where you sit there and say, okay, how much do you have in reserve relative to what your average use is right. And so, when you see China at a multi-year high in terms of days on hand, it gives them a little bit more flexibility as to when and how or under what conditions they’re going to purchase.

[06:41] John Anderson

Right. So, they can be a little less aggressive in those commitments.

[06:44] Aaron Smith

Yeah. Yeah. And so that’s a challenging one. You know, I was talking with a few of our producers out in West Tennessee about cotton recently, and we’ve kind of been rangebound for a substantial amount of period. We’ve been trying to get over $0.90. It just hasn’t materialized on the futures side of things. And so, you seem to we have kind of that content trading range of between kind of 83 to $0.87 on the futures market with, you know, some minor pushes up out of there.

[07:10] Aaron Smith

The big challenge that I see on the on the cotton side is we really need a return to strong demand if we’re going to get above and maintain $0.90. And I think that’s going to be challenging due to a whole bunch of macroeconomic factors that are out there. You know, I think our crop in the U.S. is probably going to be down a little bit.

[07:28] Aaron Smith

We’ll have to see what USDA does in terms of their revisions out in Texas. You know, the one of the big factors that that everybody always looks at in terms of the U.S. crop is what’s the abandonment rate going to do right.

[07:40] John Anderson

Right. And so, most of our crop is grown in west Texas now, such a big proportion. And production in West Texas is inherently volatile.

[07:49] Aaron Smith

It’s about 60%. Just over 60% is what’s typically grown in Texas. And so that’s just a huge amount. And it really does influence what’s going on in terms of the markets in the U.S., for sure.

[08:02] John Anderson

Yeah, certainly the supply side of that market has gotten more difficult to forecast over the course of my career as more of that production is migrated to that West Texas environment, which West Texas is a wonderful place, but it is a pretty volatile environment for agriculture production. 

[08:19] Aaron Smith

It is and I remember last time we were talking, you know, we were talking about the potential for an active hurricane season. And for the most part, that really hasn’t materialized. Right? I mean, we’ve had a couple of severe storms and, you know, obviously, those that were affected by that, it’s a a terrible tragedy. But I know with some of the record temperatures we’ve seen in terms of temperatures in the Gulf of Mexico, they were really concerned about the potential for a very active hurricane season.

[08:42] Aaron Smith

And now we’re sitting, you know, in the middle of October and we really haven’t seen that much in terms of affecting the Mid-South and most of the cotton belt. And so that’s been a been a blessing in terms of not having any of those disruptions from those storm events.

[09:00] John Anderson

Yeah, no, that’s a good point. You know, when I worked in Mississippi, we had a couple of years where you just had disastrous effects from, really not even in a couple of cases, not even hurricanes. Very wet tropical storms coming up at exactly the wrong time. And quality falls apart. I remember one year where we just had seeds sprouting in the bowls all over the delta.

[09:24] John Anderson

It was just a horrific disaster in terms of cotton yield and quality.

[09:29] Aaron Smith

Yeah, that’s always one of the big challenges. You get the quality hit and then one of the ones that you know, when I talk with producers, there’s always a huge challenge depending on if you get winds and how the direction that they’re flowing, it can really create havoc with the efficiency of harvest as well, right? Because I mean, you start getting, you know, things that are all intertwined and tangled.

[09:46] Aaron Smith

I mean, it affects the quality, but it also affects the ease to which you can harvest.

[09:50] John Anderson

 Right. I mean, it relates directly to the quality and the amount of trash that’s going to show up in that lint. Yeah, it’s a big deal. A lot of interesting factors that you have to manage as a cotton farmer, that’s for sure.

[10:03] Aaron Smith

Yeah, it’s one of those ones that’s a tremendously interesting crop, but it’s got a lot of challenges and usually, you know, it’s a home run or you can end up having some pretty good losses with it.

[10:14] John Anderson

And so, you know, the folks I’ve talked to in Arkansas have been pretty happy with the way harvest has progressed. It’s been a pretty good season. You know, we had some wet weather last week that I think slowed some things down. But overall yield and quality, from what I’m hearing from our farmers, sounds pretty good.

[10:28] Aaron Smith

Yeah, I would say the same with Tennessee. And we’re going to be pretty close to that 1100 pound per acre average is where we’re going to be. Most of our cotton is dryland cotton in Tennessee, we don’t have the irrigation systems that that are prevalent in Arkansas. So, I think a lot of people are going to be pretty happy with that.

[10:47] Aaron Smith

I was talking with a couple of brokers that are friends of mine out in Brownsville and the Memphis area, and he said one of their big concerns is that typically around this time of year, we’d have somewhere closer to 50% of the cotton priced. And they thought that right now for their portfolios or their clientele, they’re somewhere closer to 20%.

[11:06] Aaron Smith

And so that means that there’s a fair amount of price risk that’s still out there on the table. And so, one of the challenges is just because of the nature of how cotton prices have been moving sideways. You know, we had several discussions about, you know, what’s a good strategy as you go through harvest here.

[11:21] Aaron Smith

Do you sell the cash crop and take it, you know what, you can get somewhere around that 87 to $0.89 is a pretty good price right now in the futures market. And so, taking that in and then if you really do think that there’s the potential for a return to strong demand, you know, taking a reownership position through a call option is something that might want to be considering.

[11:43] Aaron Smith

If you really think that by March or maybe a little bit later in 2024 looking kind of at the May or the July contract and saying, okay, maybe I want to take a re-ownership position through a call option rather than holding that physical cotton, because one of the big ones that, you know, in this cuts across cotton and in grains and oilseeds as well is you really have to factor in because of the elevated interest rates, what the carrying costs are.

[12:09] Aaron Smith

But when you start looking at it, I think the Federal Reserve put out an average interest rate of eight and a half percent on an operating facility. So, if you’re got money borrowed from, you know, eight and a half percent, that’s a fair amount that is going to be required.

[12:25] John Anderson

And it’s been a while since we were in a relatively high interest rate environment. I mean, that’s honestly that’s a cost that for the last decade you didn’t have to think a whole lot about, honestly.

[12:36] Aaron Smith

Yeah.  I mean, you know, it was really crazy how quickly interest rates went up. I mean, 18 months ago we were at three and a half percent in terms of bank prime rate. And so to see that elevated costs, I mean, it it affects all things in in agriculture because we are such acapital-intensivee business.

[12:54] Aaron Smith

But a lot of times people think of it in terms of buying land or buying equipment, you can kind of postpone or delay some of those decisions, whereas on an operating note, you’re going to have to end up paying that. And so, you know, any time you’re carrying a balance…

[13:07] John Anderson

And you don’t pay it till you’ve sold the crop for the most part, right? I mean, that’s how you pay it. So that’s a really good point about the carrying cost. I mean, that’s one that, you know, I think it’s been easy to kind of take your eyes off that ball in recent years. But that’s what needs to be different this year for sure from a management standpoint.

[13:24] Aaron Smith

Yeah, absolutely. I mean, we’ve been we’ve been trying to encourage people to kind of look and see what their carrying costs are and then, you know, taking a position after you’ve sold that cash crop, whether it’s corn, soybeans or cotton. I mean, it’s not a position that everybody wants to enter into. But if you feel strongly about missing out on a rally.

[13:40] John Anderson

So you’re talking about store in the crop on paper, as we always say. Liquidating the physical and then and then taking a long position in the futures market. I would be remiss if I didn’t point out that that is that is a speculative position.

[13:51] Aaron Smith

It is. It is. You know, and everybody’s got different, different risk tolerances. You know, I’m not as big of a fan of just using the straight futures position. I think there’s a little bit more undue risk in that. I’m more of a fan of doing an out of the money options.

[14:07] John Anderson

More of an options guy. Yeah. So, you buy a call out of the money and kind of a low-cost way to participate in a rally if one develops.

[14:16] Aaron Smith

It does and then the one that I like about those, then your exposure is defined right? And so, I mean, I think that’s one of the ones that I always look at it and I say, well, okay, if you really feel strongly on getting back in, make sure you understand where your risk is. And, you know, we were talking about this at our Southern Outlook conferences, is how do you look at risk exposure?

[14:38] Aaron Smith

Right. And, you know, it’s one of those ones where we sit there and we say, well, this is, you know, kind of what the supply and demand situation is, both local and global and national. But to be honest, I mean, we really it’s such a dynamic environment that, you know, you can come up with projections and forecasts, but you’re only one event or multiple events away from being completely out to lunch in terms of what your forecasts are.

00;15;03] Aaron Smith

And so trying to pick a price or pick a price in the future I think is not the appropriate way to look at it and think have to look at is what’s your risk and how do you end up managing that risk within what your individual tolerances are.

[15:18] John Anderson

Yeah, no, I love that point of view. I mean that the way I would put it when I would do extension meetings with producers, you know, markets respond to information and information can hit the market randomly. So, I can give you a forecast based on what I know now, that might be a pretty good forecast, but that forecast might get blown up tomorrow because new information is going to come out tomorrow.

[15:42] John Anderson

And it’s that randomness of information that that you don’t anticipate. If I knew what information was going to hit the market, this would be an easy game. We don’t know that.

[15:51] Aaron Smith

Yeah, we always look at it in terms of, you know, a lot of it’s usually a USDA report. But I mean, there’s several other information events that can be out there. And it’s always those ones where you can take a look at what the numbers are. But the numbers really in just by themselves is not what moves markets.

[16:07] Aaron Smith

It’s the numbers relative to what the expectations of the market participants are. And so when we look at things like WASDE reports, it’s something where we always kind of look at what are the numbers. But what we really need to look at is what was the expectation relative to numbers? And that’s going to tell you how the market is going to react more than the numbers themselves.

[16:26] John Anderson

The context of expectations is absolutely critical. And the discrepancy between expectations and actuals is where the market moves. And, you know, anything with that in mind, anything that affects expectations can change the market. And expectations I think are notoriously difficult to pin down.

[16:49] Aaron Smith

Yeah, they really are. I mean, you know, it’s it’s one of those ones where, you know, everybody’s going to have a little bit of a different opinion. There does seem to be, you know, some some underlying currents that are going to pull people in a certain direction. But, you know, some of those times, those underlying currents get it wrong as well.

[17:05] Aaron Smith

And then you get a real sharp correction on the on the futures side. Once we end up seeing some new information that runs counter to what the prevailing thought process is.

[17:14] John Anderson

Speaking of expectations before we get too far away from cotton, which you were just talking about, I’ll put you on the spot a little bit because obviously the situation in the Middle East right now has become a lot more volatile in the last week, orders of magnitude more volatile potentially. That always has a potential to affect energy markets in the link between cotton and energy is a really interesting one, right?

[17:38] John Anderson

You got energy prices have a big effect on synthetics, which are a big competitor for cotton, but energy prices also tend to have a negative effect on demand when they’re going up, which is. So how has that shaken out for cotton? Are we are we looking at a potential upside or downside out of this?
Where do we go?

[17:53] Aaron Smith

Yeah, I mean, it’s really challenging to kind of forecast what’s going to happen over there. It’s such a such a volatile set of circumstances. But you’re right. I mean, anytime you’re looking at the Middle East, you’re looking at changes in energy prices. And that is potential that has the potential to provide a little bit of, you know, I guess, increased support for energy prices that is going to affect our producers here and indirectly cotton markets.

[18:21] Aaron Smith

You know, I think it’s so, so new over there. We’re only talking the past four or five days is really, really all we’ve really seen there. And I kind of like it to, you know, and again, it depends on how long hopefully this is shortened duration and there’s a resolution to the conflict over there. It doesn’t look like that’s going to be necessarily the case.

[18:41] Aaron Smith

I think, you know, some of the initial reports indicate this could be a prolonged, you know, conflict over there. But if you think about back to when Russia first invaded Ukraine and the impact on grain and oil seed markets, what we’ve seen was a tremendous run up and a lot of volatility in those markets directly. And then after that, we’ve still got the active conflict area right now.

[19:03] Aaron Smith

But that risk has been more or less factored into the market. And so, you know, it’s a question of how long does the initial shock end up lasting, you know, what ends up occurring in terms of any potential supply disruptions to energy markets. And then, you know, how long do we have that amount of uncertainty, and then do we eventually get back to whether it’s, you know, a continual conflict, but do you get back to a stable point where people are just factoring that in into their decision making?

[19:32] John Anderson

That’s great point. I mean, markets are really good at assimilating information, even complicated information.

[19:40] Aaron Smith

Yeah. I mean, you know, the challenge I always run into is, you know, obviously if it escalates and spills out into multiple other countries and, you know, you start seeing more of a global nature that gets much more challenging to try to see what the implications would end up being.

[19:55] John Anderson

Yeah, it’s certainly something we’ll be watching and something that market analysts like you will be scratching their heads about over this marketing year, I imagine.

[20:03] Aaron Smith

Yeah, I’d like to. We have a trade economist that I work a fair amount with and I usually like to dump some of the international stuff out on him because it’s.

[20:10] John Anderson

Is it Andrew Mohammed?

[20:13] Aaron Smith

Yeah, he does a really, really good job. He’s got a lot of contacts with the USDA, foreign egg service, and so he stays up to date on a lot of that stuff. And so, he does a good job.

[20:22] John Anderson

But a great trade economist. 

[20:24] Aaron Smith

Yeah, so, he’s one that I always try to pick his brain in terms of, well, how does this potentially affect the movement of commodities? And what’s going to happen in terms of the prices? And, you know, they can run some models. But again, the challenge is, is that the circumstances are so dynamic that it’s really difficult to try to have a model that’s going to predict anything that is remotely close to what we’re experiencing.

[20:50] John Anderson

Moving on, let’s talk about other disruptions. You know, we’ve seen a couple of years now, Aaron, where harvest time basis has just been a train wreck. Last year, river issues, transportation issues, basis kind of fell apart from a producer standpoint as we kind of got into really in the heart of our harvest time. And that was, you know, again, not something you expect to see very often.

[21:21] John Anderson

And here we are a year later kind of looking at the same thing or something very similar. So, basis has really not been a friend the last couple of years. What do you think, how do you deal with that from a marketing and management point of view?

[21:34] Aaron Smith

Yeah, I mean, it’s been a real challenge the last couple of years, particularly in that harvest timeframe to end up predicting basis. And I’ll just give a quick example. I mean, I wrote an article a couple of weeks ago on this, so it’s a little bit dated. But on August 15th, our average soybean basis in Tennessee was 75 over the board.

[21:51] Aaron Smith

And about a week ago it was 105 under. So that’s 180-cent swing in the price of soybeans in the span of just over six weeks. And so, when you look at that, that is a tremendous amount of risk.

[22:04] John Anderson

Not the way you want that to go if you’re a short hedger.

[22:06] Aaron Smith

No, and a lot of it’s been driven, obviously there’s been it’s been well-documented the challenges with moving stuff up and down the Mississippi River due to the low water levels. Hopefully, we get some relief as we progress towards the end of end of this year and into 2024 to facilitate some of that movement. So, you get that double hit, right?

[22:24] Aaron Smith

It’s not just the increased cost because the traffic is restricted, but you’ve got smaller quantities as well. And so, you get that you get that double hit in terms of moving stuff. And so, you know, it left a lot of people in Tennessee scrambling for storage to try to avoid having to sell at these very, very low basis levels.

[22:45] Aaron Smith

You know, those that have been storing, you know, they were storing the majority of their crop. But one of the big challenges that we had this year in Tennessee versus last year’s, if you think back to last year, we actually had a very drought-reduced crop in Tennessee. Yeah, we average, I think on corn. It was just just right about 130 bushels per acre.

[23:05] Aaron Smith

And so normally we’re up around 175 bushels, well storing 130 bushel per acre crop versus 100 and probably be about 175 to 177 bushel per acre corn crop. That’s a huge difference in terms of the quantity that’s stored. Now we’re very fortunate that seasonally our basis is usually very strong. We have, you know, ethanol facilities, we have very strong poultry and livestock demand.

[23:28] Aaron Smith

We have access to the rivers. And so, the key to me when we think about this and obviously hindsight’s 20/20, but this is basically three years in a row where we’ve seen what I would call much deeper reductions in basis during the harvest interval. And so one of the ones we might want to think of in terms of a risk management standpoint is taking a look at some basis offerings in the spring, in the summer, and looking at, okay, if I can’t store this crop, if I don’t have access to storage, do I end up signing a basis contract when it’s, you know, 10 to 30 under the December futures contract and you know, if it you know, if everything goes well, I mean you’re still, you know, a 10 to 20 cent decline or in basis or under the futures board is is substantially different than 100.

[24:16] John Anderson

Right. So, you’re talking about moving that decision point up to the earlier end of the production cycle than we’ve thought about in the past, right?

[24:24] Aaron Smith

Yeah. And I’m a huge proponent of a break in your price risk between futures and basis price risk. I think that there’s a substantial difference there. I mean, one of the ones I know we have a lot of guys in Tennessee, in Arkansas, I’m sure as well that use forward contracts. Right. And forward contracts. They serve or serve a purpose, but very rarely do you get the strongest basis offerings and futures offerings at the same time.

[24:46] John Anderson

Yes, good point.

[24:47] Aaron Smith

And so, when you can kind of pick your points, whether it’s through a short hedge or whether it’s through an option strategy on the future side, you can set that price and then you can look at your basis as a separate transaction. So, we’re looking at not just the two differences, but the two differences as they move through time.

[25:07] Aaron Smith

And so I think that’s how we kind of need to think of it in terms of establishing a price. The other one that I do like is…

[25:13] John Anderson

So let me dig in on that just a second, to be clear. So, what you’re talking about is basically having a decision point where you manage your price risk with futures instruments primarily and you make that decision independently of the basis decision. And then you log basis with a contract with an elevator at some independent point.

[25:34] Aaron Smith

Yes. And I guess there’s a third component that I would throw in there, and that is how much storage do you have access to, right? Yeah, because, I mean, I think that factors again into that time component, right? If you can store most of your crop, that’s a very different decision than if you have to sell it, you know, 70 to 80% off the combine.

[25:52] Aaron Smith

Yeah. And so again.

[25:53] John Anderson

Primarily affecting that basis decision.

[25:55] Aaron Smith

Yes. Yeah absolutely.

[25:57] John Anderson

Yeah. Because you can manage the bases with storage if you’ve got the storage.

[26:02] Aaron Smith

Yeah absolutely. And you know that that’s another good point for those that do have commodities particularly going to use corn and soybeans as an example and storage I’m right now given where we’re at in terms of market, I would be much more inclined to leave the basis unfixed and fixed the futures because I think moving forward you’ve got a much better chance that basis is really going to strengthen.

[26:26] Aaron Smith

The futures is much more uncertain to me because if we start seeing particularly on soybeans, but I think corn as well, if we start seeing, you know, South American growing conditions very strong, that futures market, I don’t think we’ve necessarily reached a bottom on that. Now it can go the other way as well. But I think if you can lock in somewhere close to $13 on the on the futures market for soybeans and close to five or just over five on corn for for early 2024, boy, that takes a lot of that risk off the table.

[26:55] Aaron Smith

And then if you can get a bump up in that basis.

[26:58] John Anderson

And basis improves hopefully as conditions on the river improve and you kind of you’re gaining on both sides of that equation, then.

[27:05] Aaron Smith

Yeah. And I mean, I think right now, if you look at it from a producer standpoint for unprice production, we had some better opportunities earlier in this year. But if you look at unprice production, if you can get somewhere between $13.50 and $14 on a cash price for soybeans and somewhere, you know, we’re on that $5.50 to $6 on on corn.

[27:26] Aaron Smith

There’s some black ink there for most producers based on what we’ve seen in terms of yield. So, again, you know, trying to work those to both the futures and the basis in terms of maximizing price, but also minimizing your risk.

[27:40] John Anderson

Yeah. To hit those price points. Yeah. Okay. That’s very helpful. That’s good advice. Aaron, one last thing I want to talk about. While we got you here related to marketing and risk management. Let’s kind of start looking ahead to new crop. Well, it’s pretty early for that, but farmers have to do this pretty early, right? They’re making input decisions.

[28:01] John Anderson

They’re probably doing some purchasing between now and the end of the year for sure, if nothing else, for tax purposes. And, you know, once you start committing funds, you’re exposed to risk on that next year’s crop. So, insurance is an important risk management tool. If you look at the R.P. products that are out there, a lot of people are going to be looking at those products, but those prices aren’t really going to be set until we get into price discovery, which is after the calendar turns.

[28:30] John Anderson

What should people be thinking about in terms of their risk management, particularly price risk management, on next year’s crop?

[28:37] Aaron Smith

Yeah, you know, this is a conversation that we we’ve been having the last couple of years and we’re in a little bit different input cost environment right now than we were the past to we’ve seen fertilizer prices in particular come down. Now you know there can be an argument that we’re getting close to a bottom here and we might even see a bit of an uptick.

[28:54] Aaron Smith

But, you know, going back to your original point, when we think about this in terms of risk for the 2024 crop, if we start buying all of our inputs right now, most producers don’t do any new crop sales or very little in terms of new crop sales prior to the spring. And so, when we think about this, we’re making our input cost decisions right now.

[29:18] Aaron Smith

We’re purchasing decisions right now and we really don’t have any price protection until we start looking at when the crop insurance prices are determined in February. And so one of the things that, you know, I’m a big proponent of is if we have really good futures prices and again, I mean, really good is a is a relative term.

[29:36] Aaron Smith

But if you look at historically where we’ve been, you know, $5 corn is a pretty good price. And so if we look at that, if we looked at the 2024 contract, one thing that I think people should kind of pencil out and you can look at different strike prices again, it’s a question of what your risk tolerance is and how you want to do it.

[29:57] Aaron Smith

But buying a put option for that, whether it’s the September the December 2024 contract and carrying that until at least our crop insurance prices are determined. And the benefit to doing that is, you know, one of I think one of the biggest misconceptions or mistakes that producers make in terms of option strategies is they carry the option too long.

[30:17] Aaron Smith

And so, this strategy would be, okay, you buy it in, say, November when you’re going to purchase some of your fertilizer in particular, because that’s one of our larger, larger ticket and then end up setting that that option or buying that put option for September or December 2024. And then what it does is it buys you time until crop insurance prices are determined early in 2024, in February.

[30:40] Aaron Smith

And then at that point, what you can do is if you’re in the money, well, the put options done its job. If prices rally and things are higher, you can still recoup a lot of that premium based on the time value that’s still embedded in there. And so I think that’s one that that is very beneficial because what you want to avoid and this goes back to when we’ve had tremendously high fertilizer prices, is if you buy that input at the peak and then your commodity prices start falling, you’re widening that you’ve.

[31:09] John Anderson

You’ve lost margin. 

[31:09] Aaron Smith

You’ve lost a tremendous amount of margin.

[31:12] John Anderson

Before you’ve even planted the crop.

[31:14] Aaron Smith

And you haven’t even done anything yet. It’s just it’s an it’s a crazy amount of risk. And so, you can take some of that risk off the table. And again, everybody’s risk tolerance is going to be a little bit different. But look at the different strike prices, what the options or what the premium cost is. But with the recognition that there’s a real good chance you’re going to be able to recoup 80 to 90% of that premium.

[31:33] John Anderson

Right. So, you’re basically saying you’re willing to pay some time value in terms of premium change to have that coverage between when the input purchases made and when you can get more complete coverage through some other instrument like crop insurance. 

[31:49] Aaron Smith

Absolutely. I mean, you can make it more complicated as well. I know we’ve run different strategies. So, if you want to end up buying an option or put option and selling a call option too.

[31:59] John Anderson

An offset premium cost.

[32:00] Aaron Smith

Paying it premium neutral, then you’re bounded, and you have some upside risk. And so, I mean, there’s plenty of different strategies out there, But I just you know, one of the big ones that I encourage people to start looking at this time of year, what’s your risk exposure for the 2024 crop?

[32:15] John Anderson

Well, I really like that idea because in essence, it’s in its most fundamental thing. I hear you saying is when you take on exposure for the crop, start thinking about taking some of that price risk out.

[32:29] Aaron Smith

Yeah absolutely. And I mean, one of the one of the biggest challenges that we’ve seen over the last couple of years is if you look at the price ranges that we’ve seen in terms of harvest futures contracts, there’s a tremendous amount of volatility that’s embedded in there. You know, when you start talking corn and you’re talking a 30 to 40% premium, that does seem large to a lot of people.

[32:52] Aaron Smith

But then you take a look at what the price movement has been over a production year, and it’s somewhere in that dollar $1.50-1.60 range. All of a sudden, that doesn’t look quite as big right?

[33:03] John Anderson

You know, those option premiums are high. That is a lot. But you do also need to recognize, you know, that option market is a pretty efficient market. If that premium is high, it’s telling you something and it’s telling you about the volatility that you’re dealing with there.

[33:20] Aaron Smith

Yeah, I mean, and you know, that’s hundred percent right. And, you know, one of the ones that I always you know, people tend to be more concerned or optimistic about the upside, but not as concerned as they probably should be on the downside. Yeah. And we always hope for the best. I mean, I think that’s that’s human nature in agriculture is to hope for the best.

[33:38] Aaron Smith

But one of the things that I always like is, okay, shouldn’t be looking to the best case scenario is how do you mitigate your risk. And so if you think of it in terms of the distribution of outcomes, right. And I know you know, you don’t want to get too academic on this, but the purpose of a lot of our risk management strategies is to truncate or to eliminate the chances of a very dramatic adverse outcome.

[34:02] John Anderson

Exactly, yes.

[34:03] Aaron Smith

What you’re trying to do is you’re trying to sort of if you think of a bell-shaped distribution just saw off that bottom three.

[34:08] John Anderson

And you make that worst case scenario less bad. 

[34:12] Aaron Smith

And it and it’s going to cost you a little bit of money. I mean, risk management is not free. And, you know, the parallel is crop insurance. We use crop insurance. Crop insurance is a great tool, but it costs you money to end up participating in that. Now, I think that money is probably some of the best investment dollars you can get for most producers, but it does cost you some money.

[34:32] Aaron Smith

The other one that I think is important, and this was one that we looked at a little bit last year, is depending on where you’re at, there’s differences in buy up behavior in terms of crop insurance. And so what we do in the Mid-South can be very different than what they do in the Midwest in terms of utilization of crop insurance products right.

[34:50] John Anderson

Absolutely.

[34:51] Aaron Smith

Right. And so, you know, you have your standard revenue protection insurance rate, which, you know, you have a lot of people that usually buy up additional coverage closer to that that 70%, 80% or 85% in the Midwest. But down in Mid-South, we’re usually not that high. 

[35:08] John Anderson

65 or 70.

[35:10] Aaron Smith

You betcha. And so then the question becomes, well, how can you utilize that with a combination of some of the area-based products?

[35:16] John Anderson

Yeah.

[35:17] Aaron Smith

And so, you know, we can say crop insurance for another day. But it is an important dynamic in terms of how do you partner your crop insurance purchasing behavior with what you do in terms of futures and options and also basis contracts. And so, I think there’s a million different ways that you can slice it, but we really need to think in terms of where do we have risk, at what point in times are we open to risk, and then what can we do to end up mitigating those risks that we’re facing?

[35:48] John Anderson

You know, I really love that approach. And really what you’re talking about is what should an optimal portfolio look like for a farmer in the mid-south. Because you’ve got you’ve got the crop, you’ve got various price risk management tools through contracting and futures and options, and you’ve got insurance products, including individual products and area products and you’ve got farm programs we could throw in there.

[36:11] John Anderson

And all of those things constitute a portfolio or the tools that you can use to construct a portfolio and what is an optimal portfolio for a Mid-South producer based on their individual circumstances, based on the production environment that they have, and based on their level of yield risk. Those things tied that a lot of that ties back to the to what is the capital situation on that farm?

[36:34] John Anderson

Do you have irrigation? Do you not have irrigation? All those kind of things. And I would say we often talk you mentioned this the Mid-South versus the Midwest in terms of crop insurance participation. And I would say I would make the case that our risk is different than theirs. And so, our portfolio should look different than theirs.

[36:52] John Anderson

And if you think of it in terms of insurance as one component of that portfolio, you know, what I don’t want is for farmers to look at that and say, well, I’m going to use insurance differently because my risk is different, but I’m not going to think about the other parts of the portfolio. Look let’s construct the best portfolio we can to manage the risk that we face.

[37:09] John Anderson

And yeah, it’ll look different than somebody in Iowa, but we can have something very effective using all the tools at our disposal.

[37:17] Aaron Smith

Yeah, absolutely. I mean, I think that’s the key, right? When we’re looking at this, our risk is very different than other parts of the country. You know, everybody’s got, you know, different factors that are going to affect what their profitability, even just from a simple crop mix standpoint. I mean, we do things very, very differently.

[37:34] Aaron Smith

And so, again, you know, trying to end up getting the most out of crop insurance, the most are futures and options strategy. Storage is another one because we have such a strong primarily poultry. But I mean, livestock in general, you’re obviously much more well versed in the livestock than I am. But we have very strong demand centers for a lot of our commodities.

[37:52] Aaron Smith

And then we have the usual benefit of the Mississippi River. And so it’s a very different risk profile. And so how do you take that portfolio of products and make sure that you’re getting the most out of your risk management portfolio?

[38:04] John Anderson

Absolutely. I think that’s something that, you know, it’s a been a lot of work on this. Keith Coble and I and our colleagues at Mississippi State, we talked about this a lot. I think there is a tendency to try to optimize individual pieces of that portfolio, instead of optimizing the portfolio as a whole, which is really the right way to make that decision.

[38:21] John Anderson

But it’s a lot more complicated. But it’s and again, I think it’s we’ve got more power to do that kind of thing than we’ve ever had before.

[38:28] Aaron Smith

Yeah. I mean, one of the ones that it’s absolutely it’s a blessing and a bit of a curse, I guess. But you can get a kind of paralysis just from information overload.

[38:38] John Anderson

Absolutely.

[38:39] Aaron Smith

I mean just the amount.

[38:40] John Anderson

Especially now.

[38:41] Aaron Smith

The amount of data that’s collected on your average farm, you know, is a real challenge to make a decision out of it. Right. It’s not a lack of data. It’s a lack of data and being able to organize it in a manner that you can make a constructive decision off of that. And, you know, I think that’s going to be rapidly evolving over the next several years where I think we will be able to get more out of the data in terms of understanding our risk exposure and making more informed decisions.

[39:12] John Anderson

It’s a good point, and that’s something that we certainly will be doing a lot of work on here. Again, across all of these risk management tools that we have at our disposal. So I think it’s a great time to be doing this kind of work, the best time I’ve ever seen in my career because you know, we can move well beyond kind of this theoretical construction of what we might do with risk to, you know, based on, you know, on the ground situation for an individual producer, what can we practically apply?

[39:39] John Anderson

And I think the ability to do that now is just leaps and bounds ahead of where we were ten years ago, certainly 20 years ago.

[39:46] Aaron Smith

Yeah. I remember even when I was a graduate student here taking Dr. McKenzie’s price forecasting class, and you know, you learn the basics of futures and options and now it’s a completely different environment in terms of what the data availability is. But, I mean, the same fundamental or fundamental tools still end up applying an analysis.

[40:09] Aaron Smith

It’s just that we’re able to extract much more in terms of data and inform decision making. Right. And so it’s a fantastic time to be involved in agriculture. It’s one of those ones where, I mean, I love what I do. I wouldn’t want to do anything else. I like to have that kind of combination between academia and then also working with directly with producers.

[40:32] Aaron Smith

 I’m a farm kid at heart and I mean, I just enjoy what I do immensely.

[40:35] John Anderson

So yeah, well, that’s spoken like a true extension specialist. I love to hear that. Aaron, thank you for joining us. I think we’ve probably gone a little bit over time with this podcast, but it’s all really good stuff. It’s always a pleasure to talk to you, always appreciate your insight in the markets, and really your insights into risk management at the farm level are fantastic and proud to have you as an alum, proud to be associated with you as a colleague.

[40:59] John Anderson

And I really, again appreciate you borrowing from your vacation time to come do a little work with us today.

[41:05] Aaron Smith

Anytime. I appreciate you having me.

[41:07] John Anderson

All right. This is John Anderson with another Relevant Risk podcast. Thanks for joining us.

[41:12] Intro/Outro

Thanks for listening to the Relevant Risk podcast, a production of the Fryar Price Risk Management, Center of Excellence and 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.