By Katie Micik
DTN Markets Editor
OMAHA (DTN) -- It's time for farmers to sharpen their pencils, open their spreadsheets and start thinking about how tighter corn margins will affect their farming operations in 2014.
An analysis by Informa Economics pegs corn's net revenue per acre at just under $300 in 2014, less than half of what it was in 2012 and 2013.
With December 2014 corn futures trading around $4.50 and November 2014 soybeans around $11.50, revenue protection crop insurance guarantees will likely be set at levels below cost of production, thrusting other risk management tools into the limelight.
"Risk management becomes more highlighted when you have margins that look like they'll be very tight, like next year," Purdue University agriculture economist Chris Hurt said. "When margins get tight, people tend to be more willing to take positions that help to guarantee their margin or reduce the risk of that margin becoming even more narrow."
Crop insurance works well when prices are high, but it's not as helpful when prices are low and farmers are paying to minimize their losses, Hurt said.
Mike Hogan, an analyst with market advisory firm Stewart-Peterson, argues that crop insurance will remain an important piece of protection in 2014.
"Sometimes the best you can do is just to lock in a small loss," he said. "Crop insurance sets a floor in revenue, especially if we add another big crop and there are no big production problems" in 2014.
With harvest wrapped up most places, farmers are turning their attention to purchasing inputs and calculating breakeven levels for next year's crop. In this third and final installment of DTN's Manage Market Transitions, Hogan, Hurt and South Dakota farmer Tregg Cronin discuss what farmers can do to plan for profits in 2014.
NEGOTIATE INPUT PRICES
The market is telling farmers they need to grow corn for less than $4.50 per bushel, Hurt said. That can be a hard price to reach, especially for farmers who rent a large portion of their land base.
"They need to be thinking: What can I do to drive my costs down? That's something they can control," he said. "As soon as a supplier gives you a price, say 'I have to have it cheaper.'"
Shop around. Early pay options or buying inputs in bulk can reduce costs.
Hurt said cash rents may come down a little bit in 2014, but said the better likelihood for significant drops in 2015. If grain prices stay low and 2014 production adds to carryover, the pressure will be on landlords to lower rents.
RESET SALES MINDSET
As a former broker, South Dakota farmer Tregg Cronin knows it's important to take emotion out of the decision-making process. He suggests farmers reframe how they think about price targets.
"Set up your marketing targets and your sell targets based on the return you want to get on each bushel you raise," he suggests. Setting targets based on return on investment, instead of on cents per bushel or revenue per acre, increases the likelihood you'll stick to those targets.
"It's easier to say, 'I'm going to sell a 10% or 15% return,' than, 'I'm only going to make 30 cents per bushel vs. the $1 I made last year,'" Cronin said.
Using ROI as a benchmark creates a better picture of your farming situation because it includes costs and isn't solely a revenue figure.
"You need to be operating on what's going to generate a return, not how does it compare to last year or the last five years."
PRICE GRAIN WHEN MARKET SHOWS YOU PROFITS
For the past few years, farmers who didn't market grain pre-harvest "came out smelling like rose," Cronin said. Unless next season has drought-induced production shortfalls, farmers who don't take price protection ahead of 2014 harvest "might be the ones left holding the bag."
"Grain farmers need to be tacticians," Hogan said. "They need to be willing to move when the market offers a profitable price and listen to the market more than they have in the past few years."
CONSIDER SELLING CALL OPTIONS
Cronin expects the corn market to stick to a $1.50 price range barring any major production disruptions in 2014. Farmers last saw this narrow trading scenario after corn hit its 2007-08 high. Prices then stuck to a range between $3 and $4.50 per bushel.
Such a narrow range would mean volatility is likely to go down, and stay down, Cronin said.
Low volatility and tight price range "offers guys a great opportunity to add to margins by selling options, in a disciplined manner, to pad returns."
Selling out-of-the-money calls is one strategy. A call seller collects the option premium, but also is obligated to give the buyer a futures contract, or deliver the grain, if the call is exercised. An out-of-the-money call is priced above where futures prices are trading.
"Farmers should ask themselves: At what level would I be comfortable being short the futures board? $4.50? $5? Or $6?" Cronin said. The higher the out-of-the-money strike price, the smaller the option premium.
Selling a call is a limited reward with unlimited risk position, DTN Senior Analyst Darin Newsom said. Option sellers are responsible for margin calls to support the position, unlike option buyers.
"Selling options is a complicated strategy and certainly not for the faint of heart," Newsom said.
KNOW HOW ALL THE PIECES WORK TOGETHER
Wintertime is a perfect time for strategy planning, Hogan said. "Build what-if scenarios. If corn goes to $3 or it goes to $8, what will I do? Will I sell a little, or will I sell a lot? Build a plan that's living and breathing."
Hogan's company uses software called AgYield to help customers understand how the sum of their marketing tools -- crop insurance, cash contracts, futures and options positions -- come together to create a range of revenue and profitability outcomes depending on where commodity prices go.
Many market advisers and brokerages have similar tools. AgYield is vendor-neutral, which means farmers can use it with their current broker, market adviser, crop insurance agent and/or banker, AgYield president Justin Kelly told DTN. The company will be releasing a free version of the software (with the option to add on different levels of consulting services) later this year.
"This is a period of moderation, not a bust," Hurt said. "It's a positive in the long run for agriculture to reset the balance between crops and livestock, bring some moderation in prices of inputs, and help farmers become more cost conscious and efficient. That's what all good businesses strive to do."
Editor's Notes: Tregg Cronin and Darin Newsom will be presenting at DTN University: Marketing Through Mayhem, an afternoon workshop on Sunday, Dec. 8 that precedes the DTN Ag Summit in Chicago. Register for this hands-on market coaching opportunity at www.dtnagsummit.com.
Commodity trading is complicated and the risk of loss is substantial. The information provided is general, and is NOT a substitute for your own independent business judgment or the advice of a registered Commodity Trading Adviser.
For more about AgYield software, please visit www.agyield.com.
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