Traditional Time for Pre-Harvest Hedging
Even more than in most years, this February feels too early to start caring about new-crop grain prices. I've just returned from another road trip through eastern North Dakota, and although it's difficult to judge what proportion of corn fields are unharvested versus harvested (with the stubble now buried under snow), farmers in that region tell me it's 70% unharvested versus 30% harvested. I believe them -- the number of still-standing corn fields is staggering. Seeing an unharvested soybean field or small-grains field is a gut punch. We, as an industry, still haven't completed or fully accounted for the 2019 crop, and now we're supposed to start trading the 2020 crop already?
Despite the surreal sense of time looping and slowing and speeding up at strange rates during the bizarre 2019 crop year, in reality the calendar has kept ticking along at its usual rate. Now February, it's the month when reference prices will be set for the upcoming 2020 crop insurance policies. Each trading day during the month of February, the closing futures price for new-crop corn (December contract), new-crop soybeans (November contract), new-crop spring wheat (September contract) and new-crop cotton (December contract) will be collected, then each contract's collection of February closes will be averaged together and those will be the numbers used for revenue-based policies. Therefore, those will be the numbers used by grain producers and their lenders to judge where profits might be confidently banked upon (with an insurance back-up) and how high or low those profits might be.
So far, corn is once again looking like the most attractive crop to plant, and there are only 12 trading sessions left in February to change this math. Grain futures prices have been relatively quiet and stable in recent days, with new-crop December 2020 corn futures hovering around $3.93 per bushel. New-crop November soybeans at $9.19 per bushel are therefore 2.34 times the price of corn, which means soybeans are historically underpriced compared to corn. New-crop September spring wheat at $5.72 per bushel, or 1.46 times the price of corn, is also historically underpriced (compared not only to corn, but also to other wheat varieties). New-crop December cotton at 69 cents per pound is also underpriced compared to corn, which isn't a natural comparison to make when the two crops aren't substitutes, but they are competitors for southern acres as spring planting gets started in Texas.
The real question, however, is whether or not these new-crop market prices represent a good selling opportunity. If the aim of a grain-production business is to make sure it sells its goods for more than it costs to produce those goods, then mathematically speaking, yes, it looks like that can be done right now for 2020 corn. The current futures price, at $3.93 per bushel, suggests a cash price of around $3.53 per bushel in the center of the Corn Belt at harvest time in 2020 (that's $3.93 minus let's guess around 40 cents of local basis). Iowa State University's latest estimates of the costs of crop production suggest a bushel of corn can be grown in 2020 for about $3.23 per bushel, assuming the field was in a corn-following-soybeans rotation and achieves 199 bushels per acre after paying $219 per acre in cash rent (or equivalent opportunity costs).
That $3.23-per-bushel cost-of-production estimate is wildly variable based on individual fields and production practices and input costs and other assumptions. Not every bushel of corn in Iowa, let alone across the United States, will be grown for $3.23 per bushel in 2020. But let's say that as a benchmark, this figure serves as a good representative for the overall industry. Using it, we see about $0.30 per bushel of profit opportunity between cost of the production and the expected price of the grain. That's profit that can be locked in and "guaranteed" right now, today, for any producer willing to write a forward contract with a grain buyer or hold a futures or options hedge in an individual brokerage account.
I say the profit from pre-harvest hedging is "guaranteed," but of course it isn't guaranteed. The 2019 crop year reminded us of all the unusual ways things can go wrong -- a predicted crop may not even get planted, let alone properly developed, free of hail and disaster, then harvested in time to fulfill a forward contract at the elevator. Those risks are reason crop insurance exists, but they nevertheless make some grain producers hesitate before committing large portions of their crop to a marketing decision. Then there is the size of profit on offer right now -- 30 cents. Is that good? Is that enough? Will there be higher or lower profit opportunities in the future?
So, although locking in the currently available profit opportunity right now may look like the screamingly obvious thing to do, there are many reasons why producers may not be choosing to do so. The most common reason, however, tends to be the psychological fear of missing out on potentially larger profits in the future, which would be available if -- and only if -- we believe the December corn chart could move upwards between now and harvest.
The traditional timeframe for pre-harvest hedging tends to be anywhere between February and July, capturing the chances for a spring or summer rally, which has sometimes occurred when poor crops are harvested in South America or poor weather is experienced in North America. Looking back at the past six crop years, during that February-to-July timeframe there has always been some opportunities to lock in new-crop corn futures prices above the expected cost of production.
Sometimes those opportunities were fleeting, and sometimes they weren't offering very large profits, but there was always something. There is that same "something" on the table right now. February may seem particularly early in 2020 for farmers who've just caught their breath after the late 2019 harvest, but nevertheless, the season for making these decisions starts now.
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