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Crop price volatility requires risk management, says MU economistEthanol for fuel has helped bring high profits to crop producers, but near-record prices for corn have a downside: increased volatility and risk to farms, said a University of Missouri Extension agricultural economist. "The use of corn for ethanol crept along a couple years ago, and then it blossomed, along with corn prices," said economist Ray Massey of the MU Extension Commercial Agriculture Program. "What we're seeing is a new driver in the corn market. When corn is used for fuel production, its price will fluctuate with the price of fuel, which is very volatile." Massey discussed market volatility and how high profits lead to high-risk marketing at the recent field day at MU Graves-Chapple Farm, near Corning, Mo. "In economics, markets abhor a profit," Massey said. "They won't allow profits to stay. They will go to zero through price increases in all the factors of production, such as seed, fertilizer, labor, management or fixed assets." Profits will go toward zero first for ethanol producers, then for crop producers, and eventually for input suppliers and landowners, he said. Fertilizer and chemical costs historically have fluctuated and may come down as corn production profits erode, but seed and land prices haven't come down as easily in the past. "It's going to be a painful transition." In July and August, the price of corn fluctuated by $1.50 per bushel, Massey said. "This is abnormal, but it occurred because of the new player in the market of what we demand of corn." High prices have helped growers, but margins are tight because of soaring input costs, Massey said. "I don't know of any crop farmers who haven't made a profit, but we still have a lot of farmers calling with concerns." Increased volatility is due in part to investors injecting cash into crop commodities, Massey said. "The bubble-burst cycle went from technology to real estate to commodities--and not just corn and soybeans, but fuel." A lot of money going into something too fast inflates prices. "At some point, the market realizes the price went too high too fast, and it bursts." With high volatility in markets, vigilant risk management is crucial. In assessing the financial strength of farms, banks look at what's called the current ratio, which compares assets and liabilities to determine if a business has the resources to pay its debts over the next 12 months. "Make sure your current ratio is at least 1.5 or 2.0 or higher," he said. A current ratio of 2.0 means that for every $1 of current debt, a grower has $2 in current assets. Grain in the bin would be a current asset, he explained. "You may put grain in the bin and think it's worth $5 per bushel, but then it drops to $4." Keeping the current ratio high will help guard against price volatility, he said. Growers also should think in terms of cash reserves. "It's costing twice as much for seed and fertilizer, but do you have twice as much cash reserves?" Risk-management strategies employed by farmers include securing a forward price from the local grain elevator. In forward pricing, buyer and seller agree on the price of a commodity before it has been produced. This protects farmers from a sharp drop in crop prices, though it also commits them to the forward price even if prices in fact go up. Farmers can similarly guard against sudden increases in Somme production costs. "There are opportunities for forward-purchasing inputs right now," Massey said. "You take a risk, but what you get rid of is the fluctuation." Communicating with bankers, input suppliers and grain buyers is also important. "If a farmer is unable to get the local elevator to forward-price his grain, he may take out a futures position," he said. But the futures position means the farmer is subject to margin calls that affect his cash requirements. "If a farmer takes on a margin call himself and doesn't communicate with his banker, the banker may hesitate when asked for cash to cover the margin call that is protecting your grain price," he said. 9/29/08 Date: 9/19/08 Advertisement
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