Risk management strategies key to weathering wheat markets
By Jennifer M. Latzke
Six spring freeze events over the course of five weeks in March and April were not what winter wheat farmers ordered in the High Plains region. Combined with ongoing drought—the worst since the 1930s in many parts—these weather events covering the High Plains had the wheat industry cautious about the final 2013 crop yield. And farmers are rethinking their risk management strategies in preparation for lower yields.
On May 2, the 2013 Wheat Quality Council Winter Wheat Tour estimated the Kansas wheat crop to yield about 313.8 million bushels. The Oklahoma Wheat Commission estimated production at about 85.5 million bushels, down significantly from 154.8 million bushels in 2012. In parts of eastern and southeastern Colorado, extreme drought took the 2013 crop and left fields and roads with dirt drifts.
The National Agricultural Statistics Service released its Crop Progress Report May 6, which showed Colorado’s winter wheat condition at over half the crop at very poor and poor conditions, with just 31 percent at fair. Kansas’s wheat was rated 33 percent fair, and 24 percent good; 21 percent poor and 19 percent very poor. Oklahoma wheat was at 35 percent fair, with 27 percent poor and 18 percent very poor.
In Texas, the report was startling, with 46 percent of the winter wheat rated very poor, 28 percent rated poor and only 26 percent rated fair, good or very good.
The U.S. Department of Agriculture’s World Agricultural Supply and Demand Estimates Report, released May 10 projected wheat production at 2.057 billion bushels, down 9 percent from 2012.
“The survey-based forecast for winter wheat production is down 10 percent with the lowest harvested-to-planted ratio since 2006-2007 and lower yields as persistent drought and April freezes reduce crop prospects in the southern and central Plains,” according to the report.
Dan O’Brien, Kansas State University Extension agricultural economist in Colby, Kan., said in a year like this revenue insurance and risk management will be key to wheat farmers weathering the storm.
“No doubt in a year like this, where a lot of places will have more uncertainty than normal in their production, there will be more hesitancy than normal in dryland wheat country in forward pricing any amount of bushels for delivery to the elevator,” O’Brien said. “If producers are inclined to take price coverage, they may look toward put options versus actual forward contracting or minimum price contracts.”
He gave the example of a hard red winter wheat contract for July 13 at $7.60 was just under 21 cents per bushel on May 6. If the crop is later than normal, farmers might consider a September contract at $7.70 selling around 36 cents per bushel.
“At 36 cents a bushel, a lot of cash conscious farmers stay away from the options route because of the perceived high cost,” O’Brien said. ““However, at 20 cents per bushel the cost is lower and they are more likely to consider a put option as a price risk management tool. Of course, farmers also have to weigh against making any forward contract commitment and not being able to deliver.”
Revenue-based insurance tools help producers if they make a forward contract and they wind up short on bushels.
“At least they’ll have insurance to fulfill the contract,” O’Brien said.
The key word in this market is the volatility, and Kim Anderson, Oklahoma State University professor and Extension economist, advised producers to have many plans for their risk management in this time of uncertainty.
“There’s just so much volatility in the market right now,” he said. “Farmers can’t just have one plan, they have to have a plan with the ability for potential modification depending on the market signals, depending on the current price level and looking at the past and the future trends.
“Right now (May 6) the market is around $7.40 per bushel for forward contracted wheat for June harvest delivery and in northern Oklahoma, southern Kansas the last five-year average was around $6.40 per bushel, give or take a dime,” Anderson said. Farmers should develop their marketing strategies around the average price ranges for their area.
And, while nobody knows what the price will do, Anderson said, producers must decide which would hurt them worse—selling less wheat for $7.40 or not getting the opportunity to sell higher than $7.40.
“The only thing we know for certain is that $7.40 is not the final price,” he added. “We know the average is about $6.40 and you’re a dollar above right now, so the odds are, it’s really even up or down, but historically this relationship tells us there’s more of a downside risk than upside potential. So, they have to ask themselves, one, do I forward contract and two, how much do I contract?”
Coming into the 2013 harvest, the question will be the 2013-14 marketing year price trend, if it goes up or down at harvest, Anderson said. Corn will be a large influence on the price of wheat because feed wheat can be a substitute for corn in some rations. O’Brien said wheat will help fill the gap for feed grain users on a short corn crop until we get into fall harvest.
“We are tight on feed grain in the U.S., and that has focused a lot of attention on the wheat market,” he said. Last summer a lot of wheat was fed from June through August and it looks to repeat again this year, he added.
“Let’s say we’re at wheat harvest and we have a $7.40 price,” Anderson explained. “That’s above average, and we have a big corn crop coming on and the world crop looks good. The odds are better for wheat prices to go down than to go up. Right now we are short of corn and we want to feed wheat.”
But, if producers wind up with a smaller wheat crop and the industry needs to keep more of it for flour, and farmers wind up with a large corn crop than they could see a reduction in the wheat price of 70 to 75 cents, he added.
Anderson said farmers should plan to stagger their wheat sales if possible to take advantage of price opportunities. And put a mechanical trigger in place so that when your target price comes around the emotion is taken out of the sale, he said.
“I had a producer come to me and ask me last year if I thought prices would reach $9,” he said. “On July 26 the price hit $9.03 and he didn’t sell. He had it, and he gambled and he had won—all he had to do was pull the trigger. That’s why I say, ‘make it mechanical.’ Put the order in the elevator that if it hits your target they sell it.
“But always keep some gambling bushels,” Anderson advised. “Figure out how many you can gamble with and keep those bushels in reserve.” Just in case.
O’Brien said as farmers begin their plans for the next winter wheat crop they should keep some things in mind.
“First, they have to control costs,” he said.
If farmers can start off with not having to defend too high of costs in their marketing plans, it eases the burden.
“Second, have a good crop insurance product in place with revenue coverage,” he said.
Even though higher levels of revenue coverage cost more, they do give more dollar coverage, and that may be a positive factor in helping farmers protect themselves financially and in risk management plans.
“Third, on the marketing side, protect your price and look at options if they are affordable for the price level you are protecting, and judiciously use forward contracts when they fit into your marketing plan,” O’Brien added.
Using risk management and marketing strategies, farmers might just be able to weather the next event Mother Nature throws their way.
Jennifer M. Latzke can be reached at 620-227-1807 or firstname.lastname@example.org.