Category: Crop Marketing

While the 2022 harvest season is not complete, it is a good time for producers to consider price risk management strategies for the 2023 crop. Agricultural commodities have a tremendous amount of uncertainty due to global and U.S. economic weakness, elevated input prices, weather, competition from South America, exchange rates, interest rates, and inflation.  With uncertainty comes greater price volatility, which is expected to continue in 2023. Additionally, many producers will be making input purchase decisions before the year’s end. With high input prices continuing into 2023, producers should consider establishing a price (or price range) for their crop when inputs are purchased. High input costs and uncertain commodity prices necessitate producers prioritizing price risk management. 

Figure 1. Example of two December corn options fence strategies that are premium neutral

For producers wanting to establish a price range in the futures market, consideration should be afforded to options fence strategies. In other words, how much upside potential are you willing to sacrifice to secure a minimum price? An options fence sets a minimum futures price and maximum futures price. To execute an options fence, a producer buys a put option with a strike price below the targeted futures price, sells a call option with a strike price above the targeted futures price, and maintains the option positions until the cash commodity is sold. For example, consider the following two option fence strategies (for reference, on October 20, December 2023 corn was trading at $6.24):

Strategy #1: A producer buys a $5.60 put option for $0.30 and sells a $7.20 call option for $0.30 (Figure 1). The producer has “fenced” in a price between $5.60 and $7.20 using options in the futures market, or simply stated the producer will not receive a futures market price below $5.30 or above $7.20, assuming execution of the options contracts and sale of the cash commodity.

Strategy #2: A producer buys a $6.00 put option for $0.50, sells a $6.50 call option for $0.50 (Figure 1). The producer has “fenced” in a price between $6.00 and $6.50 using options in the futures market, or simply stated will not receive a futures market price below $6.00 or above $6.50, assuming execution of the options contract and sale of the cash commodity.

Similar to a short hedge, when using an option fence, it is imperative to have offsetting transactions in the cash market. If the December futures market price is above the call option, strike price money is made in the cash market at the same rate as the losses in the futures market (without accounting for basis). Similarly, if the December futures contract is below the put option strike price, losses in the cash market are offset by gains in the put option position. Thus, the net return to the producer remains between the put option strike price and the call option strike price (assuming no changes in basis). 

Option fences can be set in a narrow (Strategy #2) or expanded range (Strategy #1), depending on the producer’s risk tolerance and the strike prices selected. An options fence is one of many strategies that can assist producers in managing their price risk. Obtaining professional advice to weigh risks and rewards when utilizing futures or options strategies is strongly recommended.

Important considerations:

• Fences do not need to be premium neutral.
• Selling options require margin, so liquidity or access to credit is essential.
• Options strategies do not protect against basis movements, this can be a positive or negative depending on your location and production season.
• Premium neutral strategies carry transaction fees and finance charges.
• Formulating reasonable price expectations are key.
• Fences do not protect against production risk and require an offsetting transaction in the cash market.

Resources and ReferencesBarchart.com. December 2023 Corn Options Prices. Accessed at: https://www.barchart.com/futures/quotes/ZCZ23/options?moneyness=20

The Southern region of the United States is more associated with cotton production than wheat. Yet, from 2005 to 2022, a time of high grain prices associated with increased production of biofuels, wheat planted acres in the South, on average, have exceeded that of cotton (Figure 1).  Wheat acres and production in the region are dominated by Oklahoma and Texas (Figure 2); Texas also leads cotton planted acres, by far, followed by Georgia (Figure 3). In 2022, the South will account for about 20 percent of total U.S. wheat production (USDA, NASS, Crop Production, August 2022). 

The year with the most wheat acres in the South in this ‘biofuel era’ is 2013 at 17.3 million. That year saw the highest plantings in seven of the fourteen states in the region for this period of time: Alabama, Kentucky, Mississippi, North Carolina, South Carolina, Tennessee, and Virginia. Oklahoma and Texas are not on this list. Acreage increases across multiple states can add up to make a significant difference in total wheat area in the region.  

Wheat is a crop with relatively high yield potential across the South. This becomes especially important when drought impacts major producing states.  With drought lowering harvested acres and yields, Oklahoma and Texas are projected to produce about 109 million bushels of wheat in 2022 from 4 million harvested acres and 9.8 million acres planted (Figure 4).  The states of Kentucky, Tennessee, North Carolina, Maryland, and Virginia combined to plant about 2 million acres of wheat for 2022 and will match the production total in Oklahoma and Texas. Kentucky’s production alone is 90 percent of that of Texas.  

Years with high wheat acres in the South tend to be associated with years of relatively low cotton acres (Figure 5).  Crop acres are positively correlated with the price received in the previous season (Figures 6 and 7). Wheat acres are negatively correlated to higher cotton prices (Figure 8).  Additionally, wheat acres tend to go up following years of high abandonment of cotton in Texas and Oklahoma (abandonment rates in other Southeastern states are minimal) (Figure 9).  In 2022, Texas and Oklahoma farmers planted 8.6 million acres of cotton, only to harvest 2.8 million (a harvested-to-planted percentage of 33 percent). 

Looking ahead to 2023, what are wheat acreage prospects in the South given:

• record high wheat prices^[*]
• record high cotton prices^*, and
• high cotton abandonment in Texas and Oklahoma? 

A regression model composed of these independent variables and recent trends in wheat planted acres shows that wheat planted area:

• is trending lower,
• goes up when the price of wheat the previous year goes up,
• goes down when the price of cotton the previous year goes up,
• goes up when percent of cotton harvested in Texas and Oklahoma the previous year goes down.   

Based on these variables, the model estimate of wheat acres in the South for 2023 is 14.4 million, up from 12.7 million acres planted in 2022 (Figure 10). Many factors will shape farmers’ planting decisions in 2023, among them persistently high input costs, lingering drought, returns from other crops such as corn and soybeans, and price prospects given global economic and geopolitical turmoil and uncertainty. This model suggests that significant factors are in place for an increase in wheat acres in 2023, maintaining wheat as an important crop enterprise in the South. 

Figure 1. Southern region planted wheat and cotton acres, 2005-2022

Figure 2. High, low, and average winter wheat acres in the South, 2005-2022

Figure 3. High low, and average cotton acres in the South, 2005-2022

Figure 4. Southern region wheat production 2022, million bushels

Figure 5. Wheat acres and cotton acres in the South, 2005-2022

Figure 6. Wheat acres in the South and the previous year’s wheat price, 2006-2022

Figure 7. Cotton acres in the South and the previous year’s cotton price, 2006-2022

Figure 8. Wheat acres in the South and the previous year’s cotton price, 2006-2022

Figure 9. Wheat acres in the South and percent cotton acres harvested the previous year in Texas and Oklahoma, 2006-2022

Figure 10. Southern region wheat acreage model

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^[*] U.S. Season Average Farm Price, World Agricultural Supply and Demand Estimates, September 2022

Welch, J. Mark. “Wheat Acres in the South“. Southern Ag Today 2(43.1). October 17, 2022. Permalink

On average, sorghum prices received by U.S. farmers have followed corn prices, albeit generally at a discount compared to corn over the last 20 years. However, since May 2020, sorghum prices have paid a significant premium over corn (Figure 1). An increase in export demand improved the U.S. sorghum-over-corn premiums from an average discount of $0.14/bu from 2014-19 to an average premium of $0.44/bu for 2020-21. The U.S.-China Phase One Trade Agreement (U.S. sorghum exports are not subject to tariff-rate quotas, like corn), the recovery of the Chinese swine sector, and high corn prices that supported high exports of U.S. sorghum to China were considered the causes for the change in sorghum/corn price ratios.

Figure 1: Sorghum Minus Corn Price Received by U.S. Farmers

Unexpectedly, sorghum premiums over corn declined sharply during the second quarter of 2022. In July 2022, the average sorghum price received by U.S. farmers was at a discount of $1.70/bu compared to corn. The sorghum/corn ratio dropped to 0.76. 

Many factors are contributing to the decline. In the past, years with strong exports of sorghum have been associated with higher sorghum premiums over corn. According to the USDA Foreign Agricultural Service (FAS), estimated sorghum exports for the 2022/23 marketing year have been reduced by 2.4 million metric tons (MT) compared to the previous marketing year (5 million MT in 2022/23 compared to 7.4 million MT in 2021/22). 

Historically, the U.S. has been the world’s leading sorghum exporter, accounting for 73% of all international exports in the last 30 years. For the 2021/22 marketing year, U.S. sorghum exports represented 61% of world exports. Considering current USDA estimated exports, U.S. sorghum exports will only represent 51.4% of world exports for the 2022/23 marketing year. 

China, the primary buyer of U.S. and worldwide sorghum is projected to cut its imports this season due to lower feed grain demand expectations. Total coarse grain imports from China are expected to decrease by 15% in 2022/23. The USDA estimated a reduction in China’s sorghum imports of 2.4 million MT (23.8%). During 2020/21, China imported 94% of total U.S. sorghum exports and about 85.5% of world sorghum exports. 

In addition, sorghum production in the U.S. has been severely affected by drought, significantly reducing the amount of sorghum available to be exported. In fact, USDA estimates a reduction of 43.7% in U.S. production for 2022 compared to the 2021 season. Estimated yields and harvested acreage are 23% and 17% lower than last season, respectively. Ending stocks are estimated to drop back to 2020-21 levels of 0.517 million MT.  

High sorghum discounts over corn generally result in a retraction of the planting area in the next growing season. FAPRI’s August Baseline Update for U.S. Agriculture Markets estimates 8% less sorghum planting area than last season. FAPRI estimates 5.8 million acres in the 2023/24 season, within the historic planting range before the 21/22 and 22/23 seasons. 

References

USDA Foreign Agricultural Service, Production, Supply, and Distribution. https://apps.fas.usda.gov/psdonline/app/index.html#/app/advQuery

FAPRI, Baseline Update for U.S. Agricultural Markets https://www.fapri.missouri.edu/wp-content/uploads/2022/08/2022-Baseline-Outlook-August-Update.pdf

Abello, Francisco “Pancho”. “U.S. Sorghum-Corn Premium Prices Sharply Fell During this Quarter“. Southern Ag Today 2(42.1). October 10, 2022. Permalink

The picture painted by the U.S. Department of Agriculture (USDA) of U.S. cotton production has been reframed several times this year already.  In August, USDA cut a historically large three million bales off of their previous month’s forecast.  The direction of that adjustment was not a surprise to anybody, but the size of it surely was.  Then, in September, USDA’s National Agricultural Statistics Service (NASS) reversed themselves and added a million and a quarter bales back to their estimate of U.S. cotton production^[1], now at 13.83 million bales of all cotton (i.e., upland and pima combined).   

Hopefully, and happily, we can expect the forecast to get more accurate going forward.  The reason for this is rooted in three sources of future information.  First, as we saw in USDA’s September forecasts, available USDA Farm Service Agency (FSA) certified acreage data were used to revise forecasted planted acreage.  This was the main reason for the September upward revision to U.S. cotton production this year.  New data on certified acres from FSA sometimes arises later in the fall or winter, so this remains a possible source of refinement.

Second, NASS surveyed more than 7,000 U.S. producers, including major cotton producing states.  This survey process includes what they call “objective yield surveys” for major crops.  For cotton, this means boll counts from randomly selected field samples in September, October, November, and December.  So again, this data flow suggests a more accurate forecast of U.S. cotton production over time.

Third, NASS also reports monthly on cumulative bales ginned, which is another independent (albeit lagged) measure of U.S. cotton production.  Altogether, we can expect fewer surprises and an increasingly clearer production picture.  This expectation is supported by historical data in Figure 1.   Figure 1 shows the percent deviations of USDA’s U.S. cotton production forecasts in August, September, November, and December, relative to the final production estimate at the end of the marketing year (i.e., the following July).  As expected, the spread of the percent deviations shrink across the fall season, presumably informed by the previously described data flow.  It is also apparent from Figure 1 that USDA tends to overestimate the crop size, at least in the September through December time period.

The marketing implication of this refinement is a fading production risk premium in U.S. cotton prices, all other things being equal. 

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^[1] https://downloads.usda.library.cornell.edu/usda-esmis/files/tm70mv177/qr46s7546/kd17f282m/crop0922.pdf

Robinson, John. “Refinement of U.S. Cotton Production Forecasts“. Southern Ag Today 2(41.1). October 3, 2022. Permalink

Several articles have discussed the benefits of on-farm storage for southern producers (Maples, 2022 and Duncan and Smith, 2022). However, there are marketing strategies that producers can investigate if they do not have on-farm storage. These include delayed pricing contracts, commercial storage, and using futures or options to establish a re-ownership position for the commodity sold.  

Delayed pricing contracts allow ownership of the grain to be transferred to a local elevator, barge point, or other purchaser without establishing the price. Delayed pricing contracts allow the producer to fix the price after delivery at a future point in time. As with any legal contract, attention to detail is important to fully understand the differences in terms and conditions offered. Additionally, counterparty risk should be investigated. Counterparty risk is the probability that the other party in a transaction may not fulfill its part of the deal and may default on the contractual obligations.

Commercial storage is another option that can be investigated. Commercial storage requires the producer to pay a monthly storage fee, while maintaining ownership of the grain. Storage fees are highly variable, based on facilities provided and local availability. Not all producers will have access to commercial storage in their location. Similar to delayed pricing contracts, terms, conditions and counterparty risks for commercial storage agreements should be fully understood. 

Futures and options can be used to establish a re-ownership position after the sale of the crop. Producers can buy a futures contract or a call option for a deferred contract month and experience financial gains if the futures contract price appreciates after the cash crop is sold. For example, buying a March corn contract at $6.90 can provide a financial gain if the March futures contract, between purchase date and expiration, increases (buying low and selling high). This is a speculative position and can result in losses if the contract price declines. This strategy also requires a margin account to cover any losses incurred by the futures position.

Buying a call option allows a producer the opportunity to profit if prices go higher with a limit on losses if prices decline. The cost of this opportunity is the upfront premium paid. For example, on September 7, 2022, a $6.80 March corn call could be purchased for 47 cents, thus the March futures contract would need to trade above $7.27 before a financial benefit is received by the purchaser. Premiums can be high, so producers may want to offset the premium cost. Selling a call option can reduce the upside potential but save the producer premium costs. Figure 1 shows a simple strategy of selling a $7.50 March corn call for $0.29 and buying a $6.80 call option for $0.47. The net result is a maximum loss of $0.18 and a maximum gain of $0.52. The return to the producer will be contingent on the price of the March corn contract and when options are exercised. The risk and reward should be fully understood before a producer enters any futures or options position. 

Figure 1. March corn option example: buying an at-the-money call option and selling an out-of-the money call option

References and Resources:

Barchart.com. Corn Options Prices. Accessed at: https://www.barchart.com/futures/quotes/ZCH23/options?moneyness=20

Biram, Hunter, and S. Aaron Smith. “The Option to Augment the Crop Insurance Price Floor.” Southern Ag Today 2(35.1). August 22, 2022. https://southernagtoday.org/2022/08/the-option-to-augment-the-crop-insurance-price-floor/

Duncan, Hence, and S. Aaron Smith. “Estimating the Cost of a Grain Bagging System“. Southern Ag Today 2(31.3). July 27, 2022. https://southernagtoday.org/2022/07/estimating-the-cost-of-a-grain-bagging-system/

Maples, William E. “On-Farm Grain Storage in Southern States“. Southern Ag Today 2(38.1). September 12, 2022. https://southernagtoday.org/2022/09/on-farm-grain-storage-in-southern-states/

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Smith, S. Aaron. “Marketing Strategies if Producers Do Not Have Access to On-Farm Storage.” Southern Ag Today 2(40.1). September 26, 2022. Permalink