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  • Fences Aren’t Just for Cattle

    Fences Aren’t Just for Cattle

    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

  • Immediate Relief for Financially Distressed FSA Farm Loan Borrowers

    Immediate Relief for Financially Distressed FSA Farm Loan Borrowers

    On October 18, 2022, USDA announced the implementation of Section 22006 of the Inflation Reduction Act of 2022. The Act provides up to $3.1 Billion in funding to the Secretary of Agriculture to provide payments for the cost of loans or loan modifications for distressed borrowers of USDA Farm Service Agency (FSA) administered direct or guaranteed loans. The distressed borrowers include borrowers eligible for loan modifications defined in the House passed Build Back Better Act and borrowers whose operations are at financial risk. Financial risk is further defined to include borrowers as of August 16, 2022, who are 60 days or more delinquent, undergoing bankruptcy, foreclosure, loan restructuring, and owe USDA more interest than principal. There are different groups of distressed borrowers; the grouping will determine if, when, and how much of a program payment will be applied to their outstanding debt. For many distressed borrowers, the program payment will be applied to the debt to make the loans current (no longer delinquent). 

    The announcement indicated that almost $800 million has either already been used or is earmarked to identified distressed borrowers. These program payment(s) will provide immediate relief to America’s farmers and ranchers with USDA FSA direct and guaranteed loans which are financially distressed. USDA officials say over 13,100 borrowers have received immediate relief through automated payments.  Additionally, about 1,600 borrowers with more complex cases have the potential to benefit from some form of relief. To learn more about the announcement, view FSA’s factsheet on the announcement, https://www.farmers.gov/sites/default/files/2022-10/farmersgov-fsa-ira-distressed-borrower-assistance-factsheet.pdf.

    The farmer and rancher relief is viewed as a program payment, and USDA FSA program payments, even applied directly to debt servicing, create a taxable event.  The program payment is considered ordinary earned income subject to Self-Employement tax. Impacted borrowers should expect to receive a 1099-G (1099s are required to be sent out for all costs of $600 or more in a year) and a 1098 (if interest was paid as part of the program payment) in early 2023. To enhance support of America’s farmers and ranchers, USDA partnered with tax experts from the National Farm Income Tax Extension Committee to provide resources detailing the important relationship between federal income taxes and USDA farm programs:  https://www.farmers.gov/working-with-us/taxes

    To offer added support and trainings, FSA entered into a cooperative agreement with the University of Arkansas Division of Agriculture to develop a tax education and asset protection program.  The agreement resulted in a newly created technical assistance program called Agricultural Finance, Tax, and Asset Protection (AgFTAP).  AgFTAP seeks to enhance farmers’ and ranchers’ ability to understand and navigate the farm business tax and asset protection strategies for their operations. To learn more about the program and its collaborators, visit the AgFTAP portal, https://agftap.org/. The project features a collaboration between educators and the National Farm Income Tax Extension Committee, which offers a collection of tax guidance on its RuralTax.org website. Selected resources, publications, webinars, decision aids, etc., developed by the tax committee will be featured on the AgFTAP portal. For example, individuals interested in understanding 1099s and their tax treatment can view a resource posted on the portal, 1099s.pdf (ruraltax.org). Future AgFTAP resources and training will help farmers and ranchers understand their risk environment and identify resources/expertise to inform their decisions. 

    Kantrovich, Adam, and Ron Rainey. “Immediate Relief for Financially Distressed FSA Farm Loan Borrowers.” Southern Ag Today 2(43.5). October 21, 2022. Permalink

  • The Drought, Exports, and Cotton Prices

    The Drought, Exports, and Cotton Prices

    The drought of 2022 in Texas has taken its toll on U.S. cotton production, with USDA forecast 13.8 million bales (mb) (or 3.7 mb lower than 2021). Lower output equals lower exports, with current forecasted exports of 12.5 mb, down 14% from the previous year (See Figure 1). That also means lower ending stocks, currently estimated at historically low levels of 2.8 mb. But the drought (and higher than average price) has not slowed exports, with roughly one-half of expected production already sold or shipped where China has been the largest destination so far this year.

    USDA data show the typical inverse relationship between crop size and farm price. And even though expected farm price is below last year, if realized, would be the second highest average farm price on record. 

    But there are concerns. Recent price action in the 22 and 23 December contracts have shown considerable weakness relative to earlier in the year. Recent lower prices would be expected to stimulate buying. In fact, exports do show strength. But there appears to be substantial selling pressure any time price moves up. And the market appears to be inverted with nearby prices above prices in out-month contracts suggesting current demand above future demand.

    What is perplexing is the relatively low DEC23 price (currently in the mid-70 cents per pound range). That price level is insufficient to cover anticipated costs in many regions of the U.S. Also, relative to grains, the price for the DEC23 contract appears to signal fewer cotton acres next year. There is still time for prices to realign, but the market may be signaling lower anticipated cotton demand in 23 driven by higher apparel prices (and general inflation). For now, cotton is moving globally, and the US is likely to end the 22/23 marketing year with historically empty warehouses.

    Figure 1. U.S. Cotton Exports and Farm Prices: 2017-2023

     Source: Figure reprinted from the October 2022 Cotton: World Markets and Trade Report, USDA, FAS. 
    https://www.fas.usda.gov/data/cotton-world-markets-and-trade
     

    Hudson, Darren. “The Drought, Exports, and Cotton Prices“. Southern Ag Today 2(43.4). October 20, 2022. Permalink

  • Adding Value to Feeder Calves

    Adding Value to Feeder Calves

    As spring-born calves across the country reach the end of their stay at their farm or ranch of origin, it is important to consider management options like implanting, weaning, castrating bull calves, and dehorning that add value on sale day. Each choice requires an investment of time, facilities, and some education, but when used appropriately, each option tends to yield a positive return on investment, ROI. 

    Whether you have weaned or are in the post-weaning phase, implanting calves has one of, if not the highest ROI of any production tool in the business. Implants contain growth stimulants that increase muscle growth and result in higher weaning weights and sale weights. Consider a popular implant priced at $40.78 for 24 doses or $1.70 per dose. The product is marketed to increase weaning weight by 20-35 lbs. That means each additional pound costs roughly $0.06 to produce, and today those additional pounds are worth anywhere from $1.70 to $2.15/lb. Some producers will reach out to us and suggest they are missing the premium for NHTC calves if they implant; if you are not in a verified, likely audited program that produces calves bound for either the EU or Whole Foods, those calves are unlikely to see any premiums at sale, and they are implanted the minute they set foot in the feed lot. Remember, even if you’ve already weaned calves, implants can be utilized post-weaning.

    On that note, weaning is another management choice that adds significant value to calves at sale. However, the investment in weaning is certainly greater than that required when implanting. The table below reports sale values for weaned steer calves and their un-weaned peers in different weight ranges. With only one exception, the value of weaned calves exceeds that of un-weaned calves. In one case, the premium for weaned calves was 20 cents per pound or roughly $94 per head. The average difference in weaned and un-weaned calf prices varies by weight class but averages $8.33 per hundredweight across the report. This sample suggests that weaning increases the value of each calf by roughly 4.6%. 

    Medium & Large #1 and #2 Steer Values for the week of 10/3/2022 – 10/7/2022 ($/CWT)

    Dehorning and castrating bull calves both add value as well. Data on each management decision is reported less frequently through AMS, but expect both management choices to yield a positive ROI. A few data points from Texas collected over the last month suggest a $0.19 per pound discount for bulls compared to steers and a $0.03 per pound discount for horned calves. 

    Consider the aggregate difference in a few management decisions presented here. Last week at the Oklahoma National Stockyards, a weaned steer calf that was implanted and sold at a weight of 450 lbs. brought roughly $787.50. A similar quality un-weaned bull calf that was un-implanted and therefore weighed only 420 lbs. may have brought only $627.80; a total discount of $159 per head compared to the calf from the producer that applied some management tools. 

    We want to keep animal welfare at the forefront of our decision-making, even before financial gains, so always read and follow the product label. It is also true that the misapplication of these tools can result in a financial loss. If implanting calves, castrating bulls, dehorning, or weaning is new to your business, be sure to reach out to your county Extension agent, Extension Animal Science Specialists, or at least experienced producers you trust. The experience and knowledge these groups will bring to your operation will help prevent a financial misstep and will help you maintain the well-being of your cattle. 

    Benavidez, Justin. “Adding Value to Feeder Calves“. Southern Ag Today 2(43.3). October 19, 2022. Permalink

  • Growth in Forward Delivery Beef Sales

    Growth in Forward Delivery Beef Sales

    In 2022, beef production has been higher than last year. An indication of beef demand can be seen in wholesale beef prices. Anderson (2022) highlighted how the wholesale price of primals translate to the retail consumer. In addition to the boxed beef cutout value report, beef sales in the wholesale market can provide insights into current and future market demand for increased beef production this year. 

                Beef sales are reported by four types or methods: negotiated cash sale with the beef being delivered in 0-21 days, negotiated cash sale with the beef delivery in 22+ days, formula, and forward contract. For definition, a negotiated sale can have a delivery window of either 21 or less days or 22+ days. This means that the contracted beef will be delivered from the packer to the buyer in either 21 or less days or in 22 or more days. Prior to the mid-2000s, most beef was sold using negotiated cash sales. After the mid-2000s, formula based sales became the predominant way beef was sold in the wholesale market. Although volume of negotiated sales has decreased since 2002, the decrease depends on the type of delivery window of the sale. The trends and data discussed below use sales data from the weekly comprehensive cutout report.  Figure 1 displays the total number of weekly load sales for the four transaction methods:  negotiated cash sale with the beef being delivered in 0-21 days, negotiated cash sale with the beef delivery in 22+ days, formula, and forward contract. 

                As indicated in figure 1, negotiated sales with delivery in 21 days or less (blue line) has trended downward since 2010, while negotiated sales with delivery in 22+ days (yellow line), and formula sales (orange line) has trended upwards in volume during the same time frame. Forward contract volumes have remained relatively unchanged. Thus, the net loss seen in negotiated beef sales is attributable to the decrease in negotiated sales with delivery in 21 or less days. 

    Compared to this week a year ago, volume of negotiated sales with delivery of 0-21 and 22+ days are down by 18% and 7%, respectively. But, through September of this year, volume of negotiated sales with delivery of 0-21 and 22+ days are down by 2%, and up 6%, respectively. The increase use of negotiated cash sales with deferred delivery could be an indicator of risk management by wholesale market participants with an expectation of future price movement.

    Figure 1. Weekly Beef Sales by Transaction Method, Number of Loads

    Source: Livestock Marketing Information Center

    Reference:

    Anderson, David. “Wholesale Beef Prices“. Southern Ag Today 2(38.2). September 13, 2022. Permalink

    Martinez, Charley. “Growth in Forward Delivery Beef Sales“. Southern Ag Today 2(43.2). October 18, 2022. Permalink

    Beef Photo by Jason Leung on Unsplash