For those who have never seen the Chicago Board of Trade trading floor, your time is limited. On July 2, 2015 all futures pits in Chicago will be closed, due to a lack of use and it will save stock holders $10 million per year. Computers and electronic trading have replaced humans for 99% of futures trades. Options pits will remain open for now because 50% of the trading volume is still done as open outcry in the pits. If you don’t have time to travel to Chicago, you can always rent the movie “Trading Places” off Netflix and let Eddie Murphy and Dan Akroyd show you what the trading floor was like at it’s prime during the 80s.
Which way is the market going?
There was significant volatility in the grain market this week. Monday the market was down. Tuesday there was a big rally. Wednesday and Thursday swings offset each other. And now Friday corn is unchanged and beans continued to fall. For the week both corn and soybeans managed to closer higher overall. If you are confused about where the markets are going right now you’re not alone. Many in the trade I spoke with are trying to wrap their arms around this market. Direction is unclear. Fundamentally the market has plenty of grain for what is needed, but farmers are holding tight. The market is locked in a tug of war with a tight trading range of $3.73 to $3.92 in corn, while beans are sitting between $9.45 and $9.80. A breakout is needed for market direction.
In February insurance prices are set based upon the average close each trading day. Right now, it looks like prices will be around $4.15 (corn) and $9.65 (beans). Obviously with 14 trading days left this month’s averages can change, but it shouldn’t be much more than 10 cents for corn and 20 cents for beans.
When a farmer “plugs” in 85% insurance coverage, the bottom side protection at $3.52 may be a loss for many farmers. If a farmer chooses 70% coverage, the payment starts below $3. At $9.65, beans would be $8.20 (85%) and $6.75 (70%). With these prices, crop insurance is no longer a marketing option some have used it as the last few years. Again, for those who haven’t started a marketing plan for their 2015 crop, now is the time.
The farm as a business
A profitable farm is more complicated than planting crops and hoping they pay the bills at the end of the year. Farmers should consider their operations as a company with multiple profit centers working to a common goal. Each profit center must “pull its own weight” without drawing profits from another division. Successful farmers understand each profit center independently and how it maximizes profit for the farm operation.
There are four large divisions (some with smaller subsets):
• Land Ownership
• Custom Operations
• Grain Storage
This is where I see farmers “cheat” the most, because most farmers are very passionate about working the land. I ask all my clients, “Are you paying yourself a fair market rental price for use of your land?” Smart farmers factor that into their costs. In theory, some farmers could spend their time on the beach while hiring someone else to do the hard work of farming the land. Considering the typical farmer’s mentality, most don’t think like that, but it’s important to understand the profit difference between renting your land and farming it.
Due to the price of farmland increasing substantially the last few years, farms purchased 10 to 20 years ago have lower costs than farms bought 1 to 2 years ago. Regardless, every farm has a fair rental price based upon market conditions in their area. In some years, farmers may only make the amount it would cost to just rent their land. It’s important to understand the guaranteed income from the start. Some farmers may be surprised about the cost of their time and energy.
Profitable farms understand the cost of every piece of equipment on the farm. Many mid-sized farmers today have more than $1 million invested. It’s important to make sure each piece of equipment pays its own way. Some questions to ask are:
• What is each custom rate in your area to have someone else own equipment (i.e. the planter, combine, sprayer, semi, tractor, etc.)?
• What are the yearly costs to maintain each piece of equipment?
• What are the yearly costs for depreciation?
• What does it cost to hire the work done with the equipment on the farmer? For some jobs on the farm it may be more beneficial for the farmer to hire someone to operate their equipment while they get work done in the office or even do a second job.
While some pieces of equipment are nice to own and can look impressive to your neighbor, sometimes it doesn’t pay and puts a strain on this division.
Grain storage is a profit center most producers use incorrectly. Most farmers store non-contracted grain hoping for a market rally, knowing that storing unpriced grain at their local elevator means hefty charges. So between storing unpriced grain at home for “free” or storing it at an elevator for a charge, it can make a little sense I guess.
However, many farmers are missing out on all of the profitable benefits of storing grain at home and selling forward — taking advantage of carry and basis appreciation. By considering on-farm grain storage as a separate cost center analyzing the expense to build new storage becomes a practical one. One just needs to analyze the premiums received from carry/basis optimization against the expense of building new bins. Almost every time I walk a client through the numbers, having on-farm grain storage is a profitable venture. Actually, I find grain storage can have the best return on investment above every other investment in a farm operation.
The “farmer” is the part of you that makes management decisions each year. One could liken it to the CEO position, but it also includes the titles of CFO and COO. Strategic decisions need to be made on crop inputs and farm operations:
* Fertilizer — What kind? How much? When to apply?
* Chemicals — What kind? How much? When to apply?
* Seed — How much corn vs beans? On which fields? Which brands/hybrids/traits?
* Insurance – How much? What program?
* Hired Help — How much? Where do I find these people? How much to pay?
There are so many decisions for farmers to make it can be overwhelming. To help in budgeting, I ask my clients: How much do you want to make on each acre and what kind of ROI is needed to be profitable? Each farm is different and has its own challenges, but these questions can be answered by the big established family farm down to the small young farmer who is renting all of his land.
Putting it together
Finally, the farmer puts all of these profit centers together to form a budget, (or business plan, but farmers don’t usually call it that). Then a marketing plan is developed to ensure the farm is profitable. If each profit center is optimized, the biggest opportunities for the farm operation can be achieved regardless of all the variable factors (i.e. weather, market volatility, etc).
Some may think all of this means just being a farmer, but breaking up the divisions/profit centers independently and then optimizing each one can help maximize profits. Perhaps there is a weak division/profit center that was only exposed after doing the analysis. Farmers can then take steps to maximize each area.
Jon grew up raising corn and soybeans on a farm near Beatrice, NE. Upon graduation from The University of Nebraska in Lincoln, he became a grain merchandiser and has been trading corn, soybeans and other grains for the last 18 years, building relationships with end-users in the process. After successfully marketing his father’s grain and getting his MBA, 10 years ago he started helping farmer clients market their grain based upon his principals of farmer education, reducing risk, understanding storage potential and using basis strategy to maximize individual farm operation profits. A big believer in farmer education of futures trading, Jon writes a weekly commentary to farmers interested in learning more and growing their farm operations.
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