By Jon Scheve, Superior Feed Ingredients, LLC
This week I heard a story that a few farmers may consider planting corn without applying fertilizer to reduce input costs. They would then take advantage of the insurance revenue guarantee on the yield using their average production history. At first, I thought it was just coffee shop talk. However, within a day several elevator managers and other farmers throughout the Midwest said they were hearing the same thing.
While initially this idea didn’t make sense to me, I gave it some more thought, and realized there may be some logic to this unconventional idea. The following explores the viability of this strategy.
Insurance is a revenue guarantee
It is important to remember that insurance guarantees are based upon the total revenue of combining yield and price. For this plan to work, a farmer would need both low yields and low prices. By cutting fertilizer out completely a farmer would almost be guaranteed of reducing their yield by maybe 50%. Since insurance revenues are based upon the futures price in October, and current forecasts show much lower prices for that time period, this strategy could theoretically work.
Farmers in areas with low basis levels would probably benefit the most from this strategy. It is my understanding that insurance guarantees are based only on futures prices, and basis levels throughout the country aren’t taken into consideration. Therefore, areas where -40 or -60 basis levels are typical during harvest may benefit the most from this strategy.
Farmers with little or no on-farm storage may could also be looking at this strategy to avoid having to sell corn under $3 at harvest, or pay hefty storage fees hoping for better prices in the future. However, I don’t believe this will work unless the basis values at harvest are at large negative values.
A higher level of coverage may also be needed for this strategy work. I think it would be more difficult for farmers who purchased 75% or less coverage to cover their expenses, compared to farmers who purchased 80% or more coverage.
10-year Average Production History
Farmers with lower 10-year average yields may have issues trying to pencil this strategy out because the 10-year average yield could be nearly 10% less than their trend line yields. For instance, the 10-year national yield average is currently around 161; while, the national trendline yield should probably be just over 177 this year. This might mean many farmers are already starting off with a 10% drag on their potential protection levels from what they have raised the last few years.
On the other hand, some farmers’ average yields have improved greatly the past 6 to 7 years and could be dramatically higher than the average farmer, so taking a drop on their yearly yield average may not be as big of an issue to their bottom line this year.
Can a farmer reduce their input costs to warrant collecting on the 80% of revenue?
Not applying any fertilizer could reduce a farmer input costs by about 15% to 25%. Decreasing seed populations is another consideration that I heard being discussed. A 40% drop in planting populations would save about 5% to 10% of total production costs, while reducing/eliminating fungicides and herbicides could reduce costs another 10% to 20%.
So, it’s possible farmers could reduce input costs by at least 30% or more. Therefore, I think farmers would need closer to 80% coverage or more for this strategy to really work. This is especially true if they have 10-year average yields that are already 10% less than the past couple years of production on their operation.
Insurance policy “best practices” clauses
Some farmers have mentioned the “best practices” clauses in their policies, which should prevent this strategy from being used. However, I’m sure some farmers may try to push the envelope on what exactly “best practices” are. For example, I heard a few farmers argue that they could see some farmers claim they are “mining” their soil for nutrients. Others suggested farmers could say they were “testing” minimum fertilizer and seed levels for optimal yield potential.
I am certainly no legal expert, but I would be concerned about how this clause could be interpreted. However, some farmers may have a different perspective of their policies or have already sought legal advice, hence why people may be discussing these strategies in the first place.
So, could this be done?
Yes, theoretically, this strategy could work for maybe a few farmers if several factors are met:
- If farmers were in areas with historically low basis levels during harvest.
- If they signed up for an 80% or higher coverage policy.
- If they haven’t applied any fertilizer yet.
- If their 10-year yield averages are pretty high.
How many farmers will realistically do this?
The vast majority of farmers won’t. Most farmers will try to raise the best crop they can, because that is what farmers do every year. However, I’m sure a few farmers have run the numbers and have found it makes sense for their operation. If just 10% of farmers would try this strategy, and raise only 50% of typical yields, production levels could decrease 5% below trendline nationally. This would amount to a 9-bushel yield reduction on a 177 national yield, which could be potentially 850 million fewer bushels this fall.
How would that affect prices?
With many estimates of 3.7 billion bushels of carryout for next year, it’s unlikely 850 million fewer bushels would mean $4 corn. But, what if 4 million acres of corn also switched to beans this spring, and reduced the carryout another 700 million bushels? Then we’d be closer to 2.2 billion carryout bushels, something we have seen for the last 3 years. That could mean $3 futures are unlikely this fall.
Flattening the curve
When times are tough, alternative solutions will always be considered. Like last year when planting conditions were terrible, many didn’t think farmers would get their fields planted, but farmers found a way. While it seems unlikely that any farmer would not try to raise a big crop, it’s important to remember that when facing unprecedented circumstances some people will consider creative solutions to solve their problems. The nation and the world are trying to flattening the curve with social distancing. Maybe some farmers will be creative in their ways to flattening the curve of corn production by doing something not imagined only a couple months ago.
Please email email@example.com with any questions or to learn more. 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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