Unnecessarily Complex

Sometimes I can’t help myself…it’s hard for me to solve problems without just going for the most complicated solution…  If you’re not into math and computers and such, just trust me when I say that just selling as little as 50 bushels per acre at prices currently available can greatly improve your odds of profit growing corn this year without sacrificing upside.  Otherwise, if your adventurous (and have had your coffee), read on…

Brace yourself while I say something controversial: you* can lock in a profit** on corn production right now***

* You: assumes your production costs are somewhat close to mine

**Profit: I didn’t say big profit…

***Now: Here’s the sticky part – you have to look out beyond the next few months to find profit

I’ll admit, selling far in the future is scary, but the market doesn’t usually reward you for being a chicken.  In fact, these days it seems like the only way to make decent money farming is to tow the line between bold and reckless.  In a “carry market” like we have today (i.e. the prices for future delivery are higher than for current delivery), the best opportunities to price your grain are 12+ months in the future.  For example, MAY’20 corn futures are currently trading 50 cents higher than MAY’19.  Would you be making money if you could sell 50 cents higher?

I think the real trouble folks have with forward selling is committing “a bunch” of their production in advance: either they fear not having enough grain to fill contracts, or they fear missing out on the big rally when it comes.  I’m going to let you in on a little secret: you don’t have to sell much to make a big difference.  It’s just a question of Risk Management.

Risk Analysis

As farmers, we deal with lots of risk every day.  Most folks who collect a paycheck every week have a difficult time understanding the array of risks you have to weigh in making decisions through the production and marketing cycle.  Typically, farmers do their risk analysis with their head and their gut.  Decisions get made based on how things feel in the moment, or how the situation relates to past experience.  Risk Analysis is the science of solving questions related to risk quantitatively, such as how much grain to sell in advance.

The method of Risk Analysis I’m most familiar with is called “Monte Carlo Simulation.”  It’s called Monte Carlo because it’s a little bit like simulating gambling on coin flips.  Essentially, you break a problem down into little pieces, estimate the probability of each piece happening, then simulate how they would all work together in tandem using the computerized equivalent of coin flips.

In order to simulate the risk of forward contracting grain, we need to make some assumptions:

1. What will be our cost of production?  For this simulation I used my corn crop budget number: $642/acre.
2. What will be our yield? I used the APH yield from the crop budget, with a “standard deviation” of 2 bpa, which equates to a yield range from 179 to 218 bpa.
3. What price can we sell today?  Our closing bid yesterday for fall delivery was $3.50 for OCT/NOV delivery.
4. What is our “most likely worst case scenario” for pricing if we don’t sell today?  This is where it starts to get more difficult.  I chose to assume that our worst case scenario would be to sell everything on some random date during October.

I get a kick out of folks who say fundamentals don’t matter in pricing grain.  Consider this chart:

This chart shows the relationship between the average price of DEC corn futures during October for the past 15 years, and the final stocks/use ratio for each of those years.  As you can see from the chart, when the stocks/use ratio gets below 10-12%, grain prices get mighty exciting.  Between 12 and 16%, which is where we’ve spent the past five years, there are some brief opportunities to sell profitable prices, but otherwise pretty boring.  And, beyond 16% is pretty much purgatory.

Prior to the last quarterly stocks report it seemed we were pre-ordained to draw corn stocks down to less than 12% of use, which sounds like a pretty fun idea if you’re a seller.  However, based on the new information we’ve learned in the past two weeks, the current thinking is that we’ll be around a 14% stocks/use ratio next year (I say “current thinking” because it’s probably going to change for the better…or worse).  At 14% stocks/use, we have no reason to expect anything much different than the past three years, or any of the other years in the past fifteen with stocks/use between 13 and 15%.  Mathematically, that looks like this:

This chart is called a “histogram”, and it basically shows how often different price levels occurred during the selected years.  The taller the bars are over a certain price level, the more often those price levels occurred.  The red line shows the mathematical model of the price distribution that I used for simulation.  Using this information, along with the yield and cost estimates, I simulated 5000 “what if” trials to see our chances of making money:

The results of the simulation are shown on the right: based on my best guesstimates of prices, costs, and yields, in about 30% of the trials I would have lost money just selling everything in October, but in nearly 70% of the trials I would have been profitable, with the average outcome about $18/acre…whoopy ding.

What if we sold some of our production at $3.50/bushel (currently available in our market)?  I cranked up my computer and pounded through another 5000 simulated crop years, but this time I figured on selling a fraction of the crop at $3.50, and the balance of the crop in October.  After repeating the process several times with different amounts sold, the simulation showed that, if we sold 50 BPA, or a bit more than 25% of our APH, we can be about 95% assured of at least breaking even or better.  The downside of course is that, while I would greatly reduce the risk of taking a loss, selling 25% at only $3.50 pretty much nails an $80/acre lid on profitability.

If only we had thought of this last year when DEC’19 futures spent a bunch of time trading over $4.15, which would have netted us about $3.75 cash.  If we would have sold just 30 BPA we could have reduced the probability of loss to less than 5%, but our chances of breaking $100/acre profit would have barely changed.