ENERGY RISK MANAGEMENT CONSIDERATIONS John Robinson Texas Cooperative Extension l Context of higher energy prices l Hearings & calls for government policy intervention lOn-farm risk mgmt. steps Ê Evaluate the risk exposure Ë Identify alternative strategies including hedging possibilities Ì Evaluate the cost of each alternative (i.e., is it a good insurance buy?) çIdentify public & private resources to implement alternatives

Available Public Resources l Extension crop budgets, energy crop profiles, and detailed machinery analysis, e.g, ç U. Florida series, çPurdue publication analyzing tillage systems l Extension info. on energy saving tips, bmp’s, and new technology l USDA-ERS & OCE analysis of energy fundamentals/Ag impacts

Help Producers Size Up Their Situation: Energy Inventory Source: Florida Energy Extension Service:

Evaluate Risk Exposure: Total Energy Use in Btu’s l Do an inventory of total energy use with a Btu Conversion Chart Gasoline125,000 Btu’s/gal Diesel fuel138,690 Btu’s/gal LP gas 98,300 Btu’s/gal Nat. gas 1,030 Btu’s/ft 3 Electricity 3,413 Btu’s/kwh Nitrogen55.21M Btu’s/ton Phosphate12.34M Btu’s/ton Potash10.43M Btu’s/ton Pesticides M Btu’s/ton Source: ERS

Evaluate Risk Exposure: Input Energy Use in DFE’s Urea, solid0.233 gal/lb 28% N liquid0.229 gal/lb NH 4 NO 3, solid0.248 gal/lb NH 4 NO 3, sol’n0.225 gal/lb Anh. Ammonia0.177 gal/lb Total N for typical corn 26.6 gal DFE/ac Machinery fuel (conv. til.) 5.0 gal DFE/ac Machinery fuel (no. til.) 1.8 gal DFE/ac Herbicides (conv. til.) 1.7 gal DFE/ac Herbicides (no. til.) 2.9 gal DFE/ac Source:

Evaluating Risk Exposure: Sensitivity Analysis Repfarm analysis of higher natural gas prices and crop prices on irrigated farms: “Effects of Energy and commodity Prices on Irrigation in the Kansas High Plains (SRP611) library/engy2/samplers/srp611.htm

Agric. Energy Risk Management Alternatives l Technology Approaches çReduced Tillage çProper equipment selection, R&M çSubstitution away from crops with higher nitrogen requirements l Purchase and storage of fuel l Forward contracting and/or hedging input costs with energy futures/options

Available Private Resources for Contracting Alternatives l Trading consultants and brokers l Energy hedging consultants l NYMEX exchange information l Agricultural Cooperatives

Theory & Practice of Agric. Energy Hedging l Correlation of fuel and fertilizer prices with NYMEX futures çNatural Gas (very actively traded) ØAlso a proxy for anhydrous ammonia çHome Heating Oil (for diesel fuel) çPropane l Whole new set of fundamentals and seasonality considerations l Scale Considerations

Contract Information l NYMEX Natural Gas çFutures: 10,000 million Btu’s çOct. ‘01 Futures: $2.103/mmBtu  At-the-money call: $0.080/mmBtu, or about $800 premium for one contract l NYMEX No. 2 Fuel Oil çOne Futures Contract: 42,000 gallons çOct. ‘01 Futures: $0.7087/gal çAt-the-money call: $0.024/gal, or $1,008 premium for one contract

On-Farm Energy Hedging Considerations l What is the impact of a 2X or 3X or 4X rise in natural gas or diesel price? l Is the impact of this risk significant relative to other risks that need managing? l Is hedging nat. gas or heating oil futures realistic in terms of type and scale of the enterprise? l Is it feasible in terms of correlation between futures and farm-gate energy prices? l What to hedging alternatives cost? Are they a good insurance buy?

Example: Diesel Fuel for Delta Cotton Operation l Typical Delta operation with conv. tillage uses 18.3 gallons of diesel per acre, or over $20 per acre. l Need 2,300 acres to match the size of one No. 2 heating oil contract l An Oct. ‘01 at-the-money call on NYMEX No. 2 Heating Oil futures costs about $0.44 per acre è Questions: How well does this contract track on-farm fuel prices, and what basis are we facing?

Example: Hedging Nitrogen costs l Typical Delta operation uses 400 lbs of N32 per acre, or $37 per acre. l Need 2,300 acres to match the size of one No. 2 heating oil contract l An Oct. ‘01 at-the-money call on NYMEX No. 2 Heating Oil futures costs about $0.44 per acre è Questions: How well does this contract track on-farm prices, and what basis are we facing?