1. Managing Risk in Agriculture
Ag. Credit School
Ames, Iowa
June 6, 2013
Chad Hart
Associate Professor/Crop Markets Specialist 1 1

2. Iowa Crop Shifts
Source: USDA-NASS

3. Diversification
Source: USDA-NASS, 2007 Census of Ag

4. Diversification
Source: USDA-NASS, 2007 Census of Ag

5. Hedging
Holding equal and opposite positions in the cash and futures markets
The substitution of a futures contract for a later cash-market transaction
Who can hedge?
Farmers, merchandisers, elevators, processors, exporter/importers

6. Short Hedgers
Producers with a commodity to sell at some point in the future
Are hurt by a price decline
Sell the futures contract initially
Buy the futures contract (offset) when they sell the physical commodity

7. Cash vs. Futures Prices
Iowa Corn in 2012

8. Short Hedge Graph
Hedging Nov $12.92

9. Put Option Graph Put Option June 2013 Live Cattle @ $128
Strike Price = $128
Put Option Return =
Max(0, Strike Price – Futures Price) – Premium – Commission
Premium = $3.275
Commission = $0.01

10. Call Option Graph Call Option Dec. 2013 Corn @ $6 Strike Price = $6
Call Option Return =
Max(0, Futures Price – Strike Price) – Premium – Commission
Premium = $0.50
Commission = $0.01

11. Hog Crush Margin
The Crush Margin is the return after the pig, corn and soybean meal costs.
Carcass weight: 200 pounds Pig price: 50% of 5 mth out lean hog futures
Corn: 10 bushels per pig Soybean meal: 150 pounds per pig
Source: ISU Extension

12. Contracting Basic Hedge-to-Arrive Basis Deferred Price Minimum Price
New Generation
Automated Pricing
Managed Hedging
Combination

13. Ego
Greed
Fear

14. Marketing Plan
To avoid fear, greed, and ego dominating your marketing, have a plan and stick to it.
A marketing plan outlines your market strategy and your marketing objectives.
It should examine marketing opportunities before and after harvest.

15. Marketing Objectives Get the highest selling price Reduce price risk
Pretty tough to do
More realistic objective: Obtain better than average prices
Reduce price risk
Cover cash flow needs
Minimize tax liability
Look at short and long-term goals for your business

16. Building a Marketing Plan
5 basic steps:
Estimate number of bushels/animals to sell
Calculate breakeven price
Project price and production scenarios
Compare pricing tools and analyze market opportunities
Develop a pricing plan

17. Tentative Pricing Plan
Outline realistic pricing targets
Have periodic price targets and quantities to sell
Have patience and be willing to reevaluate price goals
Remember it’s hard to lose money when making a profit

18. Seasonal Pricing Patterns
Source: USDA, NASS,
Monthly Price Data

19. New Farm Bill Program? Yield per Planted Acre Year Farm (bu./acre)
County
Season-Average Price
($/bu.)
2003
2.42
2004
2.06
2005
2.00
2006
3.04
2007
4.20
2008
160
4.06
2009
175
3.55
2010
164
5.18
2011
163
6.20
2012
165
5.00
Olympic Average
4.75
10-year average
3.77

20. Potential Payout Graph
No payments
Payment

21. Crop Insurance One of many risk management strategies
Traditionally set up to protect farmers in times of low crop yields
Now offers coverage for low prices
Available on over 100 commodities

22. Causes of Loss for Iowa Corn, 1948-2010

23. Causes of Loss for Iowa Soy, 1955-2010

24. Federal Crop Insurance
Federal Crop Insurance Corporation – 1938
Government’s initial move in crop insurance
Federal Crop Insurance Act of 1980
Premium subsidies
Federal Crop Insurance Reform Act of 1994
Catastrophic coverage and higher subsidies
Agricultural Risk Protection Act of 2000
The 2008 Farm Bill

25. Federal Crop Insurance

26. Types of Crop Insurance
Individual Yield (YP)
Area Yield (GRP)
Individual Revenue (RP and RPE)
Area Yield - Individual Revenue Combination (GRIP)

27. Federal Crop Insurance: Total Acres Insured

28. Example Farm
A 100 acre corn farm in Story County, Iowa with a 5-year average yield of 180 bu/acre
Purchases insurance at the 75% coverage level
Spring price: $5.65/bu (average of Feb. prices for Dec. corn futures)

29. Individual Yield Insurance (YP)
Farmer chooses percentage of expected yield to insure
Expected yield measured by average yield
Price at which the crop is valued is set up front and does not change
If yields are 100 bushels per acre, the farmer receives $ per acre = $5.65/bu * (75% * 180 bu/ac bu/ac)

30. Yield Insurance Payout Graph
No Payout
Payout

31. Yield Insurance is like an Option

32. Individual Revenue Insurance (RP or RPE)
Farmer chooses percentage of expected revenue to insure
Expected revenue measured by average yield times initial crop price
Price at which the crop is valued can move with price changes in the market

33. Individual Revenue Insurance (RP or RPE)
In our example, the farmer has insured $ of revenue per acre (75% * $5.65/bu * 180 bu/ac)
Final value of the crop determined by average futures prices over harvest period

34. Individual Revenue Insurance (RP or RPE)
If yields are 100 bushels per acre and harvest prices average $4.50, the farmer receives $ per acre
0.75*$5.65/bu.*180 bu./acre $4.50/bu.*100 bu./acre

35. RPE Payout Graph
No Payout
Payout

36. Rev. Insurance is like an Option

37. Individual Revenue Insurance (RP)
This policy has a “harvest price option”
If the harvest price is greater than the planting price, then the harvest price is used in all calculations
In essence, the policy is giving you a put option with the strike price at the planting price

38. Harvest Price Option

39. Individual Revenue Insurance (RP)
If yields are 100 bushels per acre and harvest prices average $7.50, the farmer receives $ per acre
0.75*$ 5.65/bu.*180 bu./acre $7.50/bu.*100 bu./acre
7.50

40. RP Payout Graph No Payment Neither Pay RPE Pays YP Pays Both Pay
RP Pays

41. Corn Insurance Prices
Harvest prices have been higher 5 out of last 13 years

42. Soy Insurance Prices
Harvest prices have been higher 7 out of last 13 years

43. What Units to Choose? Optional Units: Each farm is separate
Basic Units: Combine owned and cash rented acres in same county
Enterprise Units: Combine all acres of the same crop in same county
Whole Farm: Combine all crops in county

44. Current Subsidy Rates 60% 64% 80% 65% 59% 70% 75% 55% 77% 48% 68% 71%
Coverage level
Basic Units
Optional Units
Enterprise Units
Whole Farm Units
60%
64%
80%
not avail.
65%
59%
70%
75%
55%
77%
48%
68%
71%
85%
38%
53%
56%

45. 2013 Insurance Premiums Per Acre Premiums ($ per acre)
Cov. Level YP RPHPE RP_
50%
55%
60%
65%
70%
75%
80%
85%
For our example farm in Story County, Iowa for corn

46. Choosing Insurance Policy
Choice depends on several factors
Type of farm and crop mix
How well the county average yield represents your farm
Your marketing strategy

47. Iowa Corn Acres Insured in 2012
91% of all Iowa
corn acres are
insured

48. Iowa Soy Acres Insured in 2012
91% of all Iowa
soybean acres
are insured

49. 2012 Corn and Soy Coverage Levels

50. Coverage Levels for YP

51. Coverage Levels for RPHPE

52. Coverage Levels for RP

53. Thank you for your time. Any questions. My web site: http://www. econ
Thank you for your time! Any questions? My web site: Iowa Farm Outlook: Ag Decision Maker: