Managing Market and Weather Risk

Early in 1991, as farmers were preparing their cash flow sheets for their operating loan application, December 1991 corn was in the $2.45 range after the cash prices the previous fall had been well below $2.00. Agricultural lenders and farmers alike were pessimistic about corn and bean prices for the 1991 crop. It was quite a challenge to get cash flows to show a positive outcome.


Farmers had been stung by the 1988 drought that ran corn prices to well above $3.50 for the third time in 9 years. Consequently, farmers did little forward pricing in ’89 and ‘90 and most of those crops were sold below breakeven. Consequently, bankers were being very cautious in extending operating loans. The high prices used on cash flow projections in ‘89 and ‘90 were overly optimistic as the market failed to deliver anything close to the projections. Lenders across the Corn Belt were taking a hard-line about using “reasonable” corn and bean prices on the 1991 cash flows. “Reasonable” meant $1.90 to $2.00 for fall delivery and $2.20 for Jan-Feb delivery.


Micah was 30 years old and had been farming about 8 years. He was steadily growing his crop acres each year. In 1991, he was going to have about 1100 acres of corn and 800 acres of beans.


Micah got his numbers together and meant his lender, Max, at the appointed time. Max was nearing retirement age and he was old school. His bank’s largest and most important client was the local elevator, which is quite common in rural communities.


Max had his own cash flow sheet he wanted to use. So Micah rattled off his numbers as Max filled-in the blanks. Max recorded all of Micah’s costs for corn and bean inputs and then he asked how many bushels of each Micah expected to produce. Micah told him and Max made the entry.


Then, Max asked Micah, “What price do you expect to be selling the corn?”


Micah said rather matter-of-factly, “$3.05”.


Max looked-up from his desk and said, “You are little optimistic, aren’t you, Micah?”


Micah said, “No, I am not optimistic about prices, but I am confident I will net more than $3.00.”


Max asked, “If you are not optimistic about prices, what makes you think you are going to net more $3.00?”


“I have 100% of my expected production priced with an HTA at $3.22 with a December HTA contract. I will roll that to March and pick-up another 12 cents or so. The basis next winter will be, at the worst, 20 under the March.”

Max jumped out of seat and leaned forward across his desk toward Micah. “You have all your corn contracted already?”


“Yes, Sir.” Micah was not sure what was about to happen, but he was not prepared what followed.


Max stood straight-up, walked to the side of his desk and began strutting back and forth behind his desk with an escalating tirade that went something like this:


“Are you out of your mind?! Do you have any idea what will happen if you get wiped out by hail or flood or drought? The elevator will own your farm, that is what will happen! How could you be so damn stupid to take such a risk? Are you out of your mind? Don’t you know we had a July hail storm went through here just ten years ago and all the crops for fifty miles around were destroyed! What in the hell were you thinking, Micah?! You scare the shit out me. How do you sleep at night? Does your wife know you did this? Surely she does not know or she would have left you by now! Micah, what in the world were you thinking?”


Max paused to catch his breath. His face was red and he was on the verge of shaking like a leave. The possibility of Max having a heart attack crossed Micah’s mind.


After a pregnant pause, Micah said, “Max, I will have hail insurance, as I always do. Since no one can make money with $1.70 corn, I realized I needed to grab the opportunity to lock-in $3 corn when the opportunity presented itself. I can pay my operating loan, farm mortgage and family living with $3 corn, but I can’t with $2.00 corn. There is very little risk of not growing corn compared to the market risk of not having the corn priced. Furthermore, the elevator has written in the contract I can postpone delivery a year if I come up short”.


Max looked Micah straight in the eye and said, “Thinking like that is going to cost you your farm someday. I don’t see how we can lend you operating money. It is such a huge risk!”


Micah said, “You would loan me money if I did not have any corn priced and a negative cash flow, but you are not going to loan me money with a dollar a bushel profit already on the books? If you think the risk of me not growing a crop is so great, why would you make an operating loan to me or any farmer for that matter?”


Max stared at Micah and said, “Micah, you just don’t understand anything about how the grain market works!”


Micah got the loan, but he had to go to bank president and his two senior advisors and explain how the grain marketing tools worked.

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