What will corn prices do this summer or fall? In the midst of ethanol fever, that equates to asking if it will rain six months from now. Thus, the answer to whether cattle feeders should “hedge” in corn price protection is probably also in the clouds.
Optimists feel corn prices have topped out because the ethanol boom may be cooling. Others feel grain prices can only go up in the long run due to the demand for alternative fuels to run our pickups, tractors and SUVs.
Many felt the impact of USDA's March 30 crop report was already built into the market in early spring. But the Chicago Board of Trade (CBOT) December '07 corn futures opened limit-down at $3.83/bu., down 20¢ from the close on March 29.
Corn plantings were projected to be up to 90.5 million acres, up 15% from 2006 and the highest acreage since World War II. But even with added acres, ethanol is expected to keep demand high.
Thus, continued volatility is expected, and corn could swing $3/bu. or more in light of increased acres, yield potential and the true demand from ethanol production, says Mark Waller, Texas Cooperative Extension economist in College Station.
Knowing whether to protect your corn price may depend on whether you already have a profit in your cattle at current cattle and feed prices, and your willingness to hedge all your inputs and outputs in a feeding venture.
Waller says that if the acres added to corn production are truly substantial and yields are high, prices will come back down some.
“But I don't think prices will stay down for very long,” he says. “So if we get some kind of drop in the market, feedyards and other users should look at some corn price protection.”
Of course, the cattleman approach to hedging corn is normally the opposite that of corn producers. That means buying corn futures or call options if you want to be protected if the price goes up.
“One problem with options is they're expensive,” Waller says. “If you try to figure breakevens, you may not be too happy with options premiums.”
For example, in late March, when September '07 corn futures were $3.97/bu., the price of a September $4.30 corn call was about 25¢/bu. The option would enable the owner to take advantage of a rise in price, but for a cost of about $1,250 for a 5,000-bu. contract.
“If you have a profit already (based on current prices) and you're looking at locking in prices, you may be better off to look at locking in margins all the way through on corn, soybean meal, feeder cattle and live cattle,” Waller says. “But you probably don't want to lock in your input prices on feeder cattle and corn and speculate on the rest of it. That could get you in trouble.”
“Cheap” corn no more
Frank Simms, manager of Carson County Feedyards, Panhandle, TX, thinks we've seen the last of “cheap” corn but believes ethanol's upward impact on corn prices may be sliding.
“We should have hedged corn last year before prices went up,” Simms says in hindsight. “Corn is already so high I think we're going the other way now. Prices are inflated because of the ethanol frenzy, and I don't think they'll go any higher, nor do the (grain) elevators I talk to.”
Simms says speculation that all the ethanol plants would go from the drawing board to construction is weaker than even a few months ago. He doesn't plan to hedge corn anytime soon.
James Herring, president of Friona Industries, Inc., Friona, TX, which runs four feedyards with a total capacity of 275,000 head, says Friona's corn purchases or hedging depends on whether cattle are custom or company cattle.
“We know $6 corn isn't out of the question in this volatile market,” Herring says. “But our policy, which I instituted a long time ago, is that when we buy cattle for our risk, we buy the corn at the same time.
“We're always looking at the value between feeder cattle and fat cattle. We want to take the arbitrage of corn out of the risk factor. We take corn out of the equation.”
That usually involves buying CBOT corn futures at the same time feeder cattle are purchased to go on feed.
“Our risk is in the feeder- and live-cattle spread and not in corn,” Herring says. “That policy has served us well over the years.”
However, for customer cattle, corn is normally purchased no longer than 45 days out.
“We're going to stay in the market with those cattle and corn,” he says. “It allows us to be competitive in feeding rations. Our customers can take advantage of what the corn price offers (through current or distant futures or forward contracts) if they want to lock in prices or quantify for their own cattle.”
A demand-driven market
Forward contracting corn or selling a futures contract at a set price could backfire if prices go down. However, John Anderson, Mississippi State University livestock marketing economist in Starkville, says that — unlike in the mid-1990s when corn prices pushed $5/bu. and were supported by a tight supply situation — the current corn market is primarily demand-driven.
“The past three corn harvests (2004-2006) have been the three largest crops on record,” Anderson says. “Corn carryover coming into this most recent harvest was nearly 2 billion bu. Despite these facts, the corn market experienced an unprecedented price rally right through the middle of harvest.
“This notable event underscores the impact growing demand from the energy sector is having on the corn market. The most important point to consider with respect to the corn market is that it could be extremely volatile in 2007,” he adds.
Anderson notes that at current use levels, there's a little over a three-week supply of corn.
“In early 1996, ending stocks projections for that year amounted to about 2.5 week's worth of use,” he says. “The 1996 crop turned out to be a good one and prices quickly retreated.
“This year, even with a good crop, prices could remain relatively high. If there's any indication during the growing season that the crop could be in jeopardy, corn prices will easily surpass all previous records.”
Waller says another reason feeders shouldn't depend solely on locking in a corn price is that, in most cases, when corn prices go up, feeder cattle prices decrease.
“If you lock in feed and prices go up, and you see an erosion in the livestock market as well, that would hurt if you have a high input locked in. So the feeder and fed market should be also protected with futures or put options,” he says.
Larry Stalcup is a freelance writer based in Amarillo, TX.