Incredibly high grain prices apparently aren't going away, and plentiful supplies of corn might be harder to find for feedyard managers. But by contracting with local farmers early for harvest-delivered corn, cattle feeders may deflect at least one of those kicks in the head.

Ethanol, which only a few years ago gobbled up 10-15% of the nation's corn, now eats 20-25% or more, or 2.5-3 million bu. And that figure is projected to go higher.

Of course, ethanol co-products — wet distillers grains (WDG) and dry distillers grains (DDG) — go into livestock feed. “Up to 65% of our corn-based ration is WDG,” says Anne Burkholder, manager of Will Feed, Inc., a 3,000-head feedyard at Cozad, NE. “But most of the remaining corn that goes into our ration comes from local farmers, our neighbors.”

The feedyard uses a dry-rolled, corn-milling system. The overall ration includes the WDG, plus ground alfalfa, ground corn stalks and rolled corn. An uninterrupted supply of the yellow grain is essential.

“We usually start contracting with growers in late spring and into fall for harvest delivery and beyond,” Burkholder says. “In late spring and into summer, we raise the amount of WDG in our rations because it becomes very available and corn becomes more scarce.”

Ethanol plants in Burkholder's area continue to run full blown. “WDG is a management tool we use to keep a steady supply of yellow corn. As we get into fall, we go back to more corn because it's more plentiful.”

New dog, same tricks

Due to the restrictions they're seeing in contracting with grain elevators because of the high margin requirements required by lenders, more growers should be eager to contract corn with feedyards, says Darrell Mark, University of Nebraska livestock marketing economist.

“While the concept of grain producers selling directly to livestock producers isn't new or novel, it may be time to embrace the practice with more enthusiasm,” Mark says. “Since both grain growers and livestock feeders have a business need to offset their risk and exchange the physical commodity, contracting with each other is a natural fit.”

Mark points out that farmers sometimes can't hedge with their traditional buyers, and they need to, given significantly higher input costs. At the same time, livestock producers are limited in their ability to hedge corn in the futures market due to higher margin requirements and more working capital needed. Contracting between growers and feeders is like scratching each others' backs.

Burkholder says about 85% of her feedyard's corn needs will likely be secured by contracts. It's good security, she says. The yard knows the quality of corn it will receive and that delivery will be on time.

She bases the pricing with growers on bids at local grain elevators, ethanol plants and the corn-futures market. “It's sometimes worth offering an extra 5¢-10¢/bu. over futures or the local bids to secure the type of quality corn we know we'll receive,” she says.

Corn delivered at harvest and beyond will normally supply the yard through early May. Burkholder then buys corn from growers who may have it in storage or from local elevators.

“We like to work closely with our neighboring farmers,” she says. “The integrity of the corn is higher.”

Mark says cattle feeders have to think more like grain originators and be concerned with obtaining grain — at any price.

“In some local areas, that could be an issue,” he says. “Nationally, I don't think we will have those kinds of problems for at least a year. The 2007-08 marketing year carryout is currently estimated at 1.28 billion bu., which is adequate.

“If 2008 planted acreage ends up in the upper 80-million-acre range and we have national yields at trendline or better (155 bu./acre), we could likely maintain an adequate carryout of more than 900 million bu. for the 2008-09 marketing year,” he says. “However, if we have significant production shortfalls, all bets are off.”

This year's use is now estimated at 13.1 billion bu. Using the USDA March Planting Intentions acreage of 86 million acres with a trendline yield, Mark says “we barely get 13 billion bu.”

Pricing corn

Mark notes that forward contracts with farmers should be a good way to offset corn basis shifts that have been extremely wide the past year. “I think cash forward contracts, or flat-price contracts, would be a good alternative because the basis is so much more variable than in the past,” he says.

Last year, for example, the Nebraska corn basis dropped from +10¢ in the summer to a harvest low of -50¢/bu., a 60¢ drop in about four months. “Grain producers should be more willing to flat-price contract, because grain elevators aren't offering that as readily now.”

Chicago Board of Trade (CBOT) corn-hedging strategies could also be considered to protect prices. Straight hedges or options strategies may be viable. “I think futures hedging by going long on corn futures (buying distant corn futures) is still an alternative for feedyards,” Mark says.

CBOT points out that since prices in the cash and futures markets move up and down together over time, a loss in either market will be offset by a gain in the other, allowing the cattle operation to lock in a corn-price level in advance of the actual feed-corn purchase.

The disadvantages to using long corn futures include paying a brokerage fee, and the potential for a strengthening corn basis, which increases effective feed buying price. Also, a feeder foregoes the potential to buy at a more favorable price level if markets move lower.

Mark says buying corn call options is also a good strategy, but relatively expensive. One way to “cheapen the naked call up” would be to use a vertical bull call spread, in which you buy a call at one strike price and simultaneously sell a call with a higher strike price, he says. “This can provide good protection at a cheaper premium cost, but only up to the strike price of the call that was sold.”

Another alternative is Livestock Gross Margin insurance, which can be used to simultaneously hedge the fed-cattle sales price and feeder-cattle and corn input prices, Mark says. (For more information, go to www.livestockinsurance.unl.edu.)

Another hedge against higher feed costs that isn't so traditional is to take advantage of seasonal lows in the distillers grain market, which normally occurs in late summer.

Mark stresses that when contracting for corn, feedyards and corn producers should carefully construct the forward contract and consider penalties for non-performance, as well as establish deposits or bonds to encourage performance. Legal advice should also be sought.

Larry Stalcup is a freelance writer based in Amarillo, TX.