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Uncharted water

Historic spring triggers rally, but is it enough for a profit?

The wettest spring on record in many areas has left farmers with more questions than answers as the summer growing season gets into gear. How high can corn prices go – and what should you do about it – could make or break your operation after years of stagnant income.

So here’s our guide on how to tackle this tough assignment, along with our best guess about where the market is headed.

How high can prices go?

During the ethanol boom corn was a demand market. No more. Supply drives corn prices now and it’s an easy equation to figure. Start with the amount leftover from the previous year, plus a few imports. Then add production, which equals harvested acres times yield.

Related: Tariff aid could vary widely

Around 2.2 billion bushels of 2018 crop corn may be around Sept. 1. Higher prices this summer already started rationing export demand a little, while a few nervous end users began booking cargoes from Brazil. But imports are usually minimal, maybe 50 million bushels.

One part of the new crop puzzle is will start to fall into place soon. USDA June 28 releases results of a grower survey completed last week on acreage. But that report won’t be the final word. For one, USDA’s June estimate tends to be too high – it overshoots the final number about 80% of the time in a normal year. This year, to be sure, was anything but.

The high rate of prevent plant this year increases potential for actual acreage to fall even further. If 5 to 7 million acres went PP, as seems likely, USDA’s final acreage number in January could be 2 million lower than June based on historical trends.

Related: Should you take prevent plant on corn?

As for yields, USDA puts out results of its first grower yield survey Aug. 12. The August estimate this year won’t include samples gathered from actual fields. Late planting could make this first forecast even more iffy.

Of course to many, the grain market feels like a game of chance with as much logic as a coin flip.  And that’s just what we did to get a feel for yields and production. Our coin flipping was done by a computer.

Using a method called Monte Carlo simulation, we looked at thousands of different possibilities based on weather patterns in key Midwest growing states during summers with El Nino warming of the equatorial Pacific. July weather – a key factor driving yields -- trends wetter in these years, though not always. Temperatures are almost equally split between warmer and cooler outcomes. With this pattern plugged into the simulation, national corn yields averaged 167 bushels per acre, 1 bpa more than USDA estimated in June. But the range was all over the map, from 153 to 183 bpa.

Depending on final acreage, this simulation showed potential production just as varied, from a low of just 11.6 billion bushels all the way up to the 15 billion USDA forecast originally before the wet spring took its toll. Anything less than 13 billion bushels gives growers at good shot at futures above $5, while more than USDA’s June estimate of 13.7 billion suggests the highs are in.

The smaller the crop, the more explosive the market’s reaction is likely to be. That’s because six continuous years of above average yields dulled the market’s price mechanism. But a reminder of the markets that culminated with $8 corn after the 2012 drought could shake the market out of their doldrums with a slap upside the head.

How the corn crop game of chance worked

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Step 1 – July weather patterns in El Nino summers

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Step 2 – How weather could influence corn yields

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Step 3 – How production affects prices

What happened in other wet years?

Hot, dry weather that bakes the corn crop is known for producing violent rallies. Think “short crop, long tail” – the market pattern associated with them. But wet years are another beast altogether.

For one, there aren’t many for comparison. And in terms of planting pace, nothing comes close to 2019. But unless the weather turns hot or the crop is visibly suffering, get ready for a long slog through summer.

In the great flood year of 1993, rains didn’t come until summer, and it wasn’t until combines rolled that the full extent of damage became clear with USDA’s November crop report. The market topped after the January report lowered yields again but never got past $3.12 a bushel. One limitation: large supplies leftover from a then-record 1992 crop.

In 1995 a wet spring delayed planting, followed by a record summer heat wave. But even then, futures didn’t hit $3 during the summer after the yield in USDA’s August crop report turned out far too optimistic. The market didn’t really get going until the truth came out in the October report, jump-starting a rally into the summer of 1996 that took futures past $5 for the first time.

Not all years with wet springs end so triumphantly. In 2009, mid-May corn planting was the second slowest on record until this year. Despite the tardy beginning the crop got off to a good start, with 70% rated good to excellent, a measure that held up during a very long growing season. July that year was the mildest in key corn states dating back 70 years. Harvest was the latest on record, and as the combines rolled the bushels kept adding up and USDA kept raising its yield estimate. When all was said and done yields were another record, wet spring or not.

New tools, like satellite imagery, could give the market a heads-up on production sooner this year. Otherwise watch weekly crop ratings to see how the crop fares.

The timing of rallies will also likely affect prices for 2020 crop corn. The smaller the crop, the more the market may need to buy acres next year, unless soybean prices stay depressed.

Beware the Black Swan

Another factor helped tamp down rallies in 2009 – the financial crisis that destroyed value in most markets. These “Black Swan” events are by their nature impossible to predict, but there are plenty to choose from that are already on the radar.

A shooting war with Iran remains a possibility that could send traders back into their bunkers. The tariff dispute with China, and perhaps Mexico or the EU could also come into play. Britain is still slogging towards Brexit with untested leadership. Throw a dart in a map of the world and you’ll probably hit a trouble spot.

Domestic politics here in the U.S. could also roil markets, headed into what’s likely to be another steamy election year.

There’s one agronomic wild card too: damage from frost. Late planting may mean even normal first killing freeze dates could be a problem for late-maturing corn. More than two-thirds of the crop was planted in June. Depending on weather this summer those fields may not mature until the second or third week of October, maybe later.

Still, betting on a freeze historically is a long-shot. Damage was enough only once, in 1974, to impact yields nationwide. Otherwise, events tend to be localized, like the freeze that knocked down the 1992 corn crop in Minnesota and Wisconsin in a year that still produced a record U.S. yield.

What do you need for a profit? 

Deciding whether to plant or not this spring was a tough decision. The job won’t get any easier for the rest of the year.

Here are three keys to consider when trying to unlock the door to a profit.

First, choose a financial objective. Do you want to cover cash flow needs only or generate enough revenues to cover the full economic cost of producing corn? The answer depends on your financial situation and what those costs are for your operation. Even estimates from the experts vary widely.

USDA’s Economic Research Service, for example, includes a high cost for machinery in its production estimates that covers not only depreciation, but an opportunity cost on the value of the equipment itself. That takes the average cost per bushel assuming normal yields to $4. By contrast, Iowa State University’s budget for corn following soybeans is around $3.40 a bushel. Its machinery cost is about half the USDA’s expense using a more cash-flow oriented measure.

Growers with high debt and shrinking working capital may want to focus on survival, limiting risk. But an older grower with no debt who owns all land farmed can roll the dice, waiting for rallies.

Second, don’t forget about potential revenue from crop insurance and government programs.

Only your crop insurance is set in stone, depending on the coverage selected. Help from the government is trickier to estimate.

Most farms will receive some type of Market Facilitation Program payment for the corn they planted. The size of the checks will vary, and specifics may not be known until late July or into August. Payments will be based on acres certified for each county to the Farm Service Agency for a laundry list of crops. Our forecast put the average full MFP at $47 an acre based on acres certified or planted in 2018, but the projections varied widely from county to county. And the aid will be paid in three installments depending on how trade negotiations turn out.

Farmers had until July 15 to certify acres; FSA normally releases its first data on this acreage the same day as the government’s August crop report, which this year comes out Aug. 12. But the release could be accelerated this year by the need to get MFP money in the hands of cash-strapped farmers.

Also try to estimate benefits from the new farm bill that takes effect for 2019 crops. Signup is expected to take place late this summer, and farmers can change programs after two years.

Which program suits your farm again depends on your outlook and tolerance for risk. The reference price for triggering Price Loss Coverage payments is $3.70 a bushel. Average cash prices could fall below that if the 2019 crop is another bin-buster, or if higher prices this year cause a stampede to corn acres in 2020.

Most farmers chose Agriculture Risk Coverage for corn in 2014, and that option looks better again as long as supplies don’t swell. The Risk Management Agency in June put out 2018 yields for most counties that will be used in ARC calculations. Your farm’s actual yields this year could be higher or lower than your neighbors’ depending on who got into the field first.

Related: Make plans for the government put

Finally, stress test your costs against revenues produced by different combinations of yields and prices. This is a good idea any year but is especially important in 2019 when sharply lower yields from late planting could mean much higher break-evens.

 Knowing where you stand may not make the drama of 2019 any easier. But when the story of this difficult year is told, you’ll already know what the ending is.

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Here’s how four different scenarios played out under different prices at harvest. The examples assume a normal yield of 176 bushels per acre and $20 per acre in MFP payment with 85% Revenue Protection crop insurance and participation in ARC program.

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