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Start with good risk plan, adjust it when necessary

One of my clients started growing oat hay in 2011. It has been interesting to see how this has worked for him. Most interestingly, this year I’ve noticed there’s truth in the Ag Economics 101 axiom: marginal revenue equals marginal cost, or MR=MC.

In the case of my client’s oat hay, in 2015 the rains came, and the oats only needed one trip around with the sprinkler. Compared to 2011-14, this meant huge savings. However, with rain came lower prices, as hay became plentiful. It was interesting to learn that the 2015 crop was only $4 per acre more profitable than the 2014 crop. The hay market is probably the most “free” market on the Plains, and it really illustrates MR=MC.

Unless you’re one of the few producers with generic acres or you’re enrolled in ARC-IC (Agricultural Risk Coverage — individual farm coverage), your farm program payments are decoupled, meaning your choice of crop doesn’t affect your payment. In that respect, the farm bill has exited the market. However, the farm bill does provide crop insurance, and most importantly, it provides revenue coverage for grain. While my oat client can only participate with the pilot annual forage program, revenue protection (RP) crop insurance policies help producers make marketing decisions and capture more of that marginal revenue as profit.

RP policies help backstop these decisions, so a decrease in revenue results in an indemnity to help cover marketing costs. Steering clear of the details, the key gap in RP is that in years with high yields and decreasing prices, revenue may be too high to trigger an indemnity. In this case the producer doesn’t capture the added revenue, and MR=MC holds. Thus, RP needs to be part of a marketing plan — not the whole plan.

Sorghum and other grain producers have many different marketing tools available. From the standard forward contract to a complex option strategy, you can tailor your marketing plan to your crops and your risk preference. I’m sure you’ve seen the disclaimers about futures and options trading being risky. This is true, and those disclaimers should be heeded. But farming itself is very risky, and this disclaimer shouldn’t keep you from using futures and options.

In fact, these tools can help decrease your risk exposure. The important thing is to have a plan and stick to it. Just remember to be flexible. Some producers are very rigid in their plans and stick with them no matter what. I lean toward modifying the plan if and when market conditions change. Again, start with a good plan and adjust it as needed.

The last thing to remember when marketing grains is basis. Because sorghum isn’t traded on a futures exchange, basis is particularly important. Basis is the difference between the local cash price and the futures price, and RP doesn’t protect the risk associated with this difference. Use historical basis data for your area to manage this risk and keep in mind basis usually falls at harvest.

Be especially mindful of this phenomenon if you’re a sorghum producer. Without the liquidity a futures contract provides, sorghum basis moves are often far more pronounced than corn basis moves. Look at this as an opportunity — similar to futures and options. Sure, a wide negative harvest basis is a risk. But spring basis often drives cash prices to their yearly highs, creating huge opportunities for producers who don’t mind putting grain in a bin or a bag.

Without knowing costs, implementing a marketing plan is next to impossible. Next month we’ll talk about tracking costs. Sorghum has a big advantage in the cost department, so it should be fun.

Chris's columns appear in Kansas Farmer magazine monthly. You can view this column published in the online edition here.