How "long" are you already in this young 2011 crop marketing year? It's only two weeks into April and planting has barely begun in Iowa, but that's a key question Steve Griffin is posing to farmers. Griffin is a West Des Moines-based risk management consultant and crop insurance expert.
With soaring and volatile prices for corn and other crops, a farmer's position in the market is an important place to manage risk and capture profits. With record prices as markets bid for acres, it is tempting to cash in a "long" position. Yet, overselling your new crop and being "short" is also a very speculative proposition, particularly if prices would continue rise. You are "long" in the market if you have product to sell and "short" if you have already sold more than you have for future delivery.
Traditionally, farmers consider themselves to be "long" in the market only when the crop is safely in the bin, notes Griffin. Bare forward contracting production is taking a big financial risk if something happens to reduce expected yields during the growing season.
However, one of the benefits of revenue crop insurance (without the harvest price option excluded) is the guarantee of a percentage of crop even before harvest, he explains. In essence, crop insurance establishes a long position well before the crop is harvestable and, at a reduced level, even before it is planted. If the crop is lost (due to insurable causes) the insurance will most likely cover financially the replacement cost of the shortage on a forward contract.
The long position established by crop insurance has two parts
The long position established by crop insurance comes in two phases, says Griffin, who offers the following explanation.
First, the policy guarantees a portion of the crop prior to planting, commonly know as prevented planting (PP) coverage. If planting is prevented and such conditions are general in the area, then coverage is provided on so-called eligible acres. Eligible acres are the maximum acreage planted to the prevented crop in the last four years.
Thus, coverage is not provided necessarily on all of the acres you intended to plant, but only the highest proportion of your acreage (if you have added acres). So, the extra acres you wanted to plant corn again this year (out of rotation) may not be covered for PP. The standard coverage for PP is 60% of the unit guarantee; buy-ups to 65% and 70% have to be requested at or before sales closing date.
For example, a 160 bushel Actual Production History approved yield times a 75% coverage level times a 60% PP coverage (160 bushels x 0.75 x 0.60) equals a preplant guarantee of 72 bushels per eligible acre. If this farmer is not expanding his corn acreage, his net position is long 72 bushels times his intended planted acres.
* The second phase comes when the crop is planted prior to final planting date. Continuing the above example, the net position grows to 120 bushels times his planted acres (including added acres) at planting.
The revenue policy includes downside price protection, so this net long position is price protected (not the bushels above the guarantee). As Kansas State University economist, Dr. Art Barnaby, has suggested, the market places a value on this price protection. Therefore, as the net long position is reduced by forward contracting at a fixed price, a farmer could resell for a cash premium this unused price protection as an out-of-the-money put option (market novices beware), lowering the net crop insurance expense.
Bottom-line: Revenue crop insurance facilitates year-round forward marketing of a crop in two phases, preplant and plant. A marketing plan of scheduled sales during the growing season, even prior to planting, and after harvest may not hit the market peak but it will also not entirely miss a great pricing opportunity. Knowing your market position is key to managing your risk.
Steven C. Griffin, AFIS, is a crop insurance consultant and expert witness in crop insurance disputes between farmers and their crop insurance companies and crop insurance companies and USDA's Risk Management Agency. Griffin can be contacted through his website at www.aggiexpert.com and is based in West Des Moines, Iowa.