The stench of fear in the wheat industry

At this writing, some Oklahoma and Texas elevators are offering to forward contract wheat for a minus 75 cents basis the Kansas City Board of Trade July wheat futures contract price. The KCBT July wheat contract price is $11.40, and wheat may be forward contracted for $10.65.

With wheat prices above $10, you would expect producers and elevator managers to be feeling good about the wheat market. What I have observed is that many are scared, worried or some other adjective that means, “They just do not know what to expect, and what happens may not be good.”

Fear comes from the fact that Oklahoma producers have had three below-average crops in a row and two total disasters. Texas producers have experienced two disasters out of the last three crops and are facing a potential disaster this year. Three out of the last four Kansas wheat crops have been below average and two were disasters.

Crop insurance and disaster payments may cover part of producers' lost income. Elevators, however, have no government help. They depend on wheat bushels (volume) to make money and the bushels have not been there.

Producers are experiencing high prices for both inputs and wheat. It costs at least twice as much per acre to produce wheat compared to two years ago. Producers must borrow more operating capital or invest more savings to produce a crop and if something happens to the crop, their savings and equity disappear relatively fast.

Elevators and farm supply stores must borrow more to buy higher priced inputs for producers to use. This necessity adds risk and drives up operating expenses. Inputs on the shelf or in the warehouse tie up operating capital, and interest must be paid on the unpaid loans.

Producers are concerned about the high prices. Given the experience of the last three or four years, producers are afraid to forward contract or hedge too much production. Producers that hedged wheat last fall and early winter, when the KCBT July wheat contract was about $7, have made margin call payments of $25,000 per contract.

Many producers “rolled over” 2007, $4.50, forward contracts to 2008. These producers will deliver $8 to $10 wheat for $4.50.

Elevators have the “rolled over” contracts hedged with KCBT July 2008 contracts at about $5. The elevators borrowed money to make $35,000 margin call payments for each 5,000-bushel contract. One Oklahoma local elevator obtained a $10,000,000 line of credit one week and in three days had paid nearly $5.5 million in margin calls. Interest costs are adding financial stress.

Elevator managers are afraid that producers will be unable to deliver forward contacted wheat. After 2007, elevator managers will be less likely to “roll over” any forward contacts.

Producers are afraid that wheat prices will decline between now and harvest. If they do not price wheat now, they may have to sell it for $2 to $3 less. Even if the wheat price is $7 or $8, $2 is important.

Elevator managers must obtain operating loans that are two to two-and-one-half times larger than three years ago. Managers use a line of credit to pay producers for the wheat for which it may take the elevator 30 days to receive payment. Nine-dollar wheat requires significantly more credit and results in higher interest costs.

Markets are volatile. From the time a producer sells wheat until the elevator can get it sold, the market price may change dramatically. Some elevators may be establishing a policy to buy wheat only when the KCBT commodity exchange is trading contracts, which is between 9:30 a.m. and 1:15 p.m.

Higher prices come with new opportunities and higher risks. Not discussed is the stress on lenders of extending the larger loans and taking more risk. With higher risks comes the opportunity for higher returns.

The wheat industry will adapt. More attention to detail is required. Producers must concentrate on producing and delivering high quality wheat and managing their finances.

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