Corn and soybean prices reached all time highs during the summer of 2012, caused by the devastating drought in the Midwest.
During such periods, producers will increase production to cash in on the high prices. The increased production will result in additional products sold in the world marketplace which will reduce demand for the products and depress prices for producers.
In times of high prices, it becomes profitable for producers to plant crops on marginal crop land, which further increases harvested bushels. Consequently, the potential for larger supplies of corn and soybeans available in the marketplace will put downward pressure on prices and profit margins, if 2013 is a normal crop year.
Many producers are reluctant to forward contract part of their 2013 corn and soybean crops during December 2012 because they are not sure of 2013 input costs.
Research at Virginia Tech shows that to produce 150 bushels of corn per acre will require 165 pounds of nitrogen, 86 pounds of phosphate and 57 pounds of potash.
Using late November 2012 fertilizer prices and corn seed price of $200 per bag and fertilizer input costs ($215), these costs make up about 45 percent of total production costs to produce 150 bushels per acre yield.
In addition, soybeans require 52 pounds of phosphate and 91 pounds of potash to yield 50 bushels per acre.
With soybean seed currently priced at $20 per bag of seed and these fertilizer inputs priced at $90 per acre, these items are approximately 39 percent of total production costs to grow 50 bushel soybeans.
Thus seed and fertilize costs make up a significant part of total production costs.
In late November 2012, fertilizer dealers in Virginia were projecting that 2013 prices will be comparable to 2012 prices with one major caveat.
The 2012 drought has significantly reduced water levels on the Mississippi River where barges are major transporters of fertilizer to dealers in the Midwest. If water levels remain low in the next three months, it is highly likely the Mississippi River will be closed to barges from St. Louis to the Gulf of Mexico.
Consequently, fertilizer will be delivered by rail and trucks. This will increase transportation costs and significantly increase the odds that shortages may occur because the fertilizer will not be delivered to dealers on a timely basis.
Thus, shortages are a likely outcome and prices will increase because supplies will be diverted to regions with the largest demand.
In today’s volatile fertilizer markets, dealers have indicated it is difficult to lock in prices for more than one or two weeks. Therefore, it is advantageous for producers to buy and store fertilizer on their farms in order to avoid potential price increases and shortages and seasonal prices that go up during planting season.
Many farms have tanks that are used to store liquid nitrogen and fertilizer. In addition, some farms have built machinery sheds that have concrete floors which were constructed with vapor barriers that prevent moisture from reaching the surface of the concrete floor.
Purchasing and taking possession of the fertilizer inputs will allow producers to lock in part of their fertilizer costs for 2013.
Crop insurance can be used to help cover production costs in the event that yields are reduced by drought or adverse weather conditions. Revenue crop insurance can be used to lock in prices that generate profits.
Likewise, during a drought year, revenue crop insurance can help a producer fulfill the financial obligations of a forward contract when the producer is unable to deliver bushels needed to fulfill the contract.
I strongly encourage producers to work with their crop insurance agents to determine the levels of crop insurance and revenue crop insurance that are needed to lock in profits and meet the financial obligation of the forward contracts in the event that a drought occurs in 2013.
The profits generated by forward contracting 2013 corn and soybean crops and locking in fertilizer costs will be significantly greater than the opportunity (interest) costs of purchasing inputs several months before planting.
Likewise, the price of the tarps that are used to cover machinery that was parked in the machinery shed will be a minor investment compared to the savings in fertilizer prices that will be generated by purchasing and storing fertilizer in the machinery shed!
In an era of highly cyclical and volatile grain and fertilizer markets, producers in December 2012 have an excellent opportunity to consider ways to limit risk and stabilize some of their production costs in 2013.
Producers should look for ways to reduce the uncertainty of spot markets for input and develop a plan to reduce risk with insurance.