How do you manage your price risk? Is it a case of prices are high so why bother? Is it a case of selling cash when prices drop? Or do you actually forward contract, and use the futures and options market? And just out of curiosity, does the fact of guaranteed farm program payments replace the need for managing your price risk? Revealing questions and embarrassing answers! We’re playing hardball today.

A research study by University of Missouri economists Andrea Woolverton and Mike Sykuta looks at the role of farm programs in your actual price risk management strategy decision. If agricultural price support programs do create incentives against managing price risk, how will your risk management practices change with the absence of farm programs? Will you be forced into unknown territory, or just pushed to work a little harder and smarter?

Before your spouse has to alert the local cardiac unit, farm programs will not be going away this week, and probably not in the 2007 Farm Bill. However, with diminished funds available for farm program payments and the World Trade Organization ready to dismantle many of our current farm programs, expect significant changes in coming years. Just how much do we avoid managing price risk? (Quite a bit!)
• Anecdotally, forward contracting use is often argued to be substituted by grain producers for traditional hedging via futures contracts.
• In 2003, it is reported that approximately 36 percent of all U.S. commercial farms (sales of $250,000 and above) used marketing contracts in 2003 with 22.5 percent of production value under contract.
• United States corn value produced under forward marketing contracts was 13.8 percent in 2003.
• According to these numbers, most U.S. producers are not forward marketing as a price risk management strategy.

When the Loan Deficiency Payment program came along, farmers learned how to pick the bottom of the market to claim their LDP payment, but avoided the options market that would have created similar revenue with puts, according to Woolverton and Sykuta, “When program commodity prices are low, LDPs and crop revenue insurance substitute for hedging.”

After interviewing about 100 producers in the US and in another country where farm supports are non-existent, the researchers found US farm programs appear to impact the likelihood to lock-in prices primarily when corn prices are low relative to the posted county price (PCP). Many US producers indicated the presence of the loan deficiency program (LDP) allowed them “to be more bullish and gamble in a low market.” Little incentive exists to actively market at prices $1.80-$2.40 according to producer discussion. In addition, the direct payment “adds the profit margin” to many producers' income statements.

Farmers who were not receiving any price supports used risk management tools to lock in profits on larger percentages of corn yields than US producers. The researchers said the US farmers made more pricing decisions relative to the Posted County Price than to the entire range of potential prices. They said price risk strategies were lacking when the corn price was close to the Posted County Price.

Summary:
US farmers have not been significant users of futures, options, or many of the good price risk management tools that exist. Instead of being unaware of them or uncertain about how to employ them, it seems that farm programs such as Loan Deficiency Payments and crop revenue insurance have replaced farmers’ needs to manage price risk.