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Tuesday, May 24, 2011

Are You Doing All You Can To Manage Fertilizer Price Risk?

Whether fertilizer prices are going up or down, frustrations mount for Cornbelt Farmers.  If they are going up, it is hard to budget a moving target.  If they are going down, it is inevitable that your fertilizer was booked at higher price levels.  And with overall production costs high and profitability very slim, dollars can easily be lost on a commodity as important as fertilizer.  So what do you do?

The fertilizer that you depend on to grow crops is a complicated commodity.  It is complicated by the fact that the domestic fertilizer industry has declined, and most of the fertilizer that you are using comes from international sources.  At that point, Cornbelt farmers and their neighbors and their local suppliers are subject to the dynamics of foreign companies, governments, weather, trade restrictions, exchange values, and any number of other frustrations.  Those dynamics can create great price volatility, such as was seen in 2007 and 2008, says Phil Kenkel of Oklahoma State University in his recommendations for Managing Fertilizer Price Risk. He says those rapid price changes were caused by structural changes in the US fertilizer industry, including a growing reliance on imported production.

For a Cornbelt Farmer, fertilizer costs are second only to cash rents.  OSU’s Kenkel says fertilizer makes up 30% of wheat production costs, 20% for sorghum, and 40% for corn.  He notes, “If fertilizer price volatility could be completely eliminated the result would be roughly two/thirds as effective as eliminating yield variability in terms of overall risk reduction.”  He says in the past fertilizer prices generally moved in tandem with commodity prices, but now the global dynamics can make fertilizer prices high when commodity prices are low, increasing profit vulnerability.

To address the problem, Kenkel recommends managing price risk in fertilizer, but readily acknowledges that either futures or over the counter derivative alternatives are limited, for both the farmer and his local supplier.  The only futures exchange traded fertilizer is in Switzerland with 5,000 ton contracts, which is more than you or your local supplier wants to hedge.  And he says the basis risk can be substantial.  Subsequently, Kenkel says the choices are limited to forward contracting or pre-purchase.

For the supplier, Kenkel reports, “Because much of the U.S. fertilizer supply is imported, retailers must buy six to nine months in advance with no opportunity to hedge. This exposes the dealer to the risk that they will inventory product only to have prices fall during the application season and be forced to drop prices to meet those of competing suppliers.”  As a result, many dealers have opted for a pre-purchase deposit to lock in prices, a practice that many farmers compare to becoming the banker for the fertilizer dealer.

Kenkel and Oklahoma State have been studying fertilizer price trends for 17 years and have charted the dates for best and worst times to book fertilizer, and how much prices typically change from one period to the next.  He says the optimal purchase date is the 1st week in July for Urea, the 2nd week in November for UAN, and the 1st week in November for DAP.  March and April are the worst times to purchase fertilizer.  He says, “The intuition behind these results is straightforward. Fertilizer prices, like crop prices, respond to supply and demand conditions. However, because of the lengthy supply chain, fertilizer availability and price during peak application periods is a function of the dealer’s accuracy in forecasting and pre-positioning product.”  To help yourself even further, Kenkel says consideration of a pre-purchase agreement should also consider tax and cash flow consequences, along with the financial stability of the fertilizer dealer.

Kenkel offers some other suggestions which are primarily applicable to producers outside of the heart of the Cornbelt, including shifting to other cropping patterns that require less fertilizer, as well as forms of the various products.  He suggests looking at the price of the nitrogen component, in urea, relative to UAN, which typically has a 1.45 price ratio.  While that is the average ratio, it has varied from 1.02 to 1.83.  By watching such comparisons and having application flexibility, a producer can switch from one to another depending on the value of the nitrogen, “Disadvantage of this method include the
inability to gauge the crop potential at the time of application and the possibility of nitrogen loss.”

Kenkel also suggests shifting the application from one year to the next, but says that philosophy varies across nutrients with the management of P & K for build up or drawdown, and nitrogen has to be balanced with crop needs.  He also says underfertilizing could be recommended when the fertilizer-grain price ratio is higher than usual, a time when he says a crop consultant can sometimes come in handy.

Summary:
Variability in fertilizer prices is due to the dynamics of the global market because fertilizer is a product that is produced in the global market and responds to it.  Farmers can take advantage of forward contracting or pre-purchase agreements with local dealers in an effort to lock in prices.  Other alternatives include changing cropping patterns, changing the type of fertilizer applied, and more closely monitoring soil tests for needs.

Posted by Stu Ellis on 05/24 at 12:00 AM | Permalink

Comments

Posted by: Pinny Sternshos at October 22, 2011 4:04AM

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