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The drought and farm finances
How to deal with crop insurance, futures and hedging
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Watching what the heat and lack of rain are doing to a farmer’s crops is difficult enough.

Farmers also have the stress of wondering what the drought will do to their finances.

Two of the speakers at the producer drought forum at First National Bank in Platteville Friday covered topics difficult to figure out given uncertain weather the rest of the growing season — crop insurance and pricing contracts.

“Most of you probably insure your corn as grain,” said Everett Hooks of Great American Insurance Co. If corn is used as an alternative use, such as silage, it must be appraised, and “right now, that’s going to be a challenge.”

One of those challenges will be determining losses based on the variability of damage to corn in fields.

The standard for appraisal is based on inspecting one 10-foot-wide strip in the first 10 acres of a field, and one 10-foot-wide strip per 40 acres after that. The term “field” is defined by its artificial boundaries — bodies of water and roads, to name the two most common — which are not necessarily the landowner’s definition of a field’s boundaries.

“A lot of them are going to be small, a lot of them are going to be short, and when we pick them by hand you have to decide is the combine going to take this ear or is the combine not going to take this ear?” said Hooks.

The UW experts in corn and soybeans at the meeting say the next week is critical to determining the viability of crops after half a dry summer.

“If it stays dry, in a few weeks we’ll probably be able to go out and zero them out — there is no production here,” said Hooks, who said he is getting “50 or 60 calls a day” from southern Wisconsin. “As long as the corn is green and has some potential, we can’t zero them out.”

Farmers can replant in a barren field, but it won’t be covered under crop insurance unless the harvest will take place next year for such crops as winter wheat or alfalfa that won’t be harvested in the fall, Hooks said. Farmers can also plant a cover crop and plow it under and choose to not harvest it next year.

The drought, which extends far beyond southwest Wisconsin, has had a predictable upward effect on prices.

“We’ve had a market that’s responded to peril … the lack of rain throughout the country the past few weeks,” said Mike North of First Capitol Ag in Platteville. “Real buyers of corn have stepped away from the market right now,” and “speculation is very high right now.”

At the end of Friday, corn was at $7.9575 per bushel, up 2.22 percent from the previous day. Corn was at $5.68 per bushel this spring.

North said farmers could get into the futures market, but futures “can be a very risky proposition.” He gave an example from 1988, when corn prices went from $2.20 per bushel to $3.70 per bushel — an increase of 68 percent — within a few weeks, before dropping to $2.65 per bushel a few weeks later, a drop of 40 percent from the high price.

“Corn’s not going to stay at $8 [per bushel], just like it hasn’t in the past,” he said.

North said a “very legitimate strategy” was a $7-per-bushel put option. In a put option, the buyer has the right, but not the obligation, to sell the asset at the agreed-upon price by a specified date; the seller has the obligation to buy if the buyer of the put wants to sell. A $7 put option costs 30 cents per bushel, he said.

High prices now are likely to mean high prices in 2013 as well.

“A rising tide lifts all boats. … prices are in pretty decent territory” for next year, said North.

Milk prices have been on an upward swing after bottoming out at $15.24 per 100 pounds for Class I milk in June. August Class I milk was priced at $16.55 per hundredweight late Friday.

Milk futures have gone even higher, to $18 to $19 per hundredweight, even though they should be around $16 to $17 per hundredweight, said North.

“It’s difficult to justify some of the prices we’re looking at,” he said. “We have said to all our clients to not pay much attention until the third quarter for 2013. There’s an abundant supply of product right now, and we’ve seen a tremendous premium for domestic prices against the world market right now.”

Another option is a “hedge to arrive,” or “futures fixed,” contract, where the futures price is determined when the contract is created, but the basis level is determined later, usually just before delivery of the grain for which the contract is sold. The basis widens when the price goes up, as now, with “real buyers leaving” and “speculators coming in,” said North.

North said commodity basis levels are now negative, which reduces the price of the contract — a contract for $7.90 with a 45-cent basis would net $7.45 — but could go positive if the drought continues, increasing the price of the contract.

“Really, we’re in a waiting game right now,” he said.

The drought will have a negative effect on livestock farmers if the drought continues.

“You’re going to see livestock guys pay for feed what they really shouldn’t pay for feed,” said North.

Commodity prices could also have an upward effect on farmland rental prices for next year, he added.