By David Bau, Extension Educator, University of Minnesota
In dry years, livestock producers are exposed to increasing feed costs. Concurrently, liquidation from producers who have run out of feed--or who are reducing livestock numbers to match feed supplies--can cause prices for the finished product to go lower. What can livestock producers do in a dry year to protect against higher feed costs and less than profitable market prices?
Producers should constantly monitor their cost of production for their livestock enterprise. If the markets allow a producer to lock in a profit on the future contracts, they should do it. They still are exposed to varying local basis and quality premiums or discounts.
If the producer raises their own feed, they should still account for the current feed costs when looking at locking a profitable price for the finished commodity.
Locking in feed supplies and costs can also give producers some assurance in a dry year. If hay prices are going up, look at reducing the hay use in rations. Also look at locking in the hay supply required to get through the year as soon as possible because in dry/short crop years, hay prices will continue to rise as supply shrinks. Farmers should examine feed rations to determine if there are less expensive alternatives.
If a producer is using corn in their rations, and they have locked in a final profitable finished market price, they should also purchase the required corn supplies either on the futures board or with forward contracts with local elevators. If they are planning to raise the corn on their fields, what can they do when the drought conditions lower yields significantly? These producers can buy a call option on the December contract on a percent of the crop they are concerned they might not produce. Even in the last major drought of 1988, Minnesota yields were about half the normal year's yield, so farmers should be confident if they purchased calls on half of their normal corn production.
The producer needs to treat the cost of these calls as price insurance on the feed supply. So if the drought is severe and corn prices increase significantly, the call option's value will increase in a parallel fashion and the producer will be able to purchase the higher-priced corn with the profits from the call option. In 2012, the corn price increase of $3.50 in June and July with call options in place, a farmer would have profits on the call option that could be used to purchase the higher priced corn. Producers who utilize soybean meal could buy call options on November soybeans and have the same price insurance.
Farmers should try to source the physical crop in advance from the elevator, feed mill, or neighboring farmer.
Livestock producers could consider decreasing livestock numbers, culling less profitable livestock heavily, and weaning calves early. Producers should work with a vet and nutritionist to determine the lowest cost ration that will ensure optimal health and growth.