Grain Industry Must Evolve, Adjust to a New Market Paradigm: Maintaining Strong Capital Base Critical for Country Elevators
DiPofi, Phil, Rural Cooperatives
It's no secret that the U.S. grain industry has undergone radical changes over the past two years. Prices for corn, soybeans began climbing steeply in the fourth quarter of 2006 and climbed steadily to near historic highs earlier this year. Strong international demand, a persistently weak dollar, biofuels production and capital from institutional investors all played a key role in that remarkable run-up.
More recently, with the sudden onset of the global credit crisis and a strengthening dollar, grain prices have dropped sharply once again. Though they still remain well above historic norms, the latest downward swing further illustrates the volatile shifts that have come to punctuate the current commodities market. Traditionally, it has been rare to see corn prices move by much more than 50 cents over the course of a growing season. Today, price swings of more than $1.50 per bushel in a single month have occurred. The same dynamic holds true for wheat and soybeans.
Obviously, no one can predict the future with certainty. But it seems the reality is that we have entered an era in which significant volatility is now the market norm for grains. It's also time for the grain industry--in particular the country grain elevator--to evolve in order to remain appropriate for this new business paradigm.
Many country elevators--a linchpin of the U.S. grain handling and grain marketing system--experienced financial stress during the run-up in grain prices due to the huge new working capital requirements of their businesses. Much of that stress related to hedging positions taken in the futures market to mitigate price risk. In fact hedging, the very tool used to reduce price risk, has in some circumstances become a risk itself due to soaring capital requirements created by large and frequent price swings in the futures market and resulting margin calls.
In today's volatile markets, hedging has become extraordinarily capital intensive and is one of the primary drivers behind the increased demand for debt capital on the part of grain elevators and agricultural businesses in general.
At CoBank, one of the largest financiers of grain in the country, we have seen dramatically increased borrowing needs for virtually all of our grain customers during the climb of grain prices. We and other financial institutions, both inside and outside the Farm Credit System, have worked to accommodate these customers during this unprecedented time and will continue to do so.
But credit is not an unlimited resource--especially in the current economic environment. And borrowing more, without a commensurate increase in earnings and equity capital, is not a long-term solution to this problem. In our view, the grain industry needs to make two key adjustments going forward:
1. A new approach to price-risk management--Historically, the lion's share of hedging risk in the system has been borne by the country elevator. Elevators, furthermore, have often been willing to contract to purchase crops for multi-year time periods--agreeing to purchase grains at a specific price even before crops were planted. Elevators have used the futures market to hedge against potential price drops in the market. More recently, country elevators have continued to bear the majority of the cost of these price-risk management programs.
But what was an acceptable business practice for elevators in the days of $2-a-bushel corn is proving far less workable when prices soar.
No one party in the grain industry should assume the financial burdens associated with protecting prices for another level in the system. …