Volatile Crop Prices Causing ‘Heartburn’ for Farmers

April 30, 2008

WASHINGTON (Apr. 30, 2008)—With the farm community’s attention focused squarely on finishing the farm bill deliberations, little notice was paid to an important meeting held at the Commodity Futures Trading Commission (CFTC) last week.

Bart Chilton, a CFTC Commissioner, said of the meeting to examine the impact of crop prices on farmers, “Commodity prices are at all-time highs. So one would think producers would be doing well. But there’s heartburn in the heartland.”

At the meeting, more than two dozen ag groups explained that this heartburn is caused by the volatility of current farm markets, which has made it much harder to properly plan for the future.

Wild price fluctuations are common in farming, which is why forward contracting in the futures market is so important. But farmers are having a much harder time locking in prices given today’s unique environment.

The Wall Street Journal first reported on the situation a month ago and explained it this way: “A fault line is emerging in the U.S. farm economy, as rising grain prices and the credit crunch combine to squeeze grain elevators, a crucial business link between farmers and markets.”

Farmers who want to manage their risks can lock in prices by entering into contracts with grain elevators to sell grains that may not be available until a harvest that’s a year or more down the road. These elevators then manage their risk by entering into futures market contracts to sell the grain once it is harvested.

If the futures market price for a specific delivery period, such as wheat for delivery in September 2009, rises above the price that the elevator has covered in an open futures contract, the elevator is required to put up additional money in the form of a “margin call.” As futures prices have sky-rocketed, the elevators have seen their credit lines shrink because of the need to commit more capital to cover these margin calls.

Without enough cash on hand, or the ability to borrow from lenders still reeling from the subprime mortgage collapse, some elevators have folded. Others are lessening the financial burden by limiting the ability of the farmers to forward contract for grains not currently under production.

“Because of the credit crunch, and the many factors involved in the futures market, producers are limited in being able to price 2009 crops,” said Jerry McReynolds, a wheat farmer in Woodston, Kan. “Available credit is a big concern and many elevators are not offering 2009 pricing. Additionally, much of the 2008 crop was priced before the advancement in prices and the input side of our business is out of control.”

Credit problems and high commodity prices aren’t the only factors contributing to the commodity market bubble. Wall Street may be partially at fault, according to MF Global, the world’s leading broker for exchange-traded futures and options. In a recent company report, the firm explained that crop futures contracts have evolved into more than just a risk management tool for producers.

“[G]rain futures contracts for some have become investment securities—not hedging instruments that offset either cash inventories or future usage,” the research paper read.

For farmers like McReynolds there’s not much comfort in being caught in the middle of fickle Wall Street investors and the country’s credit woes.

He just hopes the lawmakers involved in the pending farm bill are paying close attention to the current situation. A new long-term farm bill could go a long way to giving rural America a much needed confidence boost, he contends.

“The farm bill is critical for producers during this time,” he said.