Managing Agricultural Risk Michael Swanson Ph.D. Wells Fargo Ag - - PowerPoint PPT Presentation

July 2011

Managing Agricultural Risk

Michael Swanson Ph.D. Wells Fargo Ag Industries

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Easy to confuse Dangerous when confused

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Is Agricultural Risk Rising?

 Yes

 Quantifiably  Qualitatively  Emotionally

 Drivers

 Interconnected markets  Policy

 Implications

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Not a physical constant

Daily percent price volatility CME corn

• 0.10
• 0.05

0.00 0.05 0.10

OLD

0.0 0.1 0.2

Proportion per Bar

100 200 300

Count

• 0.10
• 0.05

0.00 0.05 0.10

NEW

0.00 0.02 0.04 0.06 0.08 0.10 0.12 0.14 0.16

Proportion per Bar

50 100 150 200

Count

Daily Percentage Change in CME nearby corn contract

2007 to June 2011 2002 to 2006

N of Cases 1,120 1,120 Minimum

• 7.8%
• 6.5%

Maximum 9.8% 8.4% Range 17.6% 14.9% Median 0.0% 0.0% Arithmetic Mean 0.1% 0.1% Mode 0.0% 0.0% Standard Deviation 2.3% 1.7% Skewness (G1) 0.01 0.70 Kurtosis (G2) 0.81 2.38

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Everything is connected …

Malting Barley Price

$4 $5 $6 $7 $8 $9 $10 $11 $12 $13 $14

Jul-06 Jul-07 Jul-08 Jul-09 Jul-10

USDA, Wells Fargo $/cwt in MT

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Emotions matter in risk management

 Credit decisions

 Probable (when will it happen?)  Possible (could it happen?)

 Fear and Greed  Integrating risk and reward

 Single owner/operator  Multi-party

 Trader or risk manager  Treasury versus operations

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Cohorts

 Old school

 Haven’t financially managed risk  Won’t financially manage risk

 Current Crop

 Selectively managed financial risk  Increasingly managing financial risk

 Next Up

 From the start managed financial risk

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Why now? The Drivers

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An intersection of factors

 Global economic growth

 China moves to the next stage  The US dollar makes US agriculture cheap

 Biofuels policy

 Deliberate  Secondary consequences

 Speculative tools and fools

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A bad forecast

China: Real Per Capita Income

$0 $2,000 $4,000 $6,000 $8,000 $10,000 $12,000 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

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Look at the impact already

China Agricultural Imports

10 20 30 40 50 60 70

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: USDA FAS, Wells Fargo Ag Industries Millions of metric tons

Grain Oilseed

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What if they want to eat meat?

Kgs. Commodity Country Meat, Beef and Veal Meat, Swine (KG) Poultry, Meat, Broiler Grand Total Hong Kong 23.9 67.3 40.1 131.3 United States 39.3 28.6 42.8 110.7 Argentina 61.3 6.5 33.1 100.8 Kuwait 26.6 67.7 94.3 Brazil 37.5 12.5 42.9 92.8 Australia 35.2 22.3 35.2 92.6 Qatar 88.4 88.4 Canada 30.0 24.7 29.7 84.4 United Arab Emirates 16.8 61.1 77.9 EU-27 16.7 43.0 17.8 77.5 Chile 23.1 22.6 30.1 75.7 Belarus 29.6 44.8 74.4 Uruguay 60.3 10.9 71.1 Singapore 6.4 26.9 36.1 69.4 Taiwan 5.6 36.4 26.6 68.5 Mexico 17.4 15.9 29.5 62.8 Korea, South 11.9 31.1 14.7 57.6 Russia 16.7 19.6 21.1 57.4 Kazakhstan 26.8 14.6 13.8 55.1 Switzerland 20.7 33.2 53.9 Venezuela 18.5 4.9 29.9 53.3 Jamaica 5.1 3.3 44.6 53.1 Bahrain 52.5 52.5 China 4.2 37.2 9.2 50.6

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A razor sharp two-edged sword

The Value of Agricultural Exports Relative to Farm Gate Revenue

20% 25% 30% 35% 40% 45%

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 11F

Source: Wells Fargo Ag Industries

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What if China stumbles?

China: Real Per Capita Income

• 5%

0% 5% 10% 15%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

YOY Pct Chg

Source: USDA

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The role of biofuels policy

 How do you get off the tiger?

 Is ethanol policy factored into land?  Can you replace the BTUs and octane?

 What numbers are right?

 Net benefit?  How much growth will there be?

 Follow the money

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Biofuels inside the US

US Domestic Grain Usage

10% 20% 30% 40% 50% 60% 70%

1969/1970 1974/1975 1979/1980 1984/1985 1989/1990 1994/1995 1999/2000 2004/2005 2009/2010

Feed FSI Exports

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Ag payments are now routed thru transportation

Government Payments

• 2

4 6 8 10 12 14 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E

Billions

• f dollars

VEETC Pmts Total ag direct pmts

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18

What are the implications Different sector different tools

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Row crops

 Marketing versus hedging

 Farmers have always been marketers  Hedging is a completely different animal

 Covering both sides simultaneously  Living with limited return

 The seen and the unseen

 Income earned  The risk avoided

 Do they need new tools or new attitudes

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Are the tools important?

Risk Tool Pro Con

Hedge To Arrive

No margin funding required Cost established upfront Delivery point established at sale Local connection Locked into single delivery point Limits ability to negotiate better basis “Rolling” risks Hard to evaluate counter- party risk Typically more expensive

Futures Accounts

Liquidity Transparency Options trading possible No counter-party risk Open on basis and delivery Margining required Harder to manage emotionally due to constant repricing Can become speculative instead risk managing Open on basis and delivery

Over the Counter

No margin funding required Cost established upfront Known counter-party risk Counter parties typically stronger financial institutions Open on basis and delivery Open on basis and delivery Dodd-Frank act reduces number of parties willing to enter swap

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Livestock – It depends on who you are

 Broilers – Looking for further tolling arrangements  Cattle feeders – Generational split

 Small operators with large feed bases still open  Larger operators almost completely hedged

 Hog feeders – increasingly hedged  Dairy – still the wild west of financial risk Key Livestock Risk Factors

Feed

Self supplied Purchased

Replacement animals

Self supplied Purchased

Output price

Open bid Contracted

Technology

Open market Proprietary

Land base

Significant Minor

Permitting

Minor Significant

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Summary

 Agricultural risk is rising

 What creates opportunity increases risk  Prediction versus planning

 Fools believe in their predictions  Management by scenario

 Policy makers have a limited role

 Unintended consequences  Trying to save everyone won’t work