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

Managing Agricultural Risk Michael Swanson Ph.D. Wells Fargo Ag Industries July 2011

Easy to confuse Dangerous when confused Wells Fargo Ag Industries - 2

Is Agricultural Risk Rising?  Yes  Quantifiably  Qualitatively  Emotionally  Drivers  Interconnected markets  Policy  Implications Wells Fargo Ag Industries - 3

Not a physical constant Daily percent price volatility CME corn 200 300 0.16 0.14 150 0.2 Proportion per Bar Proportion per Bar 0.12 200 0.10 Count Count 100 0.08 0.1 0.06 100 50 0.04 0.02 0 0.00 0 0.0 -0.10 -0.05 0.00 0.05 0.10 -0.10 -0.05 0.00 0.05 0.10 NEW OLD 2007 to 2002 to Daily Percentage Change in CME nearby corn contract June 2011 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 Wells Fargo Ag Industries - 4

Everything is connected … Malting Barley Price $14 $/cwt in MT $13 $12 $11 $10 $9 $8 $7 $6 $5 USDA, Wells Fargo $4 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Wells Fargo Ag Industries - 5

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 Wells Fargo Ag Industries - 6

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 Wells Fargo Ag Industries - 7

Why now? The Drivers Wells Fargo Ag Industries - 8

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 Wells Fargo Ag Industries - 9

A bad forecast China: Real Per Capita Income $12,000 $10,000 $8,000 $6,000 $4,000 $2,000 $0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Wells Fargo Ag Industries - 10

Look at the impact already China Agricultural Imports 70 Millions of metric tons 60 Grain 50 Oilseed 40 30 20 10 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: USDA FAS, Wells Fargo Ag Industries Wells Fargo Ag Industries - 11

What if they want to eat meat? Kgs. Commodity Meat, Poultry, Meat, Beef Swine Meat, and Veal Country Broiler Grand Total (KG) 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 Wells Fargo Ag Industries - 12 China 4.2 37.2 9.2 50.6

A razor sharp two-edged sword The Value of Agricultural Exports Relative to Farm Gate Revenue 45% 40% 35% 30% 25% Source: Wells Fargo Ag Industries 20% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 11F Wells Fargo Ag Industries - 13

What if China stumbles? China: Real Per Capita Income YOY Pct Chg 15% 10% 5% 0% -5% 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030 Wells Fargo Ag Industries - 14 Source: USDA

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 Wells Fargo Ag Industries - 15

Biofuels inside the US US Domestic Grain Usage 70% Feed 60% 50% FSI 40% 30% 20% Exports 10% 1969/1970 1974/1975 1979/1980 1984/1985 1989/1990 1994/1995 1999/2000 2004/2005 2009/2010 Wells Fargo Ag Industries - 16

Ag payments are now routed thru transportation Government Payments 14 Billions of dollars 12 VEETC Pmts Total ag direct pmts 10 8 6 4 2 - 2003 2004 2005 2006 2007 2008 2009 2010 2011E 2012E Wells Fargo Ag Industries - 17

What are the implications Different sector different tools Wells Fargo Ag Industries - 18 18

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 Wells Fargo Ag Industries - 19

Are the tools important? Risk Tool Pro Con Hedge To Arrive No margin funding required Locked into single delivery point Cost established upfront Limits ability to negotiate Delivery point established at better basis sale “Rolling” risks Local connection Hard to evaluate counter- party risk Typically more expensive Futures Accounts Liquidity Margining required Transparency Harder to manage emotionally due to constant Options trading possible repricing No counter-party risk Can become speculative Open on basis and delivery instead risk managing Open on basis and delivery Over the Counter No margin funding required Open on basis and delivery Cost established upfront Dodd-Frank act reduces number of parties willing to Known counter-party risk enter swap Counter parties typically stronger financial institutions Open on basis and delivery Wells Fargo Ag Industries - 20

Livestock – It depends on who you are 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  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 Wells Fargo Ag Industries - 21

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 Wells Fargo Ag Industries - 22