Farmers could have avoided hog price disaster by hedging

Whoever survives this present tsunami of losses in the hog industry has no excuse to not hedge most of their hog production in the future.

In the cruel Darwinian reality of business, only the hedgers are likely to survive this profitability collapse anyway, so that advice will be useful only to the lucky producers who aren’t hedged now and yet somehow manage to limp through until next spring, when profitability should return.

The sad reality of the present crisis is that it could have been almost entirely avoided. Farmers can hedge both feedgrain purchase prices and hog sales prices. They can use cash contracts, futures contracts, options contracts and a wide array of tools to protect their margins well into the future.

Most of the time, farmers can lock in profitable prices for spring and summer, break-even prices for the winter and slight losses for fall. This is a pattern that has lasted decades.

That means farmers can generally ensure a profitable business year after year by diligently locking in their feedgrain and market hog sales prices each time they take on a future risk, such as breeding sows or buying a barn full of feeder hogs.

Because of the four-year hog cycle, one year will usually be very profitable, one slightly loss-making and two modestly profitable. The result should be a profit over the four year cycle.

Risk management professionals all know this, and it’s what they tell their clients. Yet many clients don’t listen, or only listen to bits of the advice.

A broker told me last week that it’s a hard sell trying to get farmers to lock in hog-feedgrain spreads that guarantee losses. That makes sense on one hand, with losses not being good for business.

But the point of risk management is to avoid exactly what we’re experiencing now: catastrophic losses that destroy your business.

Back in the first days of June, farmers could lock in December hog futures at $80 per hundredweight, $5.25 per bushel corn and $12.75 per bu. soybeans. Contracts for other fall month contracts were similar. Similar spreads were available with Canadian cash hog and feedgrain prices.

December hogs are now about $75.40, corn about $7.44 and soybeans $16.10.

Locking in the prices in June would have led to a modest loss in the fourth quarter, a period when profits are hardest to generate and when catastrophic collapses are most likely.

However, a lot of producers can’t bring themselves to lock in a loss, even for a short period, so they leave themselves open to the kind of disaster many are now experiencing.

Everyone should have a lot of sympathy for the many producers who tried to hedge themselves, only to find that their risk management tools had failed.

That was true in 2008-09, when many sleazy American feeder barn operators reneged on weanling contracts when prices fell. Farmers thought they were hedged but ended up completely exposed. There is no futures contract for weanling pigs, so farmers either have to cross-hedge with slaughter hog futures or rely on cash contracts. Alas, these are far from perfect and leave them more exposed to risk than farrow-to-finish or feeder barn operators.

We should also have much sympathy for anxious farmers who have hedged some, but not all, of their production.

Another hog risk management specialist told me he recommends farmers lock in prices for 80 to 90 percent of their future production, but farmers are leery about going beyond 50 to 60 percent.

Farmers are understandably concerned that their production might fall short of their expectations, so they don’t want to be over-hedged. However, being shy of coverage creates situations like now, where you have 50 percent hedged but the remaining 50 percent is costing $50 losses per pig for months.

We should have a lot of respect for producers who hedge themselves by being well-diversified farms.

That’s true of most Hutterite colonies, where a large crop base supports and supplies the hog barn. This year, big profits from the crops will offset big losses on the hogs. The value of the grain they feed might be less than what they could get if they sold it, but in exchange for a reduction in grain profit they get a sustainable hog operation.

This kind of hedging doesn’t work when you get hit with drought, which is why so many Midwest American farmers are in crisis. Diversification does not give you a hedge when you don’t have the grain.

However, for any farmers who don’t hedge at all, even after the disasters of 1998-99 and 2008-09, we can have sympathy for the human situation of being caught in crisis, but less for their situation as business operators.

Most of them probably won’t be around by next spring, and the lucky few non-hedgers who survive had better learn their lesson or they’ll be devastated in the next fourth-quarter slump we experience.

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