By: Rob Wolter
Over the last number of years, many executives and managers in the food space have done well by essentially employing a “do nothing” approach when it comes to hedging their price risk in food commodities. They’ve done this by simply keeping an eye on heavy supply forecasts and waiting for deferred prices to drop as consumption months approach.
“Doing nothing” to establish your forward prices is doing something in the sense that you are willing to accept where the market is at when your consumption month approaches. Doing nothing works when you expect prices to grind lower. The consequential question today is: Can this price pattern continue to be counted on or is price activity changing & increased volatility around the corner?
“Doing nothing” or implementing the same approach that’s served you well the past five years, is worth taking a hard look at now.
Two big reasons: Weather and trading volatility.
Back in January, no one was forecasting the drought Argentina experienced. Then, Brazil’s Safrina corn crop experienced its own drought. The net result has been unanticipated drops in forecast production for corn and soybeans in South America. And, the larger net result has been strong trade out of other major corn- and soybean-producing countries like the United States.
At the tail end of the growing season in the Southern Hemisphere, the attention now turns to growing conditions in North America. Recent forecasts are calling for the lowest acreage for U.S. corn planted acreage in more than a decade.
The need to achieve an average to above-average corn yield has escalated. Without a normal growing season, the U.S. has the potential to maintain the trajectory towards tighter global corn supplies. If corn tightens, more acres will be required for corn to reload supplies. These corn acres will be in competition with acres going to wheat, soybeans, and other crops.
Bottom line: Weather has always mattered in the food commodity business. We all know the potential impacts droughts, floods and other weather events can have on crops. But, this year weather might just matter a little more.
So, how can you start rethinking your food commodity hedging approach—especially leaving the biggest food event of the year in Kansas City?
For starters, consider shifting your mindset—from “doing nothing” to being more active. Now, that’s not easy. In fact, we wrote about the emotions of dealing with “bad trades”. The emotional component can keep a lot of people from making these kinds of tough decisions. But keep in mind, “doing nothing” is still a decision. And, it’s still a risk.
I’d also encourage you to consider that you can have price protection AND the opportunity for improvement in your margins and profits. People do it every day. Should your approach to managing risk in a potentially higher volatility environment be different than a low volatility one? No one wants to lock in prices at levels that would negate the chance for year-over-year savings. That said, you don’t want to have costs get any worse than they are already forecasted to be either. It’s a real dilemma, with real dollars and cents on the line.
On top of it all, can you really count on passing on all the increases to your end customers? The case for upside protection with the opportunity for downside participation is strong today. It’s time to dust off those old strategies and challenge the strategies employed for the past five years.