The Hindu Business Line : Life on an American farm

Even in economies such as the US where farms are large and mechanised, and their owners take recourse to sophisticated marketing and hedging mechanisms while being beneficiaries of gratuitous government support, agriculture is far from being a risk-free enterprise.

The Schillings on their 1,300-acre farm.

Harish Damodaran

Rodney Schilling is one of those typical farmers one would encounter in Midwestern US — hard-working, friendly and straightforward. The 53-year-old, fourth-generation agriculturist operates 1,300 acres of land in Okawville, a village in Washington County, Illinois with less than 1,500 people. The entire 1,300 acres is worked by Mr Schilling himself along with his still-active 81-year-old father.

The Schillings engage no farmhands. Instead, they have three John Deere tractors of 160 to 365 horsepower range and a harvester combine, fitted with Global Positioning Systems (GPS) and controller-driven application equipment that track all corners of the field and enable more accurate placement of seeds, fertilisers and chemicals. The farm also has a workshop for undertaking repairs of machinery.

Reaping what he sows

Mr Schilling plants corn (maize) around mid-April, followed by soyabean a month later, and harvests the two from between mid-September and early-October. Wheat sowing happens almost immediately after that; the latest ‘no-till’ drill technologies permit effective seeding of wheat, even on freshly harvested soya or cornfields containing residual plant stalks. Unlike in India, wheat here is a long duration crop harvested only towards the second and third weeks of June — the reason being the severe intervening winter that sets in a period of dormancy.

The Schillings annually produce 70,000-odd bushels of corn, 23,000 bushels of soyabean and 20,000 bushels of wheat, which, at today’s prices, would gross well over $750,000 (one bushel equals 25.4 kg of corn and 27.216 kg of wheat and soyabean). The harvested produce is stored in their in-house farm silo that has a capacity of 50,000 bushels. If the prices are good, the grain ready for marketing is taken by Mr Schilling in his truck to the nearby Top Ag Co-operative elevator that can stock up to a million bushels.

The co-operative, jointly owned by farmers of the area, also supplies them fertilisers, seeds, chemicals and animal-feed in addition to housing a feed mill and a lumber yard. The grain from the Top Ag elevator is further hauled about 40 miles to the Mississippi River, from where it is loaded onto barges owned by the likes of Cargill and Archer Daniels Midland, before being dispatched to the New Orleans Port for shipping to world markets.

Crop hedging

Mr Schilling regularly hedges himself against adverse crop price movements. Even while his crop is in the field, he ‘locks’ in the prevailing price by selling a futures contract of the corresponding quantity for that price at the Chicago Board of Trade (CBOT).

In the event of prices falling during harvest time, the loss incurred in the cash market (where the crop is physically sold) is offset by gains on the futures position (as the futures contract sold initially at the higher price is subsequently bought and liquidated at a lower price). Besides, Mr Schilling has insurance protection, covering 75 per cent of losses due to either yields or prices turning out below federally guaranteed levels. This is a revenue assurance programme, under which the Federal Crop Insurance Corporation bears 55 per cent of the premiums payable.

Business risks

But it’s not a bed of roses all the way. Farming is a tough job the world over, the US being no exception. Only 16 per cent of all its harvested cropland is irrigated, which is less than the 40 per cent for India! The Schillings’ farm is 100 per cent rain-fed, linking their fortunes to the vagaries of the weather. While federal insurance and other support programmes provide substantial cover against drought, floods, frost or hail, they do not, however, guarantee prosperity.

The Schillings also voice the usual complaint that farmers everywhere make — about food prices being maintained artificially low to keep city folk happy. True, grain prices have improved in the last few years, but so have the cost of fertilisers and other inputs. As Mr Schilling puts it, “Ours is the only business where you buy everything in retail and sell in wholesale”.

Tracking the futures

Compounding this cynicism has been the recent not-so-sanguine experience with commodity futures. Hedging, in principle, presupposes that prices in the cash (spot) market and the derivatives (futures) market move in tandem; they track each other close enough so that the risk of a loss in the cash market is reduced by taking an opposite position in the futures market. That does not mean prices are always identical.

The spot price of corn on May 15 may not be same as what its November futures contract is quoting on the same day (since the latter is the price for corn to be delivered not on May 15, but at a future date in November). However, as the expiration date approaches — when the corn covering the futures contract is due for delivery — the latter’s price ought to very nearly match the price in the cash market (after allowing for freight costs to the specified futures contract delivery points).

If futures prices rule higher than cash prices, any smart trader would buy corn physically and simultaneously sell futures and make delivery. Likewise, when prices in the cash market are higher, corn consumers will buy futures and take delivery, forcing convergence of the two rates.

Of late though, the tendency has been for American farmers to be short-changed, with cash prices of wheat, for instance, being around $2 a bushel (Rs 3.40 a kg) below the corresponding CBOT futures rates even at the time of expiry. The major factor behind this has been the influx of index funds, pension plans and hedge funds into the commodities futures segment over the last three-four years.

These institutional investors — unlike millers, bread makers, grain wholesalers and others with direct stakes in the underlying commodity — have no particular interest in taking delivery.

For them, commodities represent an ‘asset class’ no different from equities, bonds or currencies. In the recent past, the funds have followed a uniform strategy of going ‘long’ on commodities — buying futures for a particular month and rolling over their positions to another contract month prior to the delivery period.

In the process, futures prices of most agri-commodities have been incessantly driven up, with the so-called fundamental factors (dry weather in Australia, diversion of food crop to bio-fuel production, growing Chinese and Indian consumption, etc) only serving as pretexts for pouring in more money and further fuelling bullish sentiments.

The result: With the demand for futures far outstripping demand in physical markets, farmers have found themselves unable to deliver cash wheat against their short contracts, leading to increased divergence between the two prices.

The Wall Street crumble

“The basis (difference between cash and futures prices) at CBOT has become so negative that hedging has lost all meaning. I now take hedging risks only on 30 per cent of my crop,” avers Mr Schilling.

Worse, even this scenario may change with the ongoing troubles in Wall Street that is unleashing an opposite trend of liquidity-strapped investors and speculative funds pulling out money from commodities.

Given that index funds alone were, till recently, holding an estimated 40 per cent of all outstanding commodities futures contracts, the implications of a change in their strategy from long-only to short-selling are obvious.

Increasingly unattractive

What emerges from all this is that even in economies where farms — like those of the Schillings — are large and mechanised, and their owners take recourse to sophisticated marketing and hedging mechanisms while being beneficiaries of gratuitous government support, agriculture is far from being a risk-free enterprise.

On the contrary, the uncertainty in returns for all the hard work it entails — the latest GPS precision farming technologies notwithstanding — has rendered it increasingly unattractive an occupation. Proof of this is the average age of all US farmers, which, according to the last 2002 Agricultural Census, was 55.3 years, with a mere 5.8 per cent of them being below 35 years and 26.2 per cent above 65 years of age.

Three out of Mr Schilling’s four children are unambiguous about not pursuing their ancestral calling. “The youngest one says he’s keen. But then he is only eight and it’s too early to be sure,” notes Mr Schilling, even as his 81-year-old father is busy taking an insurance company surveyor around the farm to show areas where the crop has suffered damage from a recent hailstorm.