ENERGY RISK MANAGEMENT CONSIDERATIONS

John Robinson Texas Cooperative Extension

Context of higher energy prices Hearings & calls for government policy

interventionOn-farm risk mgmt. steps

Evaluate the risk exposure Identify alternative strategies including hedging possibilities

Evaluate the cost of each alternative (i.e., is it a good insurance buy?)

Identify public & private resources to implement alternatives

Available Public Resources

Extension crop budgets, energy crop profiles, and detailed machinery analysis, e.g,

U. Florida series, http://www.agen.ufl.edu/~fees/pubs/agcrop.htmlPurdue publication analyzing tillage systems http://www.agcom.purdue.edu/AgCom/Pubs/NCR/NCR-202.html

Extension info. on energy saving tips, bmp’s, and new technology

USDA-ERS & OCE analysis of energy fundamentals/Ag impacts

Help Producers Size Up Their Situation: Energy Inventory

Source: Florida Energy Extension Service: http://www.agen.ufl.edu/~fees/pubs/agcrop.html

Evaluate Risk Exposure: Total Energy Use in Btu’s Do an inventory of total energy use with a Btu

Conversion Chart Gasoline 125,000 Btu’s/gal Diesel fuel 138,690 Btu’s/gal LP gas 98,300 Btu’s/gal Nat. gas 1,030 Btu’s/ft3

Electricity 3,413 Btu’s/kwh Nitrogen 55.21M Btu’s/ton Phosphate 12.34M Btu’s/ton Potash 10.43M Btu’s/ton Pesticides 215.41M Btu’s/ton Source: ERS

Evaluate Risk Exposure: Input Energy Use in DFE’s

Urea, solid 0.233 gal/lb 28% N liquid 0.229 gal/lb NH4NO3, solid0.248 gal/lb NH4NO3, sol’n0.225 gal/lb Anh. Ammonia 0.177 gal/lb

Total N for typical corn 26.6 gal DFE/ac Machinery fuel (conv. til.) 5.0 gal DFE/ac Machinery fuel (no. til.) 1.8 gal DFE/ac Herbicides (conv. til.) 1.7 gal DFE/ac Herbicides (no. til.) 2.9 gal DFE/ac

Source: http://www.agcom.purdue.edu/AgCom/Pubs/NCR/NCR-202.html

Evaluating Risk Exposure: Sensitivity Analysis

Repfarm analysis of higher natural gas prices and crop prices on irrigated farms: “Effects of Energy and commodity Prices on Irrigation in the Kansas High Plains (SRP611)

http://www.oznet.ksu.edu/ library/engy2/samplers/srp611.htm

Agric. Energy Risk Management Alternatives

Technology ApproachesReduced TillageProper equipment selection, R&MSubstitution away from crops with higher nitrogen requirements

Purchase and storage of fuel Forward contracting and/or hedging

input costs with energy futures/options

Available Private Resources for Contracting Alternatives

Trading consultants and brokers

Energy hedging consultants NYMEX exchange information Agricultural Cooperatives

Theory & Practice of Agric. Energy Hedging Correlation of fuel and fertilizer prices

with NYMEX futuresNatural Gas (very actively traded)

Also a proxy for anhydrous ammoniaHome Heating Oil (for diesel fuel)Propane

Whole new set of fundamentals and seasonality considerations

Scale Considerations

Contract Information NYMEX Natural Gas

Futures: 10,000 million Btu’sOct. ‘01 Futures: $2.103/mmBtuAt-the-money call: $0.080/mmBtu, or about $800 premium for one contract

NYMEX No. 2 Fuel OilOne Futures Contract: 42,000 gallonsOct. ‘01 Futures: $0.7087/galAt-the-money call: $0.024/gal, or $1,008 premium for one contract

On-Farm Energy Hedging Considerations

What is the impact of a 2X or 3X or 4X rise in natural gas or diesel price?

Is the impact of this risk significant relative to other risks that need managing?

Is hedging nat. gas or heating oil futures realistic in terms of type and scale of the enterprise?

Is it feasible in terms of correlation between futures and farm-gate energy prices?

What to hedging alternatives cost? Are they a good insurance buy?

Example: Diesel Fuel for Delta Cotton Operation

Typical Delta operation with conv. tillage uses 18.3 gallons of diesel per acre, or over $20 per acre.

Need 2,300 acres to match the size of one No. 2 heating oil contract

An Oct. ‘01 at-the-money call on NYMEX No. 2 Heating Oil futures costs about $0.44 per acre

Questions: How well does this contract track on-farm fuel prices, and what basis are we facing?

Example: Hedging Nitrogen costs

Typical Delta operation uses 400 lbs of N32 per acre, or $37 per acre.

Need 2,300 acres to match the size of one No. 2 heating oil contract

An Oct. ‘01 at-the-money call on NYMEX No. 2 Heating Oil futures costs about $0.44 per acre

Questions: How well does this contract track on-farm prices, and what basis are we facing?