Farmers prepare for higher fuel costs

Cattle Market & Farm Reports, Editorials
Jun 27, 2008
by DTN

Farmers prepare for higher fuel costs

Central Iowa corn and soybean farmer Charles Helland usually waits until closer to fall before securing his fuel needs for the season, but this year he’s planning to firm up fuel needs in the next week or so.

"In the past, fuel costs haven’t varied that much from the beginning of summer to the end, so it wasn’t much of an issue,"" said Helland, who farms with his brother Mike near Huxley, IA. "But in these markets, who knows how high the price of diesel will be come fall?"

Early-bird buying isn’t the only new habit for farmers. Helland also has been adding fuel storage so that he can time his fuel purchases and store all his needs.

"We had two 1,000-gallon tanks and we added another 1,000-gallon tank a couple years ago. We also have a 500-gallon portable tank and two other 500-gallon tanks at other locations," Helland said.

However, adding storage isn’t the answer for all growers.

"We’ve seen producers increase from 500- to 1,000-gallon tanks and also replace old tanks for environmental reasons or to protect their investment," said Kevin Lange with Heartland Co-op Energy in West Des Moines, IA. "But for the average farmer, with all the containment and fire marshal regulations, to increase to over 1,000 gallons of storage is usually not cost effective."

That can be true even for large producers.

"Our goal was to have enough fuel storage to be able to buy a semi load of fuel at a time. But that didn’t work in some locations," said Gregg Halverson, CEO of Black Gold, a chip potato producer based in Grand Forks, ND.

"We farm in 10 states, and each one has different environmental rules and regulations. You might end up spending a dollar to save a penny," he said. "We looked into installing bigger fuel tanks at one farm in Indiana, but once you get above a certain size, containment and set-back regulations can be cost-prohibitive. It would have cost us $150,000 in containments and set-backs to add more fuel storage at that farm. We said, ‘Forget it.’"

The price of fuel has caused us to rethink our business model, Halverson said.

"Now, we’re evaluating production sites as to how close they are to terminal use as opposed to looking at the most perfect production site with the best soils, and rainfall or irrigation."

Brett Crosby, a cow/calf and irrigated sugar beet, malt barley producer in Cowley, WY, is looking at a more creative risk-management solution for his fuel costs. He has invested in the Deutsche Bank Oil (DBO) index fund and is working with Kansas State ag economics professor Kevin Dhuyvetter to see how closely that fund tracks diesel fuel.

"For most farm operations, selling a regular heating oil futures contract is not an option because one contract is equivalent to 42,000 gallons of diesel fuel. Most farmers have about 1,000 to 2,000 gallons of fuel storage," Crosby said.

"Right now, DBO tracks very well with the price of oil. For every dollar that oil has gone up, DBO shares have increased 37 cents. One share of DBO is equivalent to 11 gallons of diesel fuel," Crosby said. "If farm operations are worried about how to protect against rising fuel costs and need 1,000 to 2,000 gallons, they could buy 100 to 200 shares of DBO. The advantage is producers can buy in small increments and they don’t buy on margin."

DBO shares currently are trading around $50 per share.

On caveat is that "the fund is not accurate enough as a hedge for a move of 10 to 30 cents per gallon for diesel, but it can hedge a producer against a move of $1 or $2 per gallon," Crosby said.

"I’ve hedged my fuel needs with DBO shares only to a small extent," he said. "And I haven’t advised anyone else to invest because I want to make sure there are not pitfalls out there in which the fund wouldn’t track well with oil prices. Right now it looks like a solid hedging tool. You can buy the shares with any brokerage. I have an Ameritrade account and it took 30 seconds to fill my order. I bought DBO shares a couple of months ago. Obviously, I’m looking brilliant now. But we’ll see what happens when the market gets more volatile."

Cash buyers face the risk that energy prices could go substantially higher, but the possibility that crude oil could plunge below $120 or even $100 a barrel over the next few months is slim, pointed out Phyllis Nystrom, energy department manager of Country Hedging, a subsidiary of co-op giant CHS. She recommends that farmers and dealers manage some of their fuel risk by exploring the use of over-the-counter options or something like Country Hedging’s CHI Compass capped-average contract, which establishes a maximum price.

High premiums for those products have discouraged farm operators from taking advantage of those offerings in the past, she said during a June 17 DTN webinar on the topic. But considering the extreme volatility in the market today, some operators may want to rethink that objection.

The Energy Information Agency forecasts that cash diesel prices alone could run $4.72 per gallon, up almost $2 per gallon from their 2007 average this summer. If such wide price fluctuations continue, the premiums for put options could be inexpensive insurance.

Many farmers uncomfortable with over-the-counter options still use forward pricing as their main risk management tool for fuel.

"We’re seeing a normal amount of forward contracting," said Mike Derickson with CHS. "Some producers are unsettled by the high price levels, so they’re buying as needed. For the most part, we’ve seen stable forward contracting in the past two years. Fuel prices are usually highest in the spring when refineries are taken down for maintenance, but there tends to be a dip in prices in the early summer," Derickson said.

Unfortunately, that Memorial Day-early June dip of 18 percent to 20 percent has yet to materialize this year.

"I tell my producers, since it’s hard to predict what will happen, the best thing to do in today’s economic environment is to keep your barrels full, forward contract some of your fuel needs and stay open on some of your needs," advised Heartland’s Lange.

Randy Hertz of Hertz Farm Management in Nevada, IA, added that it is good risk management to have some fuel in inventory, but you also need to protect yourself against theft.

"You have to put a lock on your fuel tank or have a switch inside the shop that turns on the pump. You also have to guard against inventory slippage from unauthorized use, such as by teenagers, neighbors or anyone else. The main thing is to make it inconvenient for people to steal your fuel," Hertz said.

"Fuel still ranks under fertilizer, seed and rent costs, but when you go through a more than 4,000 gallons and diesel is over $4 per gallon, we try to not pay any more than we have to," said Iowa farmer Helland. — DTN