Posted by: usset001 | September 29, 2008

Earl Eitheror and a new definition of large carrying charges

Earl Eitheror is one of many celebrity grain producers who I use to illustrate marketing plans and strategies. Earl has on-farm storage. When carrying charges are large after harvest, Earl holds grain in storage and sells the carry. If carrying charges are small, Earl holds unpriced grain in storage for sale the following spring. These two strategies are quite different, but Earl’s simple choice has earned him surprisingly good results over time, in corn, soybeans and spring wheat. You can examine his results, and the results of other celebrity producers since 1990, here.

Earl’s choice after harvest is based on his definition of “large” and “small” carrying charges. From my book, here is Earl’s classification of “large” carry charges at harvest…

  1. December-July corn carry >15 cents (i.e., nearby December contract and next year’s July contract)
  2. November-July soybeans >35 cents
  3. September-March wheat >20 cents

Albert Einstein once said, “Everything should be made as simple as possible, but not simpler.” My current classification of “large” carrying charges slips into the “simpler” (too simple) category for two reasons…

  1. It ignores interest rates and the impact they have on storage costs. Financing $3 corn at 10% interest is more costly than financing $3 corn at 5% interest
  2. It ignores commodity prices. Financing $6 corn at 5% interest is more costly than financing $3 corn at 5% interest.

I like my original, simple definitions, but $6 corn, $12 soybeans and $8 wheat have made them outdated. Let me show you some new definitions for “large” and “small” carrying charges that will be employed by Earl in the future. To get there, I need to do a little math to compare current carrying charges to the cost of financing stocks held in storage.

Step 1: calculate the carrying charge per month

carrying charge / # of months

This analysis can be applied to any commodity and any time frame for storage (Dec-Mar corn, Nov-July soybeans, etc.). On Friday, September 26, Dec’08 corn closed at $5.43 and Jul’09 corn closed at $5.825. Take the $0.395 carry from Dec to Jul and divide by 7 months gives us a carrying charge per month of 5.6 cents.

Step 2: calculate a monthly per bushel interest cost for grain storage

cash grain price * annual interest rate / 12 months per year

What does it cost to finance grain held in storage? Interest is the largest variable on-farm storage cost. The current cash price of corn is $5 and interest rates are about 6%. It currently costs 30 cents per year or 2.5 cents per month to finance corn in storage.

Step 3: compare the size of the carry (Step 1) to interest costs (Step 2)

carrying charge / interest cost

The current carrying charge of 5.6 cents per month easily covers monthly interest costs of 2.5 cents – carrying charges are over 200% of interest costs. To creat a new definition for Earl, I had to ask a couple of questions. Would Earl store grain if the market carry did not cover his interest costs (<100%)? I think the answer is no. So how large should the carry be for a strong incentive to store grain (150%, 200%, 300%, etc.)? I’ve examined this ratio on Earl’s farm since 1990 and I am ready to offer a new definition of “large” carrying charges:

carrying charge / interest cost > 120%

Does this new definition alter past conclusions about Earl’s approach to grain marketing? No it doesn’t, but that is a topic for futures posts.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

Categories

%d bloggers like this: