Risk Management: (in business) the forecasting and evaluation of financial risks together with the identification of procedures to avoid or minimize their impact.
Let's examine the annual price volatility in the corn market over the past decade. In this study, when we discuss volatility, we are measuring monthly average prices. We are using USDA monthly average corn prices received by U.S. farmers. We identify both the highest and lowest monthly average prices, followed by the average price for the entire marketing year. Next, we take the difference from the highest monthly price from the lowest monthly price for the year, which is then divided by the marketing year average price received from U.S. farmers for corn. This gives us an annual percent volatility in the corn market. In the chart 1, you can observe the annual volatility in the corn market going back to the 1976 marketing year. We had a marketing year record low volatility of 8% 2016/17, and a high of 63% in 1987/88. The average annual volatility over the period is 28%.
Why is understanding price volatility important for a producer of commodities?
Let's run this scenario on 500 acres of corn production in Northwest Iowa. We will assume 200 bushels-per-acre yield. That would give us 100,000 bushels of production, which would amount to $238,000 in revenue volatility during the 2010/11 marketing year. That crop year, we experienced a marketing year high price of $6.88 per bushel and a low of $4.08. This same operation would have experienced $27,000 of revenue volatility in 2016/17, of which we had a marketing year high of $3.49 per bushel and a low of $3.22. In chart 2 and 3 below I've identified the last 10 years annual revenue and price volatility on 100,000 bushels of corn production. Recall, this value is from the price range for the year, derived from average monthly prices.
As a producer of a commodity product in which you have no pricing leverage, it is crucial to understand the importance of pricing opportunities and the impact they have on the revenue of your operation. The average high/low price range per bushel over the 10 years was $1.28 per bushel. This amounts to $128,000 of annual revenue opportunity for the average 500-acre corn operation.
Do you have a risk management process in place to capitalize on volatility?