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ENERGY RISK MANAGEMENT CONSIDERATIONS John Robinson Texas Cooperative Extension

ENERGY RISK MANAGEMENT CONSIDERATIONS John Robinson Texas Cooperative Extension. Context of higher energy prices Hearings & calls for government policy intervention On-farm risk mgmt. steps Evaluate the risk exposure

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ENERGY RISK MANAGEMENT CONSIDERATIONS John Robinson Texas Cooperative Extension

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  1. ENERGY RISK MANAGEMENT CONSIDERATIONSJohn Robinson Texas Cooperative Extension • Context of higher energy prices • Hearings & calls for government policy intervention • On-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

  2. 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.html • Purdue 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

  3. Help Producers Size Up Their Situation: Energy Inventory Source: Florida Energy Extension Service: http://www.agen.ufl.edu/~fees/pubs/agcrop.html

  4. 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

  5. Evaluate Risk Exposure: Input Energy Use in DFE’s • Urea, solid 0.233 gal/lb • 28% N liquid 0.229 gal/lb • NH4NO3, solid 0.248 gal/lb • NH4NO3, sol’n 0.225 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

  6. 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

  7. Agric. Energy Risk Management Alternatives • Technology Approaches • Reduced Tillage • Proper equipment selection, R&M • Substitution away from crops with higher nitrogen requirements • Purchase and storage of fuel • Forward contracting and/or hedging input costs with energy futures/options

  8. Available Private Resources for Contracting Alternatives • Trading consultants and brokers • Energy hedging consultants • NYMEX exchange information • Agricultural Cooperatives

  9. Theory & Practice of Agric. Energy Hedging • Correlation of fuel and fertilizer prices with NYMEX futures • Natural Gas (very actively traded) • Also a proxy for anhydrous ammonia • Home Heating Oil (for diesel fuel) • Propane • Whole new set of fundamentals and seasonality considerations • Scale Considerations

  10. Contract Information • NYMEX Natural Gas • Futures: 10,000 million Btu’s • Oct. ‘01 Futures: $2.103/mmBtu • At-the-money call: $0.080/mmBtu, or about $800 premium for one contract • NYMEX No. 2 Fuel Oil • One Futures Contract: 42,000 gallons • Oct. ‘01 Futures: $0.7087/gal • At-the-money call: $0.024/gal, or $1,008 premium for one contract

  11. 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?

  12. 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?

  13. 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?

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