Commodity markets are emerging from the worst two-year stretch of volatility ever, and the boom-and-bust markets have caused many feed companies to change the way they look at price swings and manage through them.

Traditionally, many in the industry purchased their needs on a deferred basis following seasonal price variations and using the spot market to fill in. Industry participants would typically contract their needs when prices hit their harvest lows. Then they banked on the price appreciation that typically occurred into February when the South American crops were harvested.

In a less volatile market, the strategy served them well. But the industry has changed.

New set of rules

Suddenly and without much warning in late 2006, corn and soybean prices began to trend higher. They didn’t stop until corn topped $7.50/bu. and soybeans broke $16/bu. in mid 2008.

Strong demand for corn from ethanol plants along with a weak U.S. dollar that boosted exports of not only grains and oilseeds but also livestock products, in part, fueled the upward trajectory. Speculation also played a role. Then the bottom fell out as a worldwide financial crisis and the worst global recession since the Great Depression took hold.

“Who would have thought that corn prices would follow crude oil higher,” says Mike Horn, president of Pennfield Corp., Lancaster, Pa. But that’s what happened. In July 2008, oil hit a record high above $147/barrel, dragging corn right along with it.

“If war breaks out between Middle Eastern countries, oil could run up again. We are no longer just a domestic industry,” Horn notes. “It’s a world industry. What happens in China can certainly affect us. I’ve seen a change in this entire industry. The risk will be greater for companies such as ours. World events are out of our control.”

Alice Fowler, president of Stillwater Milling Company, Stillwater, Okla., and her purchasing manager Dan Hubbard used to buy six-month contracts in the fall of each year. When prices dipped in February, they’d buy another set of six-month contracts. That worked well for the company until prices began to unravel from their unprecedented highs of 2008.

“We do so much of our purchasing on a deferred basis that it was tough to stay ahead of the volatility,” says Hubbard.

Chart: Corn, soybean prices turned volatile in 2008-09 

It soon became clear to Fowler and Hubbard that outside speculators and markets were influencing grain and oilseed prices.

“We were very conscious that a price bubble had developed and that it was waiting to burst,” says Fowler. “It just came more quickly and sooner than we anticipated.”

New price patterns

While both managing through the boom and bust were challenging, feed industry sources generally agree that the bursting of the bubble was most difficult and that the industry can no longer bank on traditional seasonal price patterns.

“That cycle no longer exists because of all the different players in the market,” says Jim Moore, vice president of the feed division of Southern States, a cooperative based in Richmond, Va., that serves 300,000 members.

The co-op’s fiscal year 2009—from July 2008 through June 2009—was more difficult than fiscal year 2008, when prices were still on the rise.

“We entered fiscal year 2009 with high prices, and in certain areas, all-time high prices, knowing that the bubble had to burst,” says Moore. “Southern States began to address that issue and manage for it starting in May 2008. Direction was given by upper management to prepare ourselves for what was coming. What we didn’t anticipate was an economic meltdown.”

With prices at or near record highs, conflicting signals began to develop indicating that the boom wouldn’t last.

“Holding up the market were the financial fundamentals,” says Moore. “People were trading more volume than the supply market could produce. Speculation can only carry you so far. Sooner or later you have to have a real seller and a real buyer. So we prepared for a difficult time.”

The co-op began to cut unnecessary expenses and overall managed its business more tightly to ensure it would not have to respond in a knee-jerk fashion to what it knew would be coming: the worst commodities bust on record.

Managing risk strategically

Moore says there is one cardinal rule when managing through price volatility: Make sure you don’t take a risk you can’t survive in case it turns bad. It’s all about risk management.

Southern States has long employed a sophisticated hedging program, which includes swaps, futures, options, and deferred contracts. That didn’t change during the volatility.

Feed companies are relying more on outside sources while soliciting the opinions of in-house managers.

“We have gotten more conservative and I have more people looking over my shoulder and that’s not necessarily a bad thing,” says Hubbard.

Stillwater is now seeking more input—directly from its customers. As one of the largest feed manufacturers in central Oklahoma, Stillwater works with mostly stocker cattle and cow-calf operations.

“We likened last winter to a perfect storm,” says Fowler. “The winter was mild. Pastures were good. Our producers fed less due to the mild winter and they fed less due to high prices.” And cattle prices were down, so Stillwater’s customers also cut back due to lower demand caused by the economic fallout.

For 2010 planning purposes, Hubbard and Fowler have asked their sales force to find out what their customers need and want.

“Producers are telling us they want to lock in a price,” says Hubbard. The company does enough volume that it can’t buy more than 25% of its needs on the spot market, so it will continue to work with deferred contracts and then lock in the end user.

Never contract 100%

Jerry Everson, feed division supervisor with Countryside Cooperative in Durand, Wis., managed through the volatility of the past couple of years pretty much the same way that he has always handled the co-op’s purchasing—conservatively. “Most of the time, if I have a contract with a farmer, I’ll go back to back, for example, if a guy wants a load a month for the next year, I’ll buy a forward contract and not do anything in futures,” Everson explains. “The farmer is happy and I’m happy. I’ve done it for years. I’m not a speculator.”

Everson also leaves himself open to the spot market to take advantage of price dips. “I never contract 100%. If my needs are for 20 loads a month, I will not buy the whole 20 loads.”