March 15, 2021
Betting on Corn in 2021?
By Brent Gloy
By: Brent Gloy and David Widmar
“Farmers love to plant corn.” It’s one of those sayings you hear a lot, but that never really tells us much. In fact, the comment is often used to explain away a report or estimate that doesn’t line-up with expectations.
While the mantra isn’t insightful, there are economic considerations – associated with operating leverage – that may favor planting corn more than one would normally think, especially in 2021.
Before jumping into corn, let’s start by laying out a scenario that is often thought to favor soybeans over corn.
During financially lean times, we often hear the comment that producers will favor soybeans. A major appeal is that compared to corn, the variable costs of production are considerably lower for soybeans. The 2021 Purdue crop budgets have variable costs at $436 for corn and $249 for soybeans. So even if the budgeted returns were equal, producers would have considerably less money invested in the soybean crop.
The Role of Operating Leverage
The inverse of soybeans’ appeal during lean times provides corn’s advantage in financially good times. This is largely a result of the benefit of the degree of operating leverage, a measure of the percentage change in operating profits relative to the percentage change in revenue. To explain, we’ll start with a simple example and build out a simple simulation to illustrate the different outcomes associated with corn and soybeans:
Given these assumptions, which are based on university budgets and county-level yields, this farmer has a crop budget that favors soybeans by $20 per acre. Case closed? Not so fast.
USDA yield data shows that, in general, there is more variability in corn yields. Specifically, the average departure from the trend for the county-level data used in this example – measured in absolute terms- was 12% for corn but only 8% for soybeans. This means there is more risk – upside and downside – with corn yields.
Corn vs Soybean Margins
Figure 1 shows the distribution of outcomes for the contribution margins of corn and soybeans for the above example. Here, we can see the farmer’s dilemma. The soybean contribution margin (blue line) shows a smaller likelihood of receiving a really low contribution margin. For example, the chance of generating less than $300 per acre is about 20% under corn (red line), but only about 8% for soybeans (blue line).
Figure 1. Distribution of outcomes for the contribution margins of corn and soybeans.
It is quite likely that in tough times, the option that provides the smallest likelihood of losing money would predominate. But on the other hand, soybeans also provide considerably less upside. For example, the chances of receiving over $500 of contribution margin with corn are 25%. Soybeans have only about a 10% chance of producing an outcome that good. In 48% of the observations, or about half the time, corn would generate a larger contribution margin than soybeans, even with soybeans’ “on average” advantage.
When Does It Make Sense to “Bet On Corn”?
The question then becomes: does the farmer feel like betting on the likelihood of receiving a draw from the distribution that favors corn and can generate a really large profit level?
Additionally, when the downside for either crop isn’t that undesirable, the “go for the gold” attitude makes sense. For example, if these distributions were both shifted to the left reflecting lower overall prices for both crops, the downside outcomes would be very undesirable. Thus, the “play it safe” go with soybeans logic would make sense.
Farm Budget Scenarios
Admittedly, most farms aren’t running a Monte Carlo simulation to measure this, but most are certainly intuitively aware of this phenomenon. In fact, it is quite likely the very thinking that led to the “farmers just like to plant corn” and “farmers plant beans when times are tough“ mantras.
This phenomenon – generated by the concept of operating leverage – can be seen in farm budgets if producers create alternative yield scenarios to consider “best-case” or “worst-case” scenarios. What makes operating leverage so powerful in 2021 is that the overall picture points to a profitable environment, particularly with the down-side protection crop insurance will provide. This is to say, the bad outcomes aren’t as likely as they were in recent years with lower prices.
Taken together, the current overall strong financial outlook for both crops and corn’s advantage in high price/yield scenarios sets the stage for corn having more appeal than the price ratios might suggest. This isn’t about corn producers “liking” to plant or harvest corn; it’s about the range of potential returns and the up-side potential of corn.
The Outlook for Corn in 2021
There are several factors that can be used to think about the relative advantage of corn of soybeans. A shortlist of factors would include:
- Soybean/corn price ratio (future prices)
- Relative local cash basis for each geography
- Relative yields in each geography
- Range of possible yield outcomes
- Overall profitability
The idea of operating leverage and “betting on corn” is influenced by all the above factors but is especially relevant when producers consider 1) the range of possible yield outcomes and 2) the overall positive financial environment. When the downside outcomes aren’t that financially devastating or dire, you tend to focus on the upside potential.
Finally, this article doesn’t consider that producers might be able to “manage” corn more intensely than soybeans.
In addition to everything outlined above, some producers might perceive an opportunity to add inputs – timely nitrogen, crop protection passes, etc. – that allow them to push the upward potential on corn yields even more than the above assumptions. Again, this is a consideration that is relevant during a period of overall strong returns and factors into how producers perceive those “best-case” scenarios and potential returns.
Wrapping it Up – A Poker Analogy
In conclusion, an analogy from poker might be helpful.
The soybean to crop price ratio is an important consideration, similar to the cards a poker player has in their hands. For 2021, the crop insurance price ratio favors soybeans slightly more than the last time we observed a roughly even acreage split between corn and soybean.
However, the poker player considers more than just the cards in their hand – their chip count, the size of the bet, etc. Similarly, producers will also be considering the overall economic environment and the potential payout for betting on corn.
One should not ignore that the game is much more favorable in 2021 than in recent years.