Ways To Manage Energy Costs

By Kris Versdahl

High fuel prices hit crop input budgets hard this year. And with energy prices that seem to rise and fall with every move by OPEC (which announced in mid summer that it would cut crude oil production by 4%) the volatility of the energy market will likely continue.

So, what can producers do to help manage their energy costs?

According to Randy Martinson of Progressive Ag Marketing, Fargo, ND, producers should consider the use of call options to lock in lower prices. “Energy options work the same as grain options do,” says Martinson. “For example, if you were to purchase a 75-cent call option on heating oil and the price rallies to $1, you’d make the 25-cent difference.  Likewise, if the price drops, you benefit from the lower fuel price on your farm.” 

The biggest drawback to using options in the energy market, however, is the large size of the contract.  “Heating oil contracts (the contract that is used to price diesel fuel) are sold in 42,000 gallon increments,” says Martinson, “and most growers don’t need nearly that much fuel each year.” 

Instead, Martinson suggests that growers work together to purchase energy options. “While a single grower probably can’t justify a 42,000 gallon contract, put five or ten guys together and it becomes a little more realistic.”

Betsy Jensen, ag commodity instructor, Northland Community and Technical College, says natural gas and heating oil futures are traded on the New York Mercantile Exchange.  Natural gas futures are approximately 75% of the costs for nitrogen fertilizer, and heating oil futures relate closely to diesel fuel prices.

She agrees with Martinson that it would only be feasible for very large farmers or groups of farms to hedge energy costs.  “You do have the opportunity to hedge your costs, but the bad news is the contract size.  These futures are not intended for a 2,000 acre farmer, but Northwest Airlines probably hedges their jet fuel using heating oil. The heating oil contract is 42,000 gallons or 100 barrels, and natural gas is 10,000 million BTU’s.   The initial margin required per contract is $4,050, and you’ll have to add to that if the market moves against you,” she says. “A few marketing groups have pooled together to hedge their energy costs because the contracts are just too big for an individual farmer. This is great opportunity for members of marketing group to work together to lock in energy costs.”

CENEX Harvest States Offers Energy Contracts
You might also consider one of CENEX Harvest States energy contract programs.  Herb Spinler with Mid-Valley Co-op in Crookston says they offer two contracts to their patrons: A fixed-price contract, and a cap contract.

The fixed price contract allows producers to lock in a price for a specific number of gallons for up to three months.  Producers pay a small fee for the service, which is currently 1 cent per gallon per month.

The cap contract is the same as a fixed price contract in that it limits your upside price risk. However, if prices fall, you also reap the benefit of lower prices.  The cost for the cap contract is currently 8 cents per gallon, which can fluctuate as prices change.

“Both of these programs are fairly new,” says Spinler. “We had several growers take advantage of the cap contract this spring, and it paid off, saving them around 13 cents a gallon for their fuel.”

Lock in Lower Propane for Fall Drying
Mike Lockhart, a farmer and NCTC farm business management instructor from Ulen, MN, says mid-to-late summer is a good time to lock in prices for propane for grain drying needs.  “Late summer, when heating demand is the lowest, is typically when we see the most favorable propane prices,” says Lockhart. “Last year, the low was around 85 cents a gallon, and we should be approaching that level fairly soon.” He suggests working with your local co-op to lock in your propane price.  “Most will require that you pay for this service up front, but it’s usually well worth it when you see prices for propane start to climb again in the fall,” he says.

Jensen agrees that it’s smart to consult with your local co-op about energy pricing alternatives.  “When you sell your grain, you can use your elevator just the same as you use the futures market. The same is true for energy futures. Your local cooperative or oil company may be able to help you minimize your risks,” she says.