Should Hog Producers Hedge Their Homegrown Corn?

Corn grown on the farm first carries a production cost: seed, fertilizer, fuel, machinery, labour, drying and storage. But that cost alone does not capture its true impact on the hog operation’s margin.

Corn fed to hogs also has a market value. By using it on the farm, the business forgoes the revenue it could have earned by selling it. That value, adjusted for local basis, transportation and quality, represents its opportunity cost—and it is this figure, rather than the production cost, that should be included in the cost of producing pork.

Conversely, if the harvest falls short, the business will have to purchase the missing volume. In that case, the replacement price matters. The economic cost of corn therefore depends on whether it is grown, consumed, sold or purchased.

Growing your own corn reduces the need for outside purchases. It does not remove your exposure to the market.

Does an integrated producer face the same risk as a corn producer?

No—and this is where much of the reasoning goes off track.

A specialized crop producer seeks to protect the sale value of the harvest against falling prices. The producer’s natural position is long corn, and the exposure is to a price decline.

A hog producer who converts homegrown corn into meat is neither long nor short: the position is roughly neutral. A rise in corn prices increases the value of the harvest, but it also increases, by the same amount, the opportunity cost of the grain fed to the hogs. The two effects offset each other at the business level.

This is why Agrintel favours its Agrégat Porc approach: shifting the focus from prices to margins. Optimizing the price of hogs, corn and other inputs separately regularly leads to decisions that benefit one part of the operation while hurting the business as a whole.

What volume is actually exposed?

The focus should be on the net exposed position—expected production minus herd consumption—over a given period.

Consider a farm with 120 hectares of corn and a herd that consumes approximately 1,150 tonnes a year:

• At an average yield of 10.5 t/ha, it produces 1,260 tonnes. Net position: a surplus of 110 tonnes, barely 9% of production. It is a small net seller.
• At 12 t/ha—a good year—it produces 1,440 tonnes. The surplus rises to 290 tonnes. It is a substantial net seller.
• At 8.5 t/ha—a difficult year—it produces 1,020 tonnes. It now faces a shortfall of 130 tonnes and must buy corn. It is a net buyer.

Three years, three positions, including two in opposite directions. A business that is “self-sufficient on average” is almost never exactly self-sufficient in any given year.

In which direction does the risk lie?

This is the question most often overlooked, and it changes the choice of hedging instrument.

The scenario that really hurts an integrated producer is a poor harvest combined with high prices. These two conditions occur together more often than chance would suggest: when yields are poor across a broad area, market prices rise. The business then has to cover its shortfall at the worst possible time, just as feed costs soar.

Selling futures contracts would have made matters worse in this scenario. The business would have lost money on its short position while its purchase costs were rising.

In other words, the integrated producer’s risk is asymmetric, so the instrument should be too. This points toward buying call options on the volume at risk of a shortfall: a premium known upfront, a ceiling on replacement costs, and no loss if the market falls. This is a fundamentally different approach from that of a grain producer who sells a percentage of the physical crop.

The expected surplus beyond the herd’s needs can be treated like any other grain and sold. But we are talking about the 110 tonnes in the example, not the full 1,260.

The point almost everyone overlooks: cash

A grain producer who hedges and then sees the market rise faces margin calls. This is unpleasant, but temporary: the producer will eventually deliver the physical grain at a higher price, bringing cash back into the business.

The integrated business, however, never sells its corn.

If it sells futures contracts and the market rises, it must post actual cash margin within days, without any physical grain sale to replenish liquidity. The offsetting benefit does exist, but it materializes as a more favourable feed cost, spread over twelve months within the cost of producing pork.

The scale of this exposure deserves attention. A Chicago corn futures contract covers 5,000 bushels, or approximately 127 tonnes. A move of US$0.50 per bushel represents US$2,500 per contract, which must be posted as the market moves. With three or four contracts and a volatile market, the business can face an unbudgeted working capital requirement.

Before recommending a position to an integrated business, one very practical question must therefore be answered: where will the money for margin calls come from, and how long can the business fund them without compromising its other obligations? A technically sound hedge that must be liquidated at the worst possible moment because of a cash shortage is a hedge that cost money without ever providing protection.

For this specific reason, over-the-counter contracts with a buyer or feed mill that do not require margin calls deserve serious consideration alongside exchange-traded instruments.

What about the interaction with ASRA?

A Quebec hog operation participating in ASRA receives compensation based on a production cost model that includes feed costs.

To the extent that this model reflects rising grain prices, the program already covers part of the input risk. Adding a hedge on top may therefore mean protecting against the same risk twice—and paying for that protection twice.

This is not an argument for doing nothing. It is a factor to verify, based on the business’s specific circumstances and the model parameters in effect, before determining the size of a position.

Three figures to establish before structuring your position

Before entering the markets or discussing options with business partners, an integrated hog operation should be able to provide three figures:

• Its projected net position in tonnes: expected production minus expected herd consumption, including whether the result is positive or negative. The relevant figure is the difference, not total production.
• Its sensitivity to yields: what happens to that net position when yields are 15% higher or lower, and whether the position changes sign across scenarios.
• Its capacity to meet margin calls: how much cash it can post, and for how many months, without drawing on its operating line of credit.

Corn grown and consumed on the farm never changes ownership, but it still carries a very real economic cost. The right question is therefore: what combination of prices, applied to what genuinely exposed volume, and supported by what financial resources, will protect a satisfactory margin for my business as a whole?

This is precisely the analytical work that Agrégat Porc enables.

In our next article, we will examine a common situation: what happens when grain production and hog farming operate as separate sister companies?

This publication provides general information. Any hedging strategy must be tailored to the business’s volumes, financial obligations and risk tolerance.