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AFTER HURRICANE Katrina battered the Gulf States in August of last year and inflated the nation's energy-related prices, some ag retailers were caught off guard. Growers Co-op, Terre Haute, IN, wasn't one of them.
“Most of our co-op facilities had adequate supplies after Hurricane Katrina,” says Joe Milner, Growers Co-op energy manager. “We always lock in some fuel supplies each month as a hedge for our customers and for our own use, and we had locked in some prior to Hurricane Katrina so that we were able to keep our customers fueled.”
This year, however, unrest in the Middle East has been rattling energy markets even more than the threat of another major hurricane. “World tensions can change rather rapidly and move prices higher,” Milner notes. “With volatility, there is a lot of inherent risk.”
To mitigate that risk, Growers Co-op secures supplies for customers who prefer having a fixed price for fuel. “We lock in some prices for our own use, but mostly we back up our farmer purchases,” Milner says. “We do have some fixed-price customers who like to lock in their prices ahead of time.”
Yet today's skyrocketing energy prices don't necessarily encourage stockpiling. “We're at all-time highs and have been there for quite a while,” Milner says. “I would expect some better price opportunities before the fall. We hate to see anyone locked in at too high a price.”
On the other hand, unexpected events continue to hold fuel prices at exceedingly high levels. “If I base my projections solely on what has happened during the last two years,” Milner says, “I'd say prices will continue to increase.”
Price pattern peaks
Historically, petroleum prices peak about the second or third week of July and fall off gradually through August, September and October, points out Dennis Conley, University of Nebraska — Lincoln agricultural economist. “All energy-related prices move together to some extent, but not completely,” he says. “For heating oil, prices start to go up in the fall and peak in January and February. These prices don't start moving up until cooler weather increases demand. So within the next month might be a good time to book heating oil, at least from a historical basis.”
Growers Co-op customers have been able to purchase fuel online for about three years now, Milner says. “Most of the new customers are people who haven't yet consented to be on our regular, keep-full program,” he says. “The keep-full program is designed for farm and home-heat customers, to keep their tanks full on an as-need basis. Our delivery people have a regular route and make sure that they keep these tanks full.”
However, he adds that “if energy prices continue to climb, we'll probably have more inquiries from our customers to lock in prices.”
Violence in the Middle East is the one wild card that will likely continue to increase energy prices, or at least make energy-related prices difficult to predict, Conley says. “Supply fundamentals aren't typically followed during times of unrest,” he adds. “In these situations, prices are already high and people don't want to buy any more than they have to, because they expect the high prices will work their way back down.”
The general rule of thumb for purchasing during unpredictable times is to just live short term, unless supplies are likely to run short, Conley advises. “Currently, there is little reason to fear a lack of energy supplies,” he says. “For now, energy supplies are coming onto the market and adequately meeting needs.”
Kevin Dhuyvetter, Kansas State University Extension ag economist, agrees. “I wouldn't be too aggressive in locking in prices for either fertilizer or diesel right now,” Dhuyvetter says. “It's awfully tough to outguess the markets.”
In particular, fertilizer prices, which escalated rapidly after Hurricane Katrina, have stabilized and are heading lower (see “Just-in-time fertilizer,” page 4). “We can import urea at a relatively low cost now,” Dhuyvetter says. “The fertilizer industry is doing a good job putting in a lot of warehouses to hold inexpensive, imported fertilizer, and it's getting much better at handling imports overall.”
Wells Fargo & Co. economist Michael Swanson agrees: “The fundamentals for cheaper fertilizer just keep getting better and better. So the replacement costs for fertilizer are going to be lower than they have been.”
Market risk reminders
Still, there are two main reasons to avoid being overly optimistic about energy prices heading lower in the short term, Swanson says. The first reason is the potential disruption that would occur from another large hurricane hitting the Gulf, and the second is escalating instability in major oil-producing countries.
The risk from a hurricane is “a fairly minor risk at this time,” Swanson says. “Last year's hurricane was very unusual. A hurricane of that magnitude hadn't occurred in 40 years. Statistically, another occurrence this year would be extraordinary.”
Middle East flare-ups are more likely than another devastating hurricane, but the market has already factored in much of that risk, he adds. The bottom line is that ag retailers and farmers should continue to make purchases on an as-needed basis for now.
“I don't think that people really want to buy aggressively in this market,” Swanson says. “Why? We're at record prices. When things are high-priced historically, you're better off buying only as much as you need. If stocks were low, I'd be saying something different, but stocks are currently heavy for both crude oil and natural gas.”
Hard as it may be to believe, energy prices are more likely to come down than to go up, Swanson says. “Short-term prices tend to run up and down, but an average price keeps reasserting itself,” he says.
“The conflict in Lebanon was a shock to the market,” he adds. “It's moved everything in the energy market higher except fertilizer.”
Without this shock effect, price increases would occur gradually. “Demand generally grows at a fairly slow rate,” Swanson says. “For example, energy needs in China and India are growing steadily, but that's not a shock. Shocks are sudden and unexpected, and they come from the supply side.”
If another market shock occurs — if the conflict in Lebanon spreads to Syria, Iraq and Iran, for example — “oil prices could easily go up another $20 per barrel,” Swanson says. “So if you're thinking about locking in your fuel supply now, sit down with your balance sheets and budgets and find out where you'd be if you had to pay $90 to $100 per barrel of oil.”
If you can do your budgets as planned at these higher prices and still get by, then you should probably only buy as much as you need now and hope that prices don't increase much or, if they do, that they don't last long, Swanson says. On the other hand, if these potentially higher prices would cause your business a financial disaster, then it would be better to lock in prices now to avoid bankruptcy. If you choose that option, however, you'll likely be paying a lot of money as insurance for something that may or may not happen.
“Insurance is supposed to cover catastrophic loss,” Swanson says. “It's not meant to cover a temporary drag on your financial performance.”
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