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Knowing your costs and market direction to extract a margin

Publication Date: 
31 May 2018

Peter Collier, Analyst, Peter.Collier@AHDB.org.uk, 02476478851

Key points:

  • By viewing the market price change along with the accumulating costs of storage, it allows a whole market view, and can help identify when the best returns could be made
     
  • By not taking in to consideration the storage and opportunity cost aspects, there could be a risk that watching a rising market could be masking an on farm loss
     
  • Ultimately, it is essential to know your monthly cost of storage per tonne, in addition to understanding your market, the seasonal trends and above all, the accumulative and often hidden costs that erode margins and profit

Introduction

The potato market is no stranger to volatility, whether within or between seasons. This latest year is no exception, with prices under pressure compared to 12 months ago as the availability of supplies influence the market. Stating the obvious, anticipating seasonal trends in the potato market is key to maximising financial gain (or indeed minimising loss), but it’s particularly vital in a season where the market may be below the cost of production for some. This article explores the inter-seasonal trends at the ex-farm level, seeking to reveal the tendencies for marketing decisions, independent of the underlying market price, against the back drop of ever accumulating costs.

What the average market direction shows

Firstly, we need to understand the average market direction. By using the AHDB WAPS price for a whole view of the potato market, averaged over the current, and previous thirteen seasons, the price movement across the year can be identified (figure 1). 

The market pressure from August to October becomes clearly identified as lifting continues to add supply to the market, creating the usual start of season trend of a falling market price. The subsequent period, up to and including December, records the sharpest rise in average price, climbing on average £20/t from October. 

Following the December rise, the market, on average, follows a near linear trend during the remainder of the season until June, where lifting will once again add to supply. Nevertheless, there is great variability within this trend, depending upon the timing and volume of the supply of new crop, affecting old crop values later in the marketing year.

Having identified the general potato market trend (figure 1), we can now focus just on the market direction and remove the underlying market value. Taking August as the start of a potato marketing year, the remainder of the season can be viewed relative to that starting month.
 

By viewing the market change from August, without the background noise of where the potato market currently is (either a high price year or low), it can allow an objective view of market direction (figure 2).

Through this method of looking at market direction, without the underlying market price, the fixed and variable costs associated with marketing and storage can be identified and marketing decisions made to extract the best rate of return.

While August might not be applicable to each business, the starting month for a market trend view can be constructed from the start of lifting, or indeed the first storage date, for individual crops.

The accumulative costs of storage

To assess the economic rationale behind why you may choose to sell, and when you choose to do so, the accumulative costs must be factored in alongside any market movement. A climbing market may be a falling profit should the costs of storage be greater than the market rise. 

There are multiple considerations to be made when making the decision to store, including direct costs of storage but also the opportunity cost, the time value of money, cash flows and finance.

In this short article, only the direct costs of storage are taken into account, the electricity, labour and machinery plus sprout suppressant. Not covered in the article are the opportunity costs, the time value of money, cash flows and finance; aspects of storage that will be returned to in subsequent articles.

Using the AHDB Sutton Bridge Crop Storage calculator, an indicative cost of cold storage in boxes can be calculated (figure 3). While individual businesses may have different fixed and variable costs associated with storage, the principles can be applicable across multiple storage options. 

Is a market rise enough?

Following the removal of the underlying market price and focusing on the seasonal trend, we can begin to analyse the benefit of storage.

Having established that there is an average seasonal trend in the overall potato market, and within individual sectors, it is important to assess whether a rising market is sufficient to compensate for the cost of storing. 

Figure 4 plots both the average market direction and that of the accumulating cost of storage. Here we can begin to see the importance of understanding the market direction and trends, as well as the costs of storage.

Taking the example of a theoretical August marketing year start, the WAPS market direction is not sufficient to generate a return on the accumulative cost of storage, should supplies be stored from the start of August. Under these theoretical costs of storage and the entire market view, not storing and selling at the market price in August would have generated the best return.

However, if the market view and lifting is from an October point and adding into store later with these theoretical values, the accumulated costs of storage are reduced. Although the underlying market price is no different, from a margin and utilisation of storage view, the market lift more than compensates for an accumulation of storage costs. 

Can you predict individual year’s market trend?

Having looked at the average market trend and typical accumulating storage costs, it is important to be able to distinguish and envisage what might happen in individual year’s markets in order to formulate a marketing strategy. As previously said, the potato industry is no stranger to volatility, but there are tell-tail signs that can help formulate a view on how the market will develop throughout the year. 

The main driver behind the potato market trend and volatility is perhaps, unsurprisingly, supply. If we break down each year from 2005 to 2017 and look again at the WAPS price relative to August, using the same methodology used above, can we gain information about the market rise from the production figures?

Shown in Figure 5 is the April WAPS price movement from August, plotted against the GB production figures for each year. By plotting both the market price and that of production, 76% of the April market price movement is explained by the production figure. With the correlation between GB production and the market movement throughout the season explaining the majority of the price movement, getting an early idea on production should form a key part of your marketing strategy. For instance, in a high production year, the market rise may be less likely to cover accumulating storage costs.

While the WAPS price is a generalisation, the supply and demand relationship will exist across all sectors, a year of high supply will reduce the market rise, while a year of tight supply will raise the market faster throughout the year. As this article has been written in a late planting year, the direction of the 2018 market will greatly depend upon the planted area, while the extension of the 2017 marketing season may provide a market lift.  

Final thoughts

While this article has only explored the overall generalisations, the theory behind this way of viewing a market trend can be applied to individual varieties and intended markets.

It can be all too easy to not take into full consideration the opposing storage and opportunity cost aspect when assessing a rising market. Without a whole cost view, there will continue to be a risk that watching a market rise transpires actually to be an on farm loss.

Armed with a view of supply and the consequence for market direction, the question in regards to seasonal marketing remains, do you know the monthly cost of your storage per tonne? Understanding your market will always be essential for profitability, along with the changing seasonal trends, and above all the accumulative and often hidden costs that erode margins and profit.

This information will allow you to take a view on how to strategically market your crop, for the best returns over the year.

AHDB has information and tools available to help support you in this decision making process, from the latest potato market and storage information https://potatoes.ahdb.org.uk/ and https://potatodatacentre.ahdb.org.uk, to Farmbench, which helps you understand and compare your full costs of production at both enterprise and whole-farm level. https://farmbench.ahdb.org.uk/.

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