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Ready for the NEW cost of production?

It's a bit more complex, but a lot more accurate

Calculating your farm’s cost of production (CoP) has been a focus of discussion for more than 20 years. According to some in the agri-food industry, it’s been embraced by more growers in the past 10 years, particularly with cyclically low commodity prices, comparatively higher land costs, plus seed and technology costs and the need to invest in technologies like precision agricultural systems.

Proponents of the “know your CoP” mantra insist that it’s every bit as important in farming as a yield monitor or calibrating machinery.

Yet as the summer of 2017 turned to autumn, several new parameters were introduced into the CoP equation, to the extent that some in the industry wondered how they would affect farmers’ bottom lines.

Higher interest rates, an expected drop in the commodity basis, and an increase in Ontario’s minimum wage will all have significant impacts and alter so-called conventional CoP calculations.

Country Guide approached four industry stakeholders — some of whom also farm — and posed a variety of questions on how these factors will affect agriculture in the coming year. Each responded with their own insights on the changes producers might expect.

Overall, the consensus is that growers are definitely more aware of their cost of production, either as a result of their own undertaking or with the help of a trusted adviser such as an agronomist, accountant or banker.

There are those who still need to increase their awareness, or adjust it according to current and emerging influences, but overall, growers are asking more questions and they’ve come a long way in understanding CoP in the past 10 years.

QUESTION: Which of the new parameters will have the greatest impact on short-term and long-term impact on growers?

Wayne Black believes the change in basis will have more of an immediate impact than interest rate hikes. An independent certified crop adviser (CCA), Black reasons that if a farm operation is highly leveraged, a lot of the interest rates can be locked-in for longer terms. As it stands now, 6.0 per cent interest may look high, but he believes anything under 8.0 per cent is a bonus, and it’s unlikely they’ll go higher without falling out of sync with the global economy.

“If it does, the basis will erode even more,” says Black. “At least with the basis, the main commodities can be protected by locking in the basis and/or the futures price at the same time you purchase your inputs. If the basis drops, it’s most likely the cost of the commodity input would drop in sync with the change in the dollar (all other factors aside).”

From a banking perspective however, the key will be the individual’s level of farm debt, according to Troy Packet, vice-president of Agriculture Services with TD Canada Trust.

“While the reducing basis may have a large impact on break-even or profitability, given increased levels of farm debt, interest rate hikes could have a major impact on CoP, as well,” says Packet. “Minimum wage increases will have a larger impact on labour-intensive sectors of agriculture, such as the greenhouse industry.”

The rising minimum wage will also affect other sectors that rely more on labourers — livestock, poultry and the fruit and vegetable sectors.

From the seed, chemical and traits side of the business, Maizex Seeds’ territory manager Adam Parker believes it’s the basis while Stephen Denys, director of business management, points to interest rates. Parker states that without the basis in the past two or three years, farmers would be looking at significantly lower profit margins in the cropping sector in Canada.

“As much as basis can provide risk, there have definitely been marketing opportunities to capitalize on, due to basis,” says Parker. “A farmer who knows their CoP can make significant gains when forward contracting or taking advantage of rallies in the market.”

Denys notes that interest rate hikes are far from the 20-plus per cent days of the 1980s, and like Black, believes that rates can’t go much higher without a significant impact on a lot of other people.

“With high levels of consumer debt, an urban-focused government cannot allow interest rates to climb out of control,” says Denys. “If the dollar increases in value relative to the U.S. dollar, it’s a double whammy with a shrinking basis. If we look at the U.S. experience in this part of the commodity cycle — the net prices we would experience with a higher dollar — the impact has been a lowering in land prices and further consolidation. Farms leveraged on land purchases would see a significant impact on the balance sheet.”

QUESTION: Will these factors affect other business decisions?

This is where changes taking place may provide an unfortunate side effect. Black has seen more farmers recognizing the benefit of long-term investments in a balanced fertility program or cover crops where they’re needed, and keeping their weed control programs in check.

“Cover crops, weed control and fertility programs pay dividends later,” he says, citing the need for replacement of nutrients in the face of higher crop yields. “Otherwise, crop health may be negatively impacted, and it could take years to rebuild that fertility.”

To Packet, farmers generally recognize the importance of good agronomic management and are excellent stewards. While some have the ability to get more precise in their fertility programs and herbicide applications, most will likely continue with current farming practices and look for ways to maximize yield.

“I would expect many to look for other ways to cut costs, such as delaying equipment replacement and lowering land rental costs,” he adds.

“I see the use of precision ag increasing in farming as margins get tighter,” says Parker. “The more a farmer can accurately use inputs, whether it’s seed, chemical or feed, if there is an ROI, the farmer will use the technology. Digital platforms are also allowing for much easier access to evaluating performance.”

QUESTION: Recent drops in fertilizer prices could help offset some of the impacts of interest rates, basis and the minimum wage. But are those prices too hard to predict?

Fertilizer prices present an interesting set of influences, notes Denys. Prices certainly have an impact on the grower as an input cost but the looming guidelines or regulations on phosphorus expected for Ontario and other provinces could affect crop management strategies in the long term. For the time being, fertilizer prices remain low.

“Unless there are global shortages that spike the price higher, which we have seen in some years past, it tends to mirror demand in the U.S. in terms of corn acres,” says Denys. “If acres are down, this helps fertilizer prices.”

Both Parker and Black believe that price histories make it too difficult to predict why prices drop or how much they may come down. And given the volatility and uncertainty of fertilizer prices, adds Packet, it’s unlikely they’ll play a major role in offsetting other costs or decisions.

QUESTION: What, if any, influence will interest rates have on land purchases?

The general consensus on this is that “farmers will continue to farm.” Interest rate hikes may slow the pace of transactions but the larger-scale farms that can cash-flow land purchases will continue to buy. And again, an urban-based government and high consumer debt loads will likely to keep rates where they are for now. For those who are leveraged a little more, there will be a tendency to rein in expanding land bases.

The final word

As for other factors that can influence CoP with these changing paradigms, the advice is simple, yet varied. For one, understand value, says Black, urging growers not to “cheap-out” to save on an expense.

“Also, know your adviser, and keep a trusted advisory team,” Black adds. “They may not be the least expensive, but they’ll provide the best advice for the long-term viability of your operation.”

For Denys, it’s a set of concerns that affects the bottom line but more from outside of the industry, particularly on government regulation.

“Out of one side of its mouth, the government talks about family farms and wanting small business, but regulatory creep is increasingly leading to consolidation and a reduction in the number of businesses,” says Denys. “This will be a difficult trend to reverse.”

Denys also emphasizes the need for farmers to manage their cost structures, and he points to technology as a way of taking some of the risk out of production, as witnessed by the back-to-back-to-back large corn crops in the U.S. What helps is a businesslike approach to commodity pricing and capturing the profitable prices when possible.

On Packet’s supplementary list is a reiteration of “knowing your CoP,” especially in the face of significant change from the three new influences.

“As margins tighten, investment decisions become more difficult and those who best understand their all-in CoP, which includes items such as labour and depreciation, will have an advantage in growing their operations.”

Like Denys, Parker has a series of cost-related, production-influenced additions, including the need for so-called rainy-day funds. Environmental change is another looming concern, with farmers subject to drought, floods, frost, hail, storms and diseases having a greater effect, all of which add to the risk of production failures.

“Barriers to entry are also concerning me for the future of agriculture,” says Parker. “The level of capital investment required to compete in today’s market is overwhelming for anybody trying to make a go of it on their own. With such tight margins, the return on investment is too long, and much too risky.”

This article was originally published in the January 2018 issue of the Corn Guide.

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