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If the good times are gone

Can your farm survive the next 25 years at this winter's grain prices? It may have to

Since 2007, grain producers have profited from unprecedented high grain prices. Even this year’s record yields and high crop insurance payments have moderated the impact of the recent drop in grain prices.

Most growers continue to feel the good times they have experienced for the past six years are going to continue.

Gary Schnitkey thinks such farmers are wrong, maybe even fatally wrong.

Schnitkey is an ag ecnomist based out of the University of Illinois, and he made his thinking crystal clear in a farmdoc daily release this past fall. Said Schnitkey: “There are good possibilities of (corn) prices being below break-even prices over the next several years.”

Schnitkey bases his prediction on skyrocketing production costs. The price required to generate a positive margin on corn in Illinois has almost tripled over the past decade, he says, with the break-even price rising from $1.67 per bushel in 2004 to $4.65 per bushel in 2013.

With Illinois harvest prices in the $4.30 to $4.40 range per bushel last fall, growers in that state who had not locked in the higher prices that were available earlier in the year, or who had below average yields may lose money on the corn they grew in 2013.

Most importantly, Schnitkey points out that the outlook for negative margins in 2013-14 isn’t restricted just to Illinois, or just to corn. Rising production costs are the reality in all crops and all grain-growing areas.

Nor is Schnitkey the only economist warning of much tighter margins.

In another farmdoc daily in the fall, University of Illinois agricultural economists Scott Irwin and Darrel Good backed up Schnitkey’s pessimism.

“Corn and soybean prices at the present time either have finished or are likely to finish what have been, by historical standards, very long runs above average,” Irwin and Good wrote. “History suggests that it is quite unlikely that corn or soybean prices will soon experience another long run of above-average prices.”

The information presented in these two newsletters is very troubling and all farmers should be concerned for three reasons.

Flat trend for commodity prices

For their studies, the three Illinois economists compared recent grain prices against average grain prices over the last six years. The reason they used such a short period to develop an average was because it has been theorized that beginning in late 2006, the demand for biofuels pushed up commodity prices roughly 75 per cent from the average prices from 1973 to 2006.

Analysis shows that grain prices in that 1973 to 2006 period had jumped 88 per cent over the previous 30 years (1942-72) due to the escalating energy prices in the ’70s, high inflation, and strong demand for grains from the Soviet Union.

Furthermore, the post-Second World War prices had jumped 62 per cent over the previous 35 years (1908 to 1942) as a result of the repeal of the price controls imposed during the early years of the Second World War and increased demand in the postwar rebuilding era.

Many economists expected biofuel demand would result in a similar step up in prices. As it turned out, the actual average for the last seven years has been very close to the predicted level. So what growers have seen as windfall prices since 2006 are actually very reflective of the current increased demand for grains, and are actually a step up in the long-term price trend.

What is scary is that if prices follow the historical pattern over the past 100 years, the next 25 to 30 years may see no major upward trend from current price levels.

Can your farm survive a generation of prices at current levels?

Rising input costs

While most farmers may be willing to accept today’s commodity prices, the problem is that costs have risen as fast or even faster than the price of grain. As a result, the break-even cost of production of an average crop is now within pennies of the current average price of the crop.

Margins have disappeared, and we are right back to the problems experienced in the ’80s and ’90s.

In Schnitkey’s words, “Grain prices have reached a new plateau, but costs have caught up.”

There is also a lack of recognition by farmers of why costs have risen. Ask a farmer about rising costs and most will blame seed costs, or fuel, or other inputs over which farmers have no price control.

In reality, much of the increase in costs is the result of management decisions farmers have made in their attempt to maximize productivity.

From the Grainews website: Minogue: Undercurrent of frustration pervades at CropSphere

While it is true fertilizer has gone up in price, the increased fertilizer application rates are an even bigger reason why corn fertilizer costs in Illinois jumped from $82 per acre in 2006 to over $200 per acre in 2012. On top of fertilizer, farmers have also increased the use of pesticides and micronutrients.

The amount farmers are spending for new and larger equipment as well as new technology have shot up as well.

Schnitkey estimates at least 30 per cent of today’s increased cost of production is a result of higher land costs. Land rents have skyrocketed as farmers compete not only with neighbours, but with foreigners, individual investors, and even investment and pension funds for agricultural land.

Unfortunately, none of these costs are expected to ease in the near future. As long as the sentiment is that agriculture is a safe investment, and as long as agriculture still seems to be booming, demand for inputs will continue to support input prices including land rental rates.

Schnitkey believes any decrease in non-land costs will be slow. Nor does he see cash rent decreasing until farmers experience a prolonged period of losses.

Increased volatility and risk

Higher average yields along with higher costs have greatly increased price volatility and risk for farmers. For example, Illinois farmers had an excellent corn crop in 2004 which led to higher input prices in 2005. In spite of the higher investment into the 2005 crop, yields averaged 35 bushels per acre lower and 2005 corn prices were 20 per cent lower than in 2004.

As a result, farmer’s profitability dropped about 50 per cent. With today’s costs of production having risen nearly three times, the impact of a 35-bushel per-acre yield decline or of prices falling 20 per cent is much greater.

When the goal is yield maximization, the risks of yield and price volatility are much higher.

“We are back to a period of higher volatility and risk,” Schnitkey says.

In effect, farmers have trapped themselves on a treadmill of ever-increasing productivity and cost. Farmers have already achieved the yields necessary to meet the demand from biofuel, thereby effectively capping the high prices they have enjoyed. But to achieve those yields, they have driven up production costs close to the predicted average price they should expect to receive for an average crop. Even a small yield drop or price drop could now result in negative margins.

There is no easy way off this treadmill.

Given this situation, it is more important than ever that farmers base management decisions on minimizing the cost per unit of production rather than seeking to maximize production. This does not mean simply cutting costs and production, but rather seeking to find the level of production at which cost per unit of production is minimized. For example, it may still make sense to make a fungicide application if the expected bump in yield and quality from applying the fungicide results in lowering the break-even price needed to cover the costs of growing the crop.

It may also still make sense to rent more land even at current rental rates if existing equipment is currently underutilized and you can lower your cost per unit of production by farming more acres without adding more equipment or labour.

Farmers need to remember that the price of any commodity declines to the lowest cost of production over time. The goal in producing a commodity should be to produce as much as possible at the lowest cost per unit possible. Too often farmers just focus on maximizing production rather than the equally important part of the equation, minimizing the cost per unit of production.

After all, if you aren’t the person who can produce for less and sell for less, someone else will survive when you can’t.

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