As self-employed individuals who provide the labor and capital to grow a crop or raise livestock, farmers and ranchers must bring in more than they spend every year. I know you enjoy driving tractors and getting your hands dirty, but the balance sheet can only have red ink for so long. What really is a fair profit?
As we reflect on the past few years, we’ve had some very good profits. This has allowed costs to creep up, especially land and labor. Now, many costs are significantly higher than in early 2000s when the current bullish run started.
I often hear producers say they have money invested in the crop and the market owes them a profit. The problem is many have forgotten a basic economic tenet of agriculture: We operate in an industry with thousands of producers of a homogenous product primarily influenced by transportation (the distance from production to consumption) and quality. We call this a pure competition economy. Because there are limited barriers of entry and exit into this industry, over the long haul the industry tends to operate very close to breakeven. The question now becomes is this a global breakeven price that might not be profitable for many U.S. farms currently in operation?
This is the point where many producers pull out their hair. They argue they can’t forward sell until they know yield, which allows them to divide by cost to get a breakeven level. However, by the time they know their yield, so does everyone else. This is why prices normally make seasonal lows during the fall when production is known. The highs occur during the spring and summer when acres and how much weather will influence yields are unknown. While we all intuitively know these trends exist, it’s hard for producers to effectively take advantage of this knowledge.
So what’s my point? Since the last major low in 2001, we have enjoyed a period when demand has grown domestically because of ethanol use as well as internationally, thanks to Mexico, Japan and China. We’ve also seen a very loose monetary policy of low interest rates combined with several significant weather events. Essentially, we have had the perfect storm for the bulls.
Now global supply has caught up with global demand and supplies are starting to back up. The natural course of events is for prices to decline due to excess supply, but who will reduce production capacity first? In other words, who will be the lowest-cost producer? The U.S. holds the title for the best overall production capacity (bushels-per-acre performance), but this is offset by rising land and labor costs.
To keep profit margins good we either have to reduce costs or increase revenue. The problem I see on a global basis is the breakeven cost can be greatly influenced by the fiscal policy of other countries in regard to protecting domestic producers from foreign inputs (subsidy and tariffs) and currency manipulation. Did you know since the U.S. election, the Brazil currency has dropped significantly? It’s enough to push corn values into the mid-$5 range and soybeans into the $11 range, which appears to be increasing excitement about producing more corn and soybeans in South America. At this point, we don’t know how currency and trade issues will turn out in 2017 and beyond. Bottom line: While U.S. farmers produce the biggest yield per acre, I don’t know if we can safely assume we are the lowest-cost producer when currency, tariffs and the fiscal policy of competitors is thrown at us.
We are entering an adjustment period where supply needs to be adjusted downward while demand will gradually move up. When combined with the annual concern about weather, we can safely say prices will rally again. However, if we don’t see a yield reduction event next summer, prices could drop to levels that force domestic and international production to the sidelines. I don’t know how long this transition will take, but producers can reduce the negative impact by following these strategies:
- If you haven’t already, 2017 is the year to batten down the hatches. That means different things for different operations, but all farmers should be building a financial war chest to take advantage of future opportunities.
- In regard to the grain markets, use a strategy that has the lowest cash-flow outlay possible. Forward sell at the elevator, but defend with calls rather than futures or options.
- If possible, plant corn. I think soybean acres will be up significantly while corn acres will be down.
- If you haven’t already, lock up long-term interest rates. If you’re thinking of borrowing for short-term needs and your land is free and clear, I prefer a long-term mortgage rather than a variable-rate annual loan.
- Those who rent need to be honest with their landlord(s). Share with them how much you’re spending and bringing in on their farm. If at all possible, move to a flexible rent where the landlord can benefit in the good times and accept some of the risk in bad times. You have to get land cost more in line with realistic revenue expectations.
- Consider ways to diversify your revenue stream outside of agriculture. Producers who have other financial and business interests outside production agriculture oftentimes are better overall managers. Diversified enterprises also help you see other ways to approach problems.
In summary, we’re entering a speed bump in time when producers must adjust. If you act responsibly, you’ll come out stronger and better able to take on the challenges ahead.
The editors at AgWeb.com are taking a look at experts’ projections for a variety of commodities in 2017 to help you succeed and be profitable in the coming year. Tune in periodically over the next six weeks as we add outlooks for corn, wheat, cotton, cattle, machinery and more. Read all the outlook pieces here.