Power Hour: Will Lower Prices Back Down Global Production?

January 3, 2014 08:30 AM
Power Hour: Will Lower Prices Back Down Global Production?

While shifts will take place among crops, don’t look for global crop acreage to contract. "Once we build a factory in agriculture, it stays in production," says Michael Boehlje, ag economist at Purdue University. In just the past eight years, global harvested acreage has increased by 147 million acres for 13 major crops, and the big two have been corn, up 77.1 million acres, and soybeans, up 42.9 million. The five fastest growing regions for boosting crop acreage since 2005 have been South America, up 40.2 million acres; Former Soviet Union, up 28 million; East Asia, up 21.7 million; North America, up 18.3 million; and South Asia, up 15.5 million acres.

"Now we have a bigger factory and demand growth is slowing down, so we have to figure out how to absorb that production," Boehlje says. "That’s why I’m concerned that maybe we won’t be able to see price recovery as we’d like." Without major cutbacks in acreage, the only way to "sop up that additional production is demand growth," he says. Boehlje spoke at a recent 2014 Purdue outlook webinar.

One key reason why Boehlje does not look for a contraction in global crop acres is to take a lesson from the 1980s and 1990s, a period of low prices and adjustment. Striking is that this followed a huge build-up of global crop acreage by 243 million from 1973-82, even more than they past eight years. "We didn’t shut anything down because agriculture is a high fixed-cost industry," he says. Looking at major global competitors who have greatly increased corn and soybean acreage since 2005, the variable cost of production is very close comparing the U.S. with Ukraine and South America, says Michael Langemeier, Purdue ag economist.

In addition to U.S. weather problems in recent years, a key driver behind record grain and oilseed prices that have brought on more global production in recent years has been U.S. ethanol demand, along with the dramatic increase in China’s imports. Ethanol demand has plateaued, however, notes Purdue economist Chris Hurt. "The bottom line is that we’re probably going to flat line on ethanol." Actually, he says the peak in ethanol corn demand was the 2010/11 marketing year. Still, he’s more optimistic on ethanol demand in the short run than USDA, but not by a lot. USDA pegs corn ethanol demand at 4.95 billion bushels for the 2013/14 marketing year, while Hurt predicts 5 billion bushels. "With cheap corn, we’re going to have cheap ethanol that’s going to go out of the country."

With little if any growth in ethanol demand likely in the short run, growing out of overproduction will require growth from more traditional corn demand sources: exports and the livestock sector. "We’re likely to see expansion across the board in the livestock sector," says Jim Mintert, Purdue ag economist. "The brightest star in agriculture the next two to three years might be the livestock sector," he adds. The growth won’t only be in the U.S., he says, but globally because of the growth of middle income consumers. Livestock sector growth both here and abroad will help grain producers, he adds.

Even with the drop in grain prices, "this is not a doomsday scenario that we are suggesting, but a transition to a period of tighter margins and most of us in agriculture have been through before," Mintert says. Because of that, he says the need to manage input costs is going to become extraordinarily important. Langemeier looks for variable corn costs to be down 3% to 5% for 2014. With the goal of reducing costs, Boehlje advises producers to aggressively negotiate with input suppliers as well as land owners. "This pie is shrinking and we have to talk about how to share that reduced pie. We shouldn’t expect producers to have to take all the reduction."

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