Drilling Deeper: Do Cash Rental Rates Most Accurately Reflect Profitability?
Short-term spikes in profitability are even more clearly reflected in cash rental rates. The rise in farm income supported land values; record farm income and land values supported record cash rental rates across the Corn Belt.
While high land values have helped to hold down debt-to-asset ratios for established landowners,
increased production costs for some new owners and tenants will make profit margins paper thin for the next one to three years. This is an important point to consider when planning and managing your commodity risk in the next six months.
The truth is that the commodity markets have two jobs. The short-term job of all commodity markets is to gather all of the information available in the marketplace and set a fair price for the commodity each day. The long-term job of the market is to make sure the commodity is being produced by low-cost producers. Simply (and harshly) put, the long-term job of the commodity markets is to hold high-cost producers underwater for a long enough period of time to reallocate the high-cost producers’ assets to low-cost producers.
The slowdown in crop revenue from the previous three years is expected to expose some of these high-cost producers. Because land costs are often the biggest difference between the regional highest and lowest-cost producers, it’s the land that will have to be reallocated. That’s not a prediction of forced farmland sales—land is held by strong hands, compared with the 1980s crisis. However, there will be pressure on high-range rental rates to pull back production costs in line with expected farm revenue. Profits will be difficult to generate for high-cost producers through this reallocation period, but for many low(er)-cost producers, there will still be profit margins to manage.
In addition, some farmers are wondering if farm profitability is on a one-year leave. Most farmers dislike linking farm profitability to federal farm programs. In recent years, farm payments only added to profit margins, rather than accounting for profit margins. Direct payments were eliminated in the 2014 farm bill, along with 2008-style safety-net programs and SURE. Replacing these programs are Ag Risk Coverage (ARC, county or individual; think revenue protection crop insurance) and Price Loss Coverage (PLC; think target prices), along with the Supplemental Coverage Option program.
The differences between the ARC and PLC programs are numerous, but there is one thing they have in common. The soonest farmers can expect any revenue from farm program participation is fall 2015. Farming is facing a tough time when farm program payments make or break revenue in any one year, but it’s nice to have it when it’s needed. For 2014, farm program payments won’t add revenue to the mix.