During the great commodity super cycle, “high prices cured high prices,” as the saying goes. Record level commodity prices automatically increased fixed and variable costs for farm businesses. The price/cost lag effect finds that prices will decline at a much more rapid rate than costs. This creates negative margins where expenses and debt obligations can become problematic if sufficient working capital is not available. Now, the traditional price/cost lag is in effect not only in grain sector but for livestock businesses as well.
Recent data compiled by a farm management consultant, from over 70 grains farms, shows us why businesses are all about cost. In 2008, corn was in the $3 per bushel range, as it is today. Looking back at the 2008 timeframe, the average corn seed cost was $50 per acre, fertilizer cost was $60 per acre and custom and rental expenses were $190 per acre; making the total variable cost of production $400 per acre. Net income per acre in 2008 was approximately $100 per acre.
Now, fast-forward to projections for 2016. Projected average corn yields on these 70 grain farms increased from 160 bushels per acre to180 bushels per acre. While this is positive, the increase will not be enough to generate a profit or return, given the cost structure. Today, corn seed is $125 per acre, fertilizer is $150, custom and rental expenses are $330 per acre, with a grand cost total of $722 per acre. With the current commodity prices, despite yield the increases, returns are now in the negative by $125 per acre.
In hindsight, profits in the 2007 to 2012 timeframe were an aberration and not sustainable, given the rising cost structure. For example, many energy businesses have failed or shutdown due to drops in oil prices. In these cases, they did not cover their variable costs. Overall expenses will need to decline approximately $100 an acre to realize a profit.
Shortly, lower fertilizer and energy costs should provide some relief along with seed cost. The more difficult costs to handle will be cash rents and leases, along with family living. With the exception of an unusual event in weather or elsewhere, 2016 will be a year all about cost containment. Obviously, this example uses corn; however, the same can be said concerning soybeans, livestock sector and many other agricultural businesses.
Yes, costs do lag prices in decline, but they are resetting. In the meantime, producers must cover variable and fixed expenses in order to continue daily operations and management. If negative margins occur, work with your lender and other advisors to develop cost strategies. Remember to focus on the factors you can change instead of the ones you cannot.
P.S. If there is not significant change on the price side of the equation, 2017 could be interesting!
For more from Dr. Kohl, follow his "Road Warrior" blogs.