Costs Slow to Realign

By Marcia Zarley Taylor
DTN Executive Editor

HADDONFIELD, N.J. (DTN) — A Halloween forecast by Purdue University paints a grim outlook for the grain economy through at least 2015, and possibly the next three or four years.

Indiana grain farm incomes are expected to tumble 30% in 2014 and another 35% in 2015, even including government payments under the new farm bill, Purdue Economist Chris Hurt said. He gauges the state’s grain incomes at $1.1 billion for 2015, down from the recent high of $3.4 billion in 2011.

"It’s a different world now, right back to the net income levels we had in the last days of $2 corn," before the Renewable Fuels Standard ignited corn demand, Hurt said. Growers will start to feel a dwindling cash flow as soon as they start marketing the 2014 crop. Many who are upside-down on farm budgets will be dipping into cash reserves to make ends meet.

In a webinar on the changing business climate for agriculture, Hurt and other Purdue economists emphasized that cash rents and farm input costs have been slow to adjust to the new realities of commodity markets. The main problem is that production costs need to fall by about 20% to realign with the current price outlook.

The crop production system could be vulnerable for the next three or four years and possibly beyond that, Hurt said. "We have a cost structure that’s built on $5 corn and $12 soybeans, but the reality is the market is only going to offer $4 corn and $9 to $10 soybeans," Hurt said. "For some growers it will mean trauma or failure, but most will make the adjustments, given enough time."

Looking back at the last 100 years of farm income, boom-bust cycles have been the norm, he added. Booms typically last 10 years, followed by busts that last 20. "I’m 65-years-old, and throughout my career, agriculture has normally been a tight margin business," he said. "If you’re too young to remember that, just ask your father or grandfather. In some ways, we’re just getting back to normal."

Nevertheless, growers will need to scrutinize cash rents and input expenses carefully next year. "Farmers will have to work harder on their cost structure," said Purdue’s Mike Boehlje. "Buying inputs is the first step of a marketing plan. It’s really, really important."

Since 2000, Indiana cash rents have doubled and land values have tripled, said Purdue’s Michael Langemeier. The problem is that rents rarely retreat — and then only modestly. "A drop of 10% in any year would be a very large drop historically," Langemeier said. That’s only happened three times in the last 50 years. "We’re not expecting a huge collapse in average rent, maybe a 5% to 10% correction in each of the next two to three years," he added.

Average rents run about $250 per acre in the Midwest, so a drop of 10% is only $25 per acre. On the other hand, really strong bids — perhaps $325 and above — could change much more substantially, Hurt said.

However, fertilizer and seed prices could offer more immediate savings. At the moment, nitrogen prices in DTN’s weekly retailer survey are hovering at levels higher than a year ago. They are likely to moderate by spring, Hurt said. A drop in global corn acreage will weaken demand for all fertilizers. What’s more, growers can tap into phosphorus and potassium soil reserves and postpone replacement until economics turn around. In 2009, growers reduced phosphorus and potassium purchases by about 20% to 25%, Hurt noted.

Seed prices also have risen 4.5% annually in recent years, but high inventories will likely force companies to begin marketing more creatively, Hurt said. Gains closer to 0% to 1% might be the case for 2015, the Purdue economist said. He expects companies to offer more non-price discounts, such as early pay discounts which effectively lower prices.

Boehlje encouraged growers to take action now to ward off financial issues later. Many growers have depleted their working capital by paying cash for farmland or equipment during the boom years. Even when they used debt financing, they repaid land on a 10-year term instead of the more normal 20-year schedule.

It might be worthwhile to restructure debt now, for example moving equipment from a 3- to 5-year note to a 5- to 7-year schedule, Boehlje said. He suggests doing this now, rather than waiting a year or two and making the same decision under duress. "Lenders get nervous if you wait until you can’t make a payment before you ask to refinance," he said. "Be pre-emptive."

Commenting on the need to realign cash rents Thursday in his daily CommStock report, David Kruse, an Iowa commodity broker, said much stiffer cuts should be in order. "If they were paying $400 per acre, a 5% or $20 per acre reduction to $380 per acre would be like tinkling on a bonfire resulting in not much effect. Without a much more significant reduction in cash rent, farming will be a losing proposition for many tenants next year."

Marcia Taylor can be reached at Marcia.Taylor@dtn.com.

Follow her on Twitter @MarciaZTaylor.

(CC/AG)