Tuesday, August 30, 2011
Making Profits With Higher Costs Of Production
Although he did not identify the bank, but commodity market advisor Rick Brock repeats the words of one of his clients that a central Illinois bank said it would take a $700 cash rent to farm their managed ground in 2012. The bank may have been in a garden spot with perfect rains and 225 bushel corn and 75 bushel beans. If their farm operators this year are going to harvesting 145 bushel corn and 35 bushel beans then a $700 cash rent will not cash flow. But can a $700 cash rent ever cash flow?
While the 2011 crop declines in size, many farmers will realize that margin is the answer to profitability, instead of being able to hit the top of the market. That is the advice of Iowa State University ag economist Steven Johnson, who says, “Consistent pre-harvest sales as the market moves toward high prices should work again in 2012, along with managing rising input costs.” Notice that he did not say anything about $700 cash rent input costs, since he is expecting Iowa, Illinois, and Minnesota cash rents to be in the $400 range.
Johnson and his colleagues forecast that 2012 crop costs will be 15% higher for non land costs, lead by fertilizer, fuel, seed, and crop protection costs. Those include a higher cash rent equivalent value, ranging from $222 to $296 per acre. Using a 180 bushel average yield, the cost to produce that quantity would be $258 for cash rent.
Johnson says cash rents for next year will see a 10% to 20% increase, depending on the age of the lease. But for other costs, fertilizer is the highest, and he says many farmers may have already locked in lower fertilizer prices than are prevalent today.
Locking in a market price for grain sales provides the opportunity for a positive margin potential with December 2012 prices over $6.65 and cash prices above $6 per acre. Johnson says such a market price should provide a 30% return. He is calculating that with $1100 in crop revenue from 180 bushels per acre, produced from $796 crop costs, and a $23 per acre government payment.
Johnson says farmers who are margin managers will combine production and pricing decisions to ensure that as they agree to higher production costs, they also have locked in sufficient marketing revenue to cover that cost. But he says there are other ways to achieve increased success. “Additional considerations might focus on hedging corn versus committing a large number of bushels to delivery via the use of forward cash or hedge-to-arrive contracts. Also, the use of crop insurance products to be used in 2012 should be a consideration. While the projected price will not be determined until the month of February 2012, the use of revenue protection (RP) at higher levels of coverage (75% or greater) should be considered.”
The Iowa State economists say margin management is not new, but there is also a chance that increased prices might lead to a decrease in demand and prices may fall. He says, “While nearby corn futures prices approach $8 per bushel, expect demand to decline, especially for U.S. livestock producers. This demand could be slow to return in the short run.” One potential price deflator that Johnson believes might happen is a decision by the EPA to reduce the ethanol mandate while corn prices are high and there is a threat of global food inflation. He says corn traders and fund investors would protect their profits and futures prices would fall much lower than price levels being traded today.
He points to the summer of 2008 when grain prices began to fade as fertilizer prices rose, and says the result was a large loss of potential income.
Summary:
Crop production prices are expected to rise for 2012, particularly with fertilizer, and farmers should remember the lesson of 2008 when high grain prices fell as fertilizer prices rose eating away at their profit margin. With that lesson still fresh, farmers should not only begin pricing some 2012 corn, but also locking in production prices before they rise any further.
Posted by Stu Ellis on 08/30 at 12:00 AM | Permalink