Through hard work and favorable economic conditions in recent years, crop farmers across America’s heartland have generally enjoyed a period of significant financial progress. However, in 2013, prices for key commodities such as corn and soybeans, as well as other key indicators, began to moderate. Net farm income is projected to fall over the next decade. Farm balance sheets, while strong today, are at risk of weakening. Is this the start of a “down cycle” in the crop production sector that could lead to a 1980s-type farm crisis? Not necessarily. Producers who see today’s environment as an “agriculture efficiency cycle”—and find ways to drive down cost per unit of production—can position themselves for continued success.
A recent Farm Credit system report highlights these three trends:
- Net farm income falling. After the record $129 billion in 2013, the U.S. Department of Agriculture (USDA) projects aggregate nominal net farm income to decline in 2014 and 2015, reaching a five-year low of $73.6 billion in 2015.
- Farm balance sheets strong but moderating.The U.S. farm sector debt-to-asset ratio, a measure of overall farm financial health, reached an all-time low of 10.6 percent in 2014 and is projected to increase only slightly to 10.9 percent for 2015—still well below the values that prevailed in the 1980s and 1990s. This compares to the high of over 22 percent during the height of the 1980s farm crisis.
- Agriculture efficiency cycles require cost cuts. While strong balance sheets provide a window of opportunity for producers to adjust to changing market conditions, the expected decline in net farm income means producers must bring income and expenses in line. A solution in periods like this is to drive a higher level of efficiency into operations, which can reduce the cost per unit of production.
The answer to lower net farm income? Agriculture efficiency
The current market conditions and resulting long-run forecasts suggest we are in the beginning of a down cycle in economic returns primarily for crop production. Lower receipts and higher expenses have led to a decline in current and projected net farm income. While strong balance sheets give individual producers a window of opportunity to adjust to changing market conditions, the ultimate solution in times of tighter margins should include bringing income and expenses in line. Historically, the successful implementation of this solution begins with implementing a higher level of operational efficiency that drives down the cost per unit of production. If current price forecasts are correct, enhancing gross receipts will be very difficult, but pricing opportunities will still present themselves. Adept marketing and risk management by producers will still have a substantive payoff in this economic environment. Note our use of cost per unit (or bushel) of production as distinguished from total cost of production. Some avenues exist whereby total cost of production may increase but unit production increases enough so cost per unit of production decreases. An example of this would be implementing new machinery technologies or seed genetics.
Corn: Reducing the cost per bushel of production
Producers can begin by focusing on achieving efficiencies in the largest cost categories for the commodities they produce. In these categories, even a small increase in efficiency can result in a significant reduction in the cost per bushel of production. Consider corn, the largest crop in terms of total production. The accompanying pie chart shows the USDA 2015 forecast for corn cost of production. The top four cost categories, by share of total costs per acre, are land, fertilizer, capital recovery (i.e., depreciation on buildings, machinery and equipment) and seed. The greatest opportunity for corn producers is to become more efficient in their cost of land, fertilizer, buildings, machinery and equipment, and seed.
Identifying your opportunity for efficiency:
- Are you in a position to negotiate more favorable terms to rent cropland?
- What is the trade-off on your fields between fertilizer/chemical usage and the choice of seed (genetically modified or not)?
- Would it be more cost-effective to delay purchases of new equipment when compared to the anticipated maintenance costs for new equipment?
- Could use of precision farming and Enterprise Resource Planning (ERP) improve your productivity and realize enough cost savings to justify the investment?
The answers to these and related questions likely will be different for each producer, depending on their unique circumstances.The USDA forecasts for net farm income don’t account for any “shocks” to the system such as weather events. Nor do they account for changes in producer behavior. Producers should not accept the forecasts as inevitable. They can help shape the future—and potentially do better than the forecasts—if they can reduce their cost structure on a per unit basis.
The cost of borrowing: Farmers in a stronger position today than in the 1980s
Another potentially significant cost for ag producers is the cost of borrowing. The cost of borrowing money for equipment, home mortgages, farm real estate and operations is substantially lower today than in the 1980s. In contrast to the double-digit rates of the 1980s, interest rates remain near historically low levels today. Also, there is greater availability of fixed long-term rates on agricultural loans today, which allows borrowers to lock in current low rates. Total farm interest expense, which exceeded net farm income in 1983 by $6.3 billion (150 percent of NFI), was just 14 percent of agregrate net farm income in 2012. As producers look for ways to drive down input costs such as land, fertilizer, machinery and seed, they can also look for ways to lower their cost of financing.
Taking the bull by the horns
Producers are not able to control market forces, such as commodity prices, that affect their financial well-being. But they can control how they respond to those forces as they plan how to protect their income statements and balance sheets. If you’re a producer, the following are steps you can take to adapt to today’s agriculture efficiency cycle:
- Understand all of the primary factors that determine your cost per unit of production.
- Research and thoroughly evaluate those practices, techniques and technologies that have the potential to reduce the major cost of production categories. Adopt those that can have a major impact on your cost per unit of production.
- Take advantage of historically low interest rates by locking in fixed rates when appropriate.
- Use crop/revenue insurance and sound, prudent marketing strategies to protect and enhance the gross revenue side of the farm income statement.
Don’t let today’s market cycle keep you down. The forecasted decline in net farm income is not a given if producers take control of their income statements through the prudent deployment of cost-reduction and risk management strategies. Please contact your Farm Credit loan officer and crop insurance specialist for assistance. We are your cooperative and are happy to serve you in any way we can.
SOURCE: Content for this article was borrowed, with permission, from the May 2015 issue of AgriBank Insights (AgriBank.com). Insights features research and analysis by AgriBank, the funding bank for Farm Credit Illinois and 16 other affiliated Farm Credit Associations. We collectively support rural communities, farm families, and agriculture with reliable, consistent credit and financial services. Insights is part of AgriBank’s AgriThought initiative to help inform the financial decisions among those we serve.
Follow Tom Tracy on Twitter – @FCI_TT