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Higher crop prices risk for farmers

Wednesday, September 12, 2007

WEST LAFAYETTE -- Farmers enjoying robust corn and soybean prices might be surprised to find themselves earning less for their crops, said a Purdue University agricultural economist.

As crop prices have risen -- especially corn to feed the burgeoning ethanol industry - so, too, has the cost to produce those crops, said Mike Boehlje.

"Even though high prices might infer higher profits, they actually have the potential, at the same time, to create higher risk," Boehlje said. "We're now seeing some fairly significant increases on the cost side in agriculture. It isn't unusual when you get better prices that you may be more willing to pay a little bit more cash rent for land and more for fertilizers, seed and chemical products.

"What we see happening increasingly is what is often referred to in the business world as margin compression. When you combine that with the fact that we are moving our entire price structure up and we aren't adjusting the government program on top of that, we also have more of what we call margin risk, or risk exposure."

The 2007 Purdue Land Values and Cash Rent Survey found that Indiana land rental rates were up about 10 percent from 2006, to between $110 and $171 per acre depending on land quality, and could continue rising. Seed, fertilizer and chemical costs are likely to increase from 5 percent to 20 percent this fall and in 2008, according to Purdue estimates.

Meanwhile, for the market year, corn and soybean cash prices are averaging well above $3 and $7 per bushel, respectively -- too high for farmers to receive such government subsidies as loan deficiency payments (LDP) and counter cyclical payments.

The bottom line is that higher production costs and lost government support payments are reducing the crop price gains, Boehlje said.

And Putnam County is seeing the affects of this trend as well.

At the Cloverdale Agri-Center, corn has been going for just about $3 and soybeans for more than $8 per bushel, said owner Norv Gottula.

The price of inputs has increased a great deal, too.

Gottula estimated that fertilizer alone costs between 25 to 30 percent more this fall than it did last fall.

Boehlje gave an example of how a farmer could be worse off even with higher crop prices:

"With a $3 price for corn and the cash cost per bushel of approximately $2.30, margins per bushel would be approximately 70 cents. In this situation, the potential of a negative margin is almost zero since the government support price system of LDPs, counter cyclical payments and direct payments provides a safety net price equivalent to almost $2.30 per bushel - assuming the farmer gets normal yields or protects the yield risk with crop insurance.

"On the other hand, if cash costs increase by 20 percent to $2.75 in 2008, average margins would decline to 25 cents per bushel assuming $3 corn. The margin risk exposure increases, as well, because prices could decline below the cash cost of production of $2.75. In a worst-case scenario, assuming no change in the government program, the government safety net of $2.30 per bushel results in the potential of an up to 45-cent loss if prices were to decline below the cost of production."

While farmers have little control over crop prices or rising production costs, they can take steps to minimize their margin risk, Boehlje said.

"We need strong risk management strategies to accommodate those risks," he said. "For example, we need to make sure we are taking a good look at crop insurance products and aggressively using crop insurance. We also need to do forward pricing to lock in prices, even if we think they might go a little bit higher. Even if there's a chance they are going to go lower, if we have guaranteed ourselves a profit with a locked-in price, margin compression and the risk of loss exposure is mitigated and eliminated."

Boehlje also urged farmers to carefully negotiate their land leases.

"We need to make sure we don't overbid the cash rent market so that we don't bid our cost structure up into a position we can't support," he said. "If we lock in high rents for 2008 and then find that crop prices aren't quite as good in 2009, trying to adjust those rents back down is difficult."

Farmers might consider land lease arrangements that both protect them and provide their landowners fair compensation, Boehlje said.

"We might think about using what is called a flexible cash rent, where you pay a base rent and then a bonus payment or an option payment," he said. "The option payment is a function of how strong prices are and how good yields are.

"So maybe we pay a $140 base cash rent and then the option payment on top of that could be $50 or $60 if we've got really strong prices and yields. Or that option payment may be only $10 if we don't have as good a price or yields. So it gives more flexibility to have that rental payment adjust to the changing economic conditions."

-- BannerGraphic staff writer Michael Zennie contributed to this report.

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