Production costs for farmers reaching new heights (complete article from source)
Source: Billings Gazette, by Jim Gransbery
October 14, 2007
Soaring prices for agricultural commodities this year have left the impression that farmers and ranchers are getting rich.
A close examination of the cost side of the ledger reveals that is not the case.
And, when commodity prices drop, there will be no commensurate decline in production input costs, setting the stage for an agricultural inflation trap like the one that created havoc in rural America through the 1980s.
That scenario is suggested by a recent U.S. Department of Agriculture analysis of farm sector income and costs and is corroborated by local input suppliers: sellers of feed, seed, fertilizer, pesticides and chemical fallow, fuel and operating loans.
"It is not just farmers, it is for consumers as well," said Dan Downs, referring to the inflation trap being set by the run-up in prices for every food commodity and the cost of producing it.
Downs, who owns and operates Montana Seed & Grain in Billings and farms, too, noted that wheat next year should be $15 a bushel to counter the costs of inputs coming down the line.
Since spring, futures and cash prices for grains have hit repeated record levels. Prices for feeder and fed cattle have remained solid, too.
The analytical look at farm and ranch income and expense for 2006 and 2007 released Aug. 30 by USDA breaks down what the U.S. agricultural sector can expect this year. Most interesting is the rapid spike in the cost of producing a crop or raising livestock.
The key factor is the accumulative cost of transportation in all sectors - that means the price of diesel fuel.
U.S. net farm income this year will hit $87.1 billion, an increase of $28 billion from 2006 and $29.7 billion above its 10-year average. The previous high was $85.9 billion in 2004. However, total production expenses will reach a quarter of a trillion dollars in 2007, according to USDA's Economic Research Service forecast.
The cost of production will increase by $17.4 billion this year to a total of $249.9 billion. That jump is exceeded only by the $20 billion increase in 1979, which, in percentage terms, was 19.8 percent. (That was the harbinger of the 1980s cost/price trap.) In the past five years, total expenses have increased $57.2 billion, or 29.7 percent. During that same period, the direct inputs for planting and harvesting a crop or producing a calf rose 25 percent. ERS said that 12 of the 16 expense groups it uses to calculate costs will reach their highest level ever in 2007.
Feed prices going up
For livestock producers, the principal cost increase is for feed, the ERS reports said.
Butch Whitman does not doubt that.
"We are dependent on the cost of all commodities," said Whitman, who heads Westfeeds in Billings, which prepares and sells livestock supplements and feed rations for cattle and other livestock.
"We are a margin operator, so we have to pass our costs to the customer," he said. "It has been a very unusual year."
He noted that the national cattle inventory did not increase this year because of the drought and the "good memory" of livestock producers, who survived the agricultural washout in the 1980s, and did not expand their herds this year.
"Production costs remain when commodity prices moderate," he said, providing a succinct description of the inflation trap.
For his business, the grain substitutes for corn, the main ration for cattle feeders, have all gone up, too. Feed barley and wheat as well as the grain byproducts such as dried distillers grains are among the most used.
"The options are all at record high prices," Whitman said.
As more corn was planted to meet demand for ethanol plants, fewer soybeans were planted, which means less soybean meal for animal feed, which in turn creates demand for canola meal and the costs of all are going up, he explained.
"The free market causes all to float up to their relative feeding value," he said.
The USDA report makes note that frequently those "cheaper substitutes are not immediately available." Livestock feed costs have risen more than $2 billion in four of the past five years, or 42 percent. The projected increase for this year, $4.9 billion, will be the largest increase ever.
Because the supply of feeder cattle has tightened, prices to feedlot operators and cattle producers have remained strong. Feeder cattle futures hit a high in September of $119 a hundredweight.
Paying some bills
The principal crop-related expenses - seed, fertilizers and pesticides - are projected to rise 12 percent to $37.3 billion this year, making the fifth straight increase of more than $1 billion or more.
The sharp increase in corn plantings has pushed up seed prices by 12 percent. Since 1995 seed expense rose 130 percent, increasing by half a million dollars or more nine times.
Downs had a handy price comparison ready for the preferred hard red winter wheat planted in Montana.
In 2005, he charged $6.80 a bushel for the wheat seed; in 2006, $7.40. This fall he is charging $10.40 a bushel. That seed will produce next year's crop. As a rule of thumb, one bushel of seed plants an acre of dryland wheat.
"The drastic swings (upward this year) are wonderful," Downs said. "Farmers and ranchers can pay some bills."
Economic studies show that an agriculture dollar rolls over seven to 11 times in the economy, Downs said. "When ag does well, everyone does well," he said, indicating some of his old machinery might get replaced this year.
Fertilizer rising double digits
Fertilizer expenses are forecast to increase $2.2 billion, or 17 percent, to a record $15.3 billion, the ERS predicted.
Allan Holliday, who owns Terra Logics facilities in Billings, Ryegate and Basin, Wyo., expects that and maybe more.
The U.S. ag industry is tied to world politics, he said, and, coupled with fertilizer production consolidation, they have put a pinch on supplies.
He noted that the European Union eliminated the 10 percent cropland set-aside for farmers for 2008, bringing an additional 7.2 million acres into production. Larger acreages in South America, India and Ukraine will also squeeze the supplies of phosphate and nitrogen that are essential to higher crop yields.
"It will be 2010 before new production facilities offset the increased demand," he said.
Prices for fertilizer have double from 2005 to 2007, he said. Phosphate went from $250 a ton to more than $500; urea has risen 100 percent.
Holliday sees no decline in the short term.
Because input suppliers normally have to ship ingredients in and finished product out, the cost of freight is the core cause of the price run-up, he said.
The availability of trucks, truck drivers and railroad cars aggravates the problem, too.
According to the federal government's Energy Information Administration, the average price of diesel fuel has risen from $2.41 a gallon in 2005 to $2.82 this year. It forecasts an average price of $2.96 a gallon in '08. Those prices are for highway-use diesel, which includes federal and state excise taxes. Agriculture producers are exempt from excise taxes on diesel fuel used solely for production purposes.
Homeland Security Department regulations are driving up the price of fertilizer, Holliday said, as most of the urea and potash used in the United States comes from Canada.
"Not every driver can get certified to cross the border," he said. "They have to be extra clean" in their background checks.
"It all adds to the cost," he said.
Fuel expenses have increased 76 percent in the past five years, the ERS report said, which was the reflection of the cost of imported oil.
Holliday said the pesticide costs have remained relatively flat in that while they are more expensive, the unit price of production has declined.
The ERS study noted the same situation with 2007 costs for pesticide rising 3.4 percent.
Even money costs more
Interest expense, the cost of borrowing money for operating expenses or buying land, will be up between 3 percent and 4 percent, the report said.
Local bankers agree that farmers and ranchers could get caught in another production cost increase/commodity price drop like the 1980s.
Butch Bratsky, president of Stockman Bank Billings West, spent his time during 1986 through 1993 in farm and ranch management. Many of those were given back to the long-term lender because producers were unable to pay the loans, he said.
"I was the bearer of bad tidings," he said.
While there is a possibility of that happening again, Bratsky said farmers, ranchers and bankers are smarter now and won't allow themselves to be put in the trap by carrying too much debt.
"People here are pretty well off," he said, with debt ratios below 40 percent.
Curt Cotton, a vice president and ag officer at Stockman Bank, said many of the people buying farms and ranches now do not depend on the production cash flow, but have outside money to operate with.
"It also keeps more land off the market," he said. That helps keep land values steady.
Bratsky said interest rates may be the best bargain in the cost category for agriculture producers this year.
The prime rate, which lenders charge their most creditworthy customers, is now at 7.75 percent. The Federal Reserve recently lowered the Fed loan rate from 5.25 percent to 4.75 percent in an effort to mitigate the fallout from subprime loan defaults. The Fed rate is what the government charges banks for money.
"We are fortunate the prime rate is where it is," Bratsky said. "There is not one other input cost that has maintained the nominal increase."
The prime rate was 6.75 percent in the fall of 2005.
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