Who’s out of whack?
Ph.D., Wells Fargo Chief Agricultural Economist
June 5, 2019
So, did Midwestern farmers make or lose money in 2018? And, how do things look for 2019? One of the first questions of analysis is “What do we know, and how do we know it?” To answer these questions, I will turn to one of the premier resources for farming data which is the University of Minnesota’s FINBIN database. It’s the longest running detailed database available for public analysis. Further, its consistency and methodology are excellent, and the only caveat would be that since it is based on voluntary participation, it doesn’t cover everyone.
In 2018 on cash-rented ground, FINBIN shows that the “average” producer lost $85/acre on corn and earned $86/acre on soybeans. Soybeans received about $80/acre in direct subsidy for the ongoing tariff dispute with China, the largest buyer of soybeans in the world. It is anyone’s guess what the profitability would have been without the dispute and the payment. So, the average producer “broke even” in 2018 on a 50/50 corn and soybean rotation.
As always, the average doesn’t come close to telling the story of commodity production. The following table shows the results for the lowest and highest quintiles based on cost of production. What led to such surprisingly large gaps? The best producers had 10 − 20% higher yields with 15 − 25% lower costs per acre. Simply stated, the best produced more crop while also spending less per acre. The lower spending reflects both efficiency in application of the inputs, and the buying of inputs at a better price. This shows the power of playing MoneyBall in crop farming. The best producers are like the best sports managers using statistics to wring out performance by only paying for results received. This puts the crop input suppliers in the position of needing to prove their inputs are the best for the price.
It’s a truism that “everything matters”, but it’s also a good way to miss what makes the difference. The FINBIN analysis has 27 different cost categories. Four of those 27 categories accounted for 91% of the spending in corn. For soybeans, five categories covered 85% of the spending. The good producers focus their efforts against these big-cost categories, and they understand the interplay between them.
A good example of connectedness involves acres farmed, and how much machinery is owned or leased. Land payments and machinery costs are number one and two respectively in terms of cost. The best producers adjust both of these categories at the same time. They don’t trap themselves into renting “overpriced” ground because they have too much equipment. Rather, they will get rid of equipment if they can’t find acres that pay. That might mean recognizing a capital loss today on some equipment sales, however this is better than taking yet another operating loss, and later taking the capital loss as the producer exits the business.
Should producers hang on to the equipment and the land because better prices are around the corner? Would a resolution of the trade dispute with China make it better to hang on with today’s configuration? I think the following chart clearly shows that the answer is to make the changes now.
Minnesota corn prices have averaged $3.47/bushel for the last five years. The market seems to be stuck in a range around this cash price. Given the price and current yield, the “Big Four” crop inputs absorbed 89% of the corn yield in 2018. Unless prices and/or yields rise significantly, on average, there just isn’t enough yield left over to produce a profit.
The three inputs “out of whack” include land rent, machinery, and seed technology. In 2018, these three inputs absorbed 71% of yield. Comparatively, in the mid-2000s, they absorbed about 52% of the yield. It is unlikely that these three inputs will quickly fall back to their previous levels, but they will get forced down as farmers make the tough decisions. The biggest component is that the market for cash rents happens to be very fragmented and opaque. You hear lots of stories, but the numbers in the below chart show how stubborn the cash rent market has been.
Crop prices peaked in 2012, and cash rents peaked two years later in 2014. The lag between crop prices and cash rents reflects the practice of setting cash rents a year in advance, and it also stems from the time it takes for land owners and renters to internalize the changing markets. Crop prices have fallen by 35 − 45% from their peaks while cash rents are down only 9 − 12% from their high water marks. In fact, 2018 saw a slight uptick in recorded cash rents.
Farmers face a tough choice. They know that another farmer typically wants to farm the ground they are renting. So, if they can’t convince the landlord to accept a price that reflects the reality of prices and yields, their only real option is to walk away. And, that typically leaves everyone upset. Plus, the possibility of getting the ground back later is very low.
This sticky relationship explains why farmers have been so reluctant to push hard on cash rents. Most of the stories I have heard this year indicate that cash rents haven’t softened by any real amount. I’ve heard both increases and decreases. So, in 2019, cash rents will probably be about equal to cash rents in 2018. Seed costs and machinery costs remain sticky as well, with small to no decrease between 2017 and 2018. This sets the stage for another year of tough profitability for the averages.
This begs the question, “Why be average?” If no one made money last year, then the question would be to either stay in business or exit. However, some farmers and livestock producers made decent money last year. There can be no doubt that they made lots of tough decisions on land rents, machinery, and crop inputs which set the stage for their success before the crop was even in the ground. It looks like 2019, 2020, and beyond will be same story. As usual, the farmer and livestock producer will have to skate to where the puck is going to be.