When the Dam Breaks – What Will be the Fallout When (Not If) Commodity Prices Drop?
“Hard times create strong men, strong men create good times, good times create weak men, and weak men create hard times” – G. Michael Hopf
Interpret this quote how you want, I know what it means to me in today’s society. I don’t write these blogs about society however, I write them for the primary producers that may be interested in hearing new and unique viewpoints.
In agriculture specifically, I believe that we have entered the “good times create weak men” era. This is not to say that primary producers today are any worse than in the past, it is more to say that increasing commodity prices over the last three years have led to a false sense of success and risk. When you break down the balance sheets and income statements on most farms, we have never been in a more high-risk time for farms. I may even go as far to say that if commodity prices were not where they are right now, many farms would be looking at a loss scenario before starting the 2023 crop year.
The statistics I reviewed back in 2017 showed an increase in cost of production of greater than 200% in the last decade. Now with inflation, cost of inputs, fuel increases, minimum wage increases, equipment costs, and numerous other factors, I am confident that the 2023 crop year will be the most expensive on record. In fact, a large majority of consulting clients and farms I work with are approaching $600 to $700 per acre break-evens this year. With current prices that means large profit, but with a slide it can result in catastrophe.
So how did we get here?
To be transparent, I have to say that this most recent drop in fertilizer prices is actually a negative for the industry. The phrase used to be “farmers have short memories”, and I fear this may be a prime example. Those that purchased crop inputs early are now regretting that decision. This will change the mindset of many producers and into 2024, I believe we will see many wait until closer to seeding to purchase. From a data perspective, the lowest prices historically are the summer months the year prior to planting. Those farms that continue to purchase early will be able to control some future costs, and those with short memories will make some bad decisions in the years to come.
On crop inputs, the majority of farms will be $50 to $100 per acre higher for the 2023 crop year. A large amount of the increase is price, but through consulting I also have seen many producers become more aggressive on nutrient and chemical packages. Multiple fertilizer passes, macro and micronutrients, growth regulators, fungicides, and many other new resources are being used to push yields. This is a positive as I don’t have a farm that has ever hit the “too much of a good thing” threshold. In fact, the statistics are still that $1 of crop inputs averages out to an additional $2.50 of gross revenue.
Now, moving forward I do see the crop input costs moving with commodities (we have already seen a large shift down from where they were). These costs are the only costs that move in unison with crop prices. So, for that, I do see a drop in cost of production from crop inputs as the commodity prices lower in the coming years.
Labour, Power, and Machinery
For those that believe machinery costs will drop with commodity prices as well, I wish I was that optimistic. Over the past three years, with numerous logistic issues, cost increases, tariffs, and many other negative factors affecting producers and relationships with dealerships, only one metric continues, the waiting list for machinery that continues to grow longer than ever.
Simple economics compares the effects of supply and demand. In commodities these fundamentals are not necessarily in charge anymore, but when it comes to machinery costs they are alive and well. We have seen compounding jumps in costs of machinery, and yet the producers continue to buy. I would even venture to say that due to shortages, farmers are even more aggressive in this higher cost environment. This will continue.
Now, fuel is another beast of its own. If somebody knows where the price is going this summer, please let me know as right now speculating is a full-time job. The one thing I do know is that the oil and gas industry has no ties to agriculture commodity prices. So, expect these costs to continue to remain high, and with carbon taxes and other great government policies, the costs will continue to escalate. In fact, you might as well throw electricity, heating fuel, and other costs into this pool as well. The fact is these costs will not come down as commodity prices fall.
Land, Building, and Finance
Much like machinery, land cost increases have not deterred purchases. In fact, as investors get scared away by costs too high for returns, farms seem to be immune to these numbers. I also don’t see land prices or rent prices coming down soon. Could we see “softening in appreciation”? Possibly, but I am not even sure I believe that. Land is an inflationary hedge (much like gold), an appreciating asset, and to be fair many farms are purchasing for real estate and not farming profitability.
When it comes to interest rates, I have my opinion that you can consider. My thought is that we are in a new interest environment, and it may move a point higher or lower, but we are not going back to the days of 2% rates. Yet again, another cost that will not decrease with the commodity prices.
When it comes down to it, welcome to the new environment. To say it does not “scare” me as a consultant would be naïve. Many of my own clients, as well as farms I talk to outside of our business, realize the risk of new cost structures, but then ask me to tell them how to fix it. The truth is there is a minimal amount of planning that can be done to “fix it”. I would say, control the over-flow (more spending right now), insure for profits, and in the end make sure you know your bottom lines. The accountant in me wanted to end with the following:
At $600 per acre break-even the difference between $18 canola and $10 canola is going from 33 bu/acre canola to 60 bu/acre canola.
This should keep you up at night if nothing else does.