Category: Farm Management

In a year like 2022 evaluating profitable input application rates is extremely important but inputs that require ongoing application through the season can be difficult to evaluate. Crop and input prices change through the year, so each input application is an individual decision that is also part of the greater profit maximizing strategy. Consider producing irrigated corn in northern Texas. 

With December futures trading at $7.31/bu., and the average basis in the region ($0.50/bu.), we’ll assume a producer can lock in $7.81/bu. At this point in the production calendar, recommended practices assume 9 acre-inches (AI) of irrigation have been applied to-date, which represents a sunk cost. With a high cost for natural gas (the primary irrigation fuel in the region), what is the most profitable irrigation amount for the rest of the season? Standard production practices for the remainder of the season call for irrigation at a rate of 6 AI in July, 5 AI in August, and 2 AI in September, totaling 22 AI for the year. The current futures price of the corresponding natural gas contracts is $6.94/MMBtu, $6.906/MMBtu, and $6.86/MMBtu, respectively, yielding a weighted average irrigation cost of $6.92/MMBtu. Given typical irrigation technologies in the region, once acre inch of irrigation typically requires one MMBtu, so the weighted average cost per acre inch for the rest of the season will equal roughly $6.92/AI. 

The Marginal Cost (MC) of each additional AI remains the same ($6.92/AI, orange line) for producers who lock in their irrigation needs today in terms of weighted average. Using the regional irrigation yield curve (green line), we can estimate the incremental benefit, Marginal Revenue (MR, blue line), of each AI beyond the 9 AI already applied (e.g. 1 additional AI = 10 total acre-inches). Corn yield response is positively related to irrigation to a point but begins to lag and eventually declines with increasing application. As the yield response fades, Marginal Revenue (MR) diminishes.

Using the rules of MR and MC (MR=MC is max profit, MR < MC is a loss per unit, MC < MR is increasing returns per unit), we can see that max profit occurs at approximately 7.5 additional AI for the remainder of the season, totaling 16.5 AI for the year. A function of very little yield response from additional irrigation after 16 AI, the outcome suggests that the most profitable irrigation amount may be less than the recommended 22 AI per year.  However, it is critical to talk to your agronomist and consider factors tangential to yield like test-weight and changes in expected weather conditions when making input decisions. 

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Benavidez, Justin. “To Irrigate or Not to Irrigate?“. Southern Ag Today 2(26.3). June 22, 2022. Permalink

In March of this year, inflationary pressures alarmed the U.S. economy as the consumer price index increased by 8.5 percent, the highest increment in the last 41 years.  The Federal Open Market Committee (FOMC) promptly adjusted the federal funds rate (FFR), its main policy tool for regulating inflation. Among other effects, a higher FFR triggers increases in short- and medium-term lending rates (with indirect influence on long-term rates).  Rising interest rates consequently serve as disincentives for borrowing. When loan volumes decrease, the money supply circulating in the economy is controlled, thus eventually lowering inflation.

How do these FOMC decisions affect farm lending?  Based on available farm lending rates from the 10^thFederal Reserve District, average variable farm interest rates for the 1^st quarter of 2022 for short- and long-term loans were 4.93 and 4.56 percent, respectively.  These levels are expected to go up with further FFR hikes projected this year.  However, current interest rates are still below the most recent highs (6.50 and 5.89 percent, respectively) registered when FFR was at its post-recession peak (2018) of 2.5 percent (Figure 1).  Shortly before the onset of the Late 2000s Great Recession (in the last two quarters of 2016), short- and long-term farm interest rates were even higher, reaching 9.15 and 8.36 percent, respectively. 

Figure 1:  Average Quarterly Variable Farm Interest Rates for Short- and Long-Term Loans, 10^th Federal Reserve District, 2002 (2^nd Quarter) to 2022 (1^st Quarter)

How would the farm lending sector fare under these conditions?  Several studies establish the farm sector’s resilience and ability to maintain good credit standing even during periods of economic adversity.  During both the late 2000s recession and the current pandemic conditions, loan delinquency rates among farm borrowers were significantly lower than their non-farm borrowing peers.  Moreover, the surge of banking failures in 2007-2009 only included a negligible fraction of agricultural banks.  This year, as the economy deals with new challenges, farm lenders already have expressed their confidence in the farm sector’s ability to withstand evolving economic concerns.  After all, its latest balance sheet credentials are strong. 

Trends in the valuation of farmland, the major asset in the farm balance sheet, have usually been regarded as a critical barometer of the sector’s financial health.  Latest national estimates from the National Agricultural Statistics Service (NASS) reported in August 2021 indicate a 7 percent increase in farm real estate values compared to August 2020 levels, with cropland values registering larger increases (7.8 percent) than pasture values (5.7 percent).    Notably, average 2021 farmland values in all states in the Southern region increased over their 2020 levels, with the growth in the Southern Plains exceeding the national rate at 9 percent, while the Southeast, Appalachian, and Delta states registered annual increments of 2.7, 2.4, and 1.6 percent, respectively (Figure 2).

Figure 2:  Average Farm Real Estate Values per Acre, U.S. and Southern Regions, 2017-2021

More recent, survey data for the 1^st quarter of 2022 from two Federal Reserve Districts – Seventh (Iowa, and most of Illinois, Indiana, Michigan and Wisconsin) and Tenth (Colorado, Kansas, Nebraska, Oklahoma, Wyoming, northern New Mexico, and Western Missouri) – reflect a sustained acceleration trend in farmland values at even more substantial year-over-year gains of more than 20 percent.

As inflationary and economic growth concerns persist, the farm economic outlook may be tempered by the effect of rising input prices on farm incomes; consequently, slowing down and limiting future farmland valuation gains.  Nonetheless, lenders expect the farm sector to hold its ground, given some liquidity cushion accumulated over sustained growth in recent periods.  Hopefully the sector will continue to uphold its usual prudent borrowing behavior, making borrowing decisions that are practical, cautious, and not necessarily driven by the credit limits commanded by appreciated collateral property – much like what caused the 1980s farm financial crises.

Escalante, Cesar L. . “Inflation Control, Farm Interest Rates, and Farmland Values“. Southern Ag Today 2(25.3). June 15, 2022. Permalink

Rainfall distribution throughout the growing season is of particular importance to rainfed farming systems. For instance, significant variations in forage yields are associated with changes in annual precipitation patterns. To protect against uncertain precipitation levels, livestock and forage producers have adopted climate risk management strategies that include short- and long-term adjustments in forage supply and demand, and the adoption of weather-related crop insurance programs.

The Pasture, Rangeland, Forage (PRF) is a pilot insurance program created in 2007 as a tool to mitigate the risk of forage loss associated with the lack of precipitation. Compared to traditional crop insurance options, the PRF program is an index-based insurance, in which indemnity payments are not based on actual precipitation or forage production, but on projected deviations from historical precipitation levels. Currently, the PRF insurance program is available in 48 states, and is one of the top crop insurance programs in the country in terms of the number of acres enrolled (Figure 1). Since its launch, the number of participating acres in the PRF program has increased by 771% from 24.5M acres in 2007 to 247.8M acres in 2022. This rapid growth could be attributed to the reduced number of insurance options for forage producers, changes in program provisions, and severe drought conditions observed during this period. In contrast, 10.8M cotton acres, 36.6M wheat acres, 78.9M soybeans acres, and 83.0M corn acres were enrolled in different crop insurance programs in 2021.

Figure 1. Insured Acres by Selected Crops

Texas, Arizona, Nevada, New Mexico, and Utah are the top participating states in the PRF insurance program (Figure 2). In 2022, these five states represent about two-thirds or 63.7% of all participating acres in the country. Namely, 34.7M acres are enrolled in Texas, 36.5M acres in Arizona, 37.9M acres in Nevada, 27.0M acres in New Mexico, and 21.8M acres in Utah. As rainfall uncertainty intensifies, participating in the PRF program could be an effective strategy for livestock and forage producers to mitigate production risk and to increase farm income.

Figure 2. PRF Insured Acres by State

Zapata, Samuel. “Increased Participation in Weather-Related Crop Insurance Program“. Southern Ag Today 2(24.3). June 8, 2022. Permalink

While inflation is an immediate challenge to all economic stakeholders, the kind of broad-based inflation currently affecting the economy also raises the prospect of higher interest rates.  Rising interest rates are a significant risk for anyone regularly using short & intermediate term and/or variable rate financing, which includes a large portion of agricultural operations.    

Although rates remain low from a historic perspective, the U.S. weekly average 30-year fixed mortgage rate hit 5.25% in mid-May for the first time since 2009 (St. Louis Federal Reserve Bank).  The US bank prime loan rate is averaging 4.0%, rising from 3.25% in step with the Federal Reserve Board’s recent increases in the federal discount rate.  The discount rate is the rate commercial banks pay on short term loans from their regional Federal Reserve Bank.  As a monetary policy tool, the Federal Reserve Board of Governors raises the discount rate as a means of curbing inflationary pressure in the economy.  See Southern Ag Today – April 5, 2022  for a brief discussion of Fed policy tools.  Figure 1 compares a measure of inflation (year over year percentage change in monthly consumer price index) to the federal discount rate, clearly illustrating the relationship between the two series.

Figure 1.  Inflation (Year-Over-Year Percentage Change in Monthly CPI) versus Federal Discount Rate

When the pandemic broke out in March 2020, the Fed dropped the discount rate from 2.25% to 0.25% to bolster an economy that hit an abrupt wall.  In the next year, inflation began to climb but remained acceptably under 2% until early 2021.  Throughout 2021, the rapid rise in prices was thought (hoped) to be transitory, meaning prices would settle back to normal as temporary market and supply chain disruptions eased.  Now clearly not transitory, the Fed is engaging interest rates to tap the brakes on inflation.  In March, the Fed increased the discount rate by a quarter of a percent from 0.25% to 0.50% and followed that with a half point increase in May, moving the discount rate to 1.0%.  Looking ahead, the Fed has projected an intention to use half point rate hikes at consecutive meetings over the next year, presumably until they begin to see an impact on inflation.  

What level of interest rates are necessary and how long will it take to tame inflation?  Can the Fed manage inflation and avoid pushing the economy into deep recession?  What is the economic and political tolerance for higher interest rates?  

The last time inflation was at levels comparable to today, interest rates were exceptionally high.  The bank prime rate exceeded 20% in 1981.  It is difficult to imagine similarly high rates today.  The federal budget implications of higher rates are far different now than forty years ago.  In 1982, federal government outlays for interest totaled $85 billion against a total debt obligation of $1,120 billion.  That implies an average interest rate on federal debt of 7.59%, the highest at any time in the last fifty years.  Those 1982 federal interest payments amounted to about 2.5% of nominal gross domestic product (GDP).  In comparison, 2020 federal interest payments were $344 billion against total debt of $26,098 billion, an implied average interest rate of just 1.32%, and only 1.6% of nominal GDP.  Historically low interest rates over the last decade have clearly softened the impact of high federal debt levels on the federal budget.  For context, consider what federal interest payments would be on current debt levels at 1982 interest rates.  At an average interest rate of 7.59%, 2020 federal outlays for interest would have been $1,981 billion, equivalent to an unsustainable 9.5% of total GDP.  In the post-WWII era, federal outlays for interest have only rarely exceeded 3% of GDP, hitting a high of 3.15% in 1991.  The current level of federal debt suggests far less policy room to maneuver in response to rising inflation compared to the early 1980s.  The aggressive interest rate hikes that ultimately tamed inflation then would be far more expensive now for both the federal government as well as individual households.  Effectively, economic policy makers are caught between the rock of inflation and the hard place of higher interest rates.  

Economic uncertainty, inflation, and high interest rates present serious challenges for managers.  On a positive note, the financial situation in agriculture is better and should be more resilient to potential shocks compared 40+ years ago, and the likelihood of a 1980s-style farm sector implosion remains remote.  However, it is no time to get complacent.  In changing financial markets, shop for your best interest rates and terms.  Ruthlessly control costs (to the extent you have control), take profits when (if) they appear, jealously guard equity, and build your individual financial resilience.

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Anderson, John D., and Steven L. Klose. “Inflation and Interest Rates.” Southern Ag Today 2(23.3). June 1, 2022. Permalink

The April U.S. Bureau of Labor Statistics Consumer Price Index (CPI) update confirms what anyone who has gone to the gas station or grocery store in the last few months already suspected: prices are rising rapidly, particularly on food and energy.  The CPI is a composite measure of the cost of consumer related products, and a number of different CPI measures include different types or bundles of consumer products.  The CPI which includes all-items was up 8.5% from March 2021 to March 2022.  The March index for food only was up a bit more than that year-over-year, increasing by 8.9%.  The March energy index was up 32.0% over the past twelve months.  

While energy and food prices have clearly gotten a lot of attention, price inflation is occurring broadly throughout the economy.  The core inflation index (all items less food and energy) for March was 6.5% higher than the previous year.  This is the largest year-over-year increase in the core index since August 1982. So, while inflation may be most pronounced on energy and food at present, it is clearly not confined to those sectors.  The overall economy is experiencing the worst inflation in forty years.  Figure 1 illustrates the annual rate of inflation over the past half century, expressed as the year-over-year percentage change in the monthly all-items CPI.      

Figure 1.  Inflation, Measured by Percentage Change (year over year) in Consumer Price Index (CPI)

Rising prices are a challenge not only for consumers but also for businesses who must deal with rising production costs.  Many businesses will respond to increasing costs of labor, supplies, materials, or other inputs by raising the price of their output to maintain profits.  Competitive pressure can certainly constrain a business’ ability to raise prices, but many businesses generally have some latitude to adjust their product prices in response to higher input costs.  This is not the case for farmers and ranchers, who are price takers in both input and output markets.   That is, farmers and ranchers have no ability to influence the price they pay for inputs or to set prices on their output.  Thus, their ability to pass along increased costs to their customers is basically nonexistent.  

Figure 2 illustrates the long term trends in consumer prices and farm product prices.  It is clear that farm prices have not kept pace with broad consumer prices.  Effectively farm products are losing buying power relative to broad consumer products.  An aggregate bundle of farm products today is sold for 5.25 times the price received in 1970.  On the other hand, a bundle of consumer products costs 7.5 times what it would have cost in 1970.  Farm commodities today will only buy about 70% of the consumer products they would have bought in 1970, and that is only after the gap has narrowed considerably since the spring of 2020.  

It is important to note that the agricultural industry as a whole is in better shape than the chart alone would suggest.  To offset the erosion of buying power, farmers have increased the quantity of products they sell by relying on improved production efficiency, yield gains, and growing the size of their farm.  In other words, the erosion of purchasing power per unit of farm output has been offset by increases in the scale of production.  Necessarily over time, an increase in farm size also implies a decrease in the total number of farms (two trends that date back hundreds of years).  The challenge for the individual farm or ranch is to manage times of volatility and uncertainty while also navigating the normal long-term trend of attrition, and thus surviving to be one of the “fewer” farmers moving forward.  We appear to be in the middle of one of those times when price volatility is a significant management challenge.          

Figure 2.  Consumer Prices and Farm Product Prices

The warning on the horizon for agricultural producers is not the immediate problem of inflation.  Instead, the concern is what comes after.  Producers can weather inflation reasonably well, as long as, farm prices are moving more-or-less in conjunction with input prices.  Such a situation is not unprecedented: take the 1970’s as an example.  While the 10 years from 1973 to 1982 represent some of the worst inflation in this country’s history, we don’t talk about a 1970’s agricultural crisis because farm prices were mostly keeping pace.  In fact, in the face of extraordinary inflation, agricultural conditions encouraged farmer investment and taking on additional debt.  The crisis didn’t appear until the 1980’s.  As inflation moderated and commodity prices flat-lined, the burden of servicing debt at high interest rates (which were both a result of and the treatment for high inflation) became unsustainable for an industry that was not only highly dependent on short and intermediate term financing but that had also leveraged up to high debt levels.  The lessons moving forward in an uncertain economy where both inflation and farm prices are rising together: 1) farm prices are not likely to keep up with broader inflation rates indefinitely, 2) higher interest rates are very likely coming soon, and 3) don’t take on new debt based on the assumption that current conditions will continue. 

Anderson, John D. , Steven L. Klose. “Inflation and Farm Prices.” Southern Ag Today 2(22.3). May 25, 2022. Permalink