Category: Farm Management

The Russian invasion of Ukraine has already had a significant impact on the global economy.  In a recent article on this site, Dr. Aaron Smith explored the grain and oilseed market implications of the conflict.  As significant as these are, they are not the only market disruptions of concern to the agricultural sector.  Russia is a major producer of energy and fertilizer, key inputs across the entire agriculture industry.

According to data from the U.S. Department of Energy, Russia is the third largest energy producer in the world and a significant source of oil and petroleum products for the U.S.  In 2021 the U.S. imported a total of 2.23 billion barrels of crude oil.  Only about 3% (72.6 million barrels) of this came from Russia – still enough to make Russia our fourth largest source of foreign oil.   Russia’s share of imported refined products is considerably larger than its crude oil market share.  In 2021, the U.S. imported 860.9 million barrels of refined products.  Russia supplied 20% (172.6 million barrels) of those imports, making that country our second largest foreign source of refined products (behind Canada).  Given Russia’s status as a major petroleum provider, it is not surprising that the sudden isolation of that market in response to the conflict has affected fuel prices.  For the week ending March 14, the U.S. average retail gasoline price (all grades, all formulations) was a record (in nominal terms) $4.414 per gallon, eclipsing the previous high from the summer of 2008. 

Russia is also a global leader in fertilizer production and exports, as shown in Figure 1.  Russia dominates global exports of urea and ammonium nitrate.  According to World Bank data, in 2018 (most recent complete data) Russia accounted for 17% of all urea exports and 40% of all ammonium nitrate exports.  With respect to ammonium nitrate, the second largest exporter (the EU) accounted for just 7% of world exports.  In 2018, Russia was also the third leading exporter of potash, accounting for just over 17% of world exports (far behind Canada’s 43% export share).

To be fair, fuel and fertilizer prices were on the rise well before the onset of hostilities in Ukraine.  Retail gasoline prices have increased steadily since their pandemic-induced low in April 2020.  Fertilizer prices began a steady march upward beginning last summer, topping out late last year before retreating in the first quarter of 2022.  But the effects of the Russian invasion – extensive sanctions on Russian products, loss of access to the global financial system for Russian companies, and the disruption of Black Sea trade routes – have reinforced and accelerated the inflationary trend on fuel and fertilizer.

For farmers, the market impacts of the conflict in Ukraine will make a high-cost year even worse.  Farmers had already planned for expensive fertilizer, and fertilizer purchases for the new crop have likely already mostly been made.  Rising prices for nitrogen may yet be a problem for some producers, and it seems possible – given global reliance on Russians supplies of nitrogen – that availability of nitrogenous fertilizers may become limited if the conflict drags on.  Fuel prices are going to be far higher than most planning budgets assumed, cutting into expected margins, particularly in more energy-intensive production systems (e.g., irrigation-intensive crops like rice).  The commodity market reaction to the conflict has created an attractive pricing opportunity on some crops, but this early in the production cycle – with planting barely underway – the decision of how aggressively to forward price can be a difficult one.

Figure 1.  Major Exporters of Selected Fertilizer Products

References and Resources

U.S. Department of Energy, Energy Information Administration Petroleum market data: https://www.eia.gov/petroleum/

 World Bank, World Integrated Trade Solution On-line Database International trade data by harmonized system (HS) code:  https://wits.worldbank.org/country-indicator.aspx?lang=en

Anderson, John D. . “The Russia/Ukraine Conflict and Farm Input Markets“. Southern Ag Today 2(14.3). March 30, 2022. Permalink

Agriculture has experienced a significant amount of change in both crop prices and input prices in the last couple of months. These changes can make it difficult for producers to determine which crop is going to be the most profitable for their situation. When deciding between two different crops a producer should examine what the costs of production for those two systems would be, along with their respective yield potential and crop price. Yield can vary from year to year so evaluating over a range of yield outcomes can give a better idea of how optimal crop choice could change as well.

Figure 1 is an example output from the Net Returns Comparison Calculator developed at Mississippi State, showing the difference in net returns between an irrigated corn system and an irrigated soybean system across a range of yield outcomes. Returns were compared using costs of production from the Mississippi State Enterprise Budgets and prices of $6.00/bu for corn and $14.68/bu for soybeans. Corn is shown to have higher returns than soybeans at most of the yields examined. Soybeans have higher returns than corn when soybean yields are relatively high. In this situation the producer can see that corn will generally be the more profitable option, unless they have a field that historically produces high yielding soybeans and low yielding corn. These results will change as prices and input costs change. For example, a fertilizer price increase would negatively impact corn more than soybeans, making soybeans more competitive.

The results shown in Figure 1 are not going to be the same for every producer. Every producer has their own unique costs and yield potential. It is important for them to evaluate their crop choices given their own situation. The Excel tool used to create Figure 1 can be found at https://www.agecon.msstate.edu/whatwedo/budgets.php (select and download the Net Returns Comparison Calculator). Users can compare net returns between various crop production practices for corn, cotton, rice, and soybeans. This tool can even be used for enterprises outside of Mississippi as users can customize the budgets to reflect their own farm’s costs, yields, and prices received. The more information collected on costs of production the more accurate these comparisons will be and ultimately the more informed decision on which crop is going to be the most profitable. 

Figure 1. Comparison of Net Returns between a Corn and Soybean Production System with MSU Net Returns Comparison Tool

Difference in Returns Between Corn and Soybeans $/ac

Corn Yields bu/ac

	190	200	210	220	230	240	250
45	$       246	$       303	$       361	$       419	$       476	$       534	$       592
50	$       173	$       231	$       289	$       347	$       404	$       462	$       520
55	$       101	$       159	$       217	$       275	$       332	$       390	$       448
60	$         29	$         87	$       145	$       202	$       260	$       318	$       376
65	$        (43)	$         15	$         73	$       130	$       188	$       246	$       304
70	$     (115)	$        (57)	$           1	$         58	$       116	$       174	$       231
75	$     (187)	$     (129)	$        (71)	$        (14)	$         44	$       102	$       159

Note: Any value in white, corn has higher returns than soybeans. Any value in red, soybeans has higher returns than corn

Mills, Brian E. . “Crop Returns Comparison“. Southern Ag Today 2(13.3). March 23, 2022. Permalink

One of the biggest challenges to farmers and landowners is negotiation of farmland leases in a manner that leaves both parties satisfied. Too often, fixed cash leases are negotiated and within a short period of time one person or the other is getting less than they think they should. One solution to this is to re-negotiate fixed cash leases on a regular basis and recognize that they will need to be changed to reflect the variability in the market and/or production conditions. Another solution is a flex lease.

Flex leases are designed with a base cash rent amount (negotiated at the beginning of the season) and a flexible “bonus” amount that depends on either market prices, yields, or both. The idea is to guarantee the landowner a certain amount of rent and have both parties share in the good times as well as the bad times. When set up correctly, they will adjust for changing revenue conditions.

The base rent needs to be calculated at the beginning of the season and is often tied to a published or well-documented measure.   A couple of options might be: a negotiated premium/discount from the county-average rent from USDA or a percentage of historical gross revenues from the leased farm (for example 15-20%). The flex component (determined at the end of the season) can be calculated as a percentage of actual gross revenue or a measure of gross margin (gross revenue less variable costs of production). For example, you might make the flex component of the payment 20-30% of gross margin.  Another flex component could be a discount in the base rent if total costs are not covered so the landowner shares in the downside risk.

A few things to remember, as you negotiate a flex lease:

1) WRITE IT DOWN, don’t rely on a verbal agreement,

2) Keep the calculations simple and transparent to avoid misunderstandings, and

3) Be willing to renegotiate if things get out of line, which can happen with big swings in farm profitability.

Flex leases should encourage communication between landowner and tenant, which will help in overall lease negotiation.

Taylor, Mykel R. . “Flex Leases for Crop Producers“. Southern Ag Today 2(12.3). March 16, 2022. Permalink

Determining what to pay or charge for custom rates is a challenge in normal years. There is very little publicly available data on custom rates, and though many universities publish surveys of custom operation rates, they usually aren’t updated every year. 

This year, rapidly rising input costs will likely compound the already challenging process of agreeing on what to pay for custom operations. However, we can estimate approximately how much we expect custom rates to increase based on the change in costs for two critical inputs: fuel and labor. Combined, these two inputs represent approximately 25% of the cost of field operations during an average year, with overhead (repairs, maintenance, depreciation, transportation, etc.) representing the other 75%. 

Restructuring the economy post-COVID-19, supply chain disruptions, and mass movement of workers around the country all led to rapidly rising wages in 2021. The Bureau of Labor Statistics (BLS) reports that the cost of employment rose approximately 4.5% across the board and approximately 4.3% for farming occupations in 2021. Surveys of private firms suggest they are planning for wages to rise 3% to 5% in 2022; a nominal increase that does not keep up with the current rate of inflation, meaning that real wages would be down. On its own, a 5% increase in wages would represent a 1% change in the cost of custom operations to maintain profit margins, on average. 

As recently as December 2021, the Energy Information Administration (EIA) forecast a modest increase in the average annual cost of WTI Crude from $68/barrel in 2021 to $73/barrel in 2022. However, cash WTI Crude is currently trading at $115/barrel. The recent war in Ukraine and Russia’s role in the global energy market led to a two-week spike in the price of WTI Crude, up from $90/barrel to $115/barrel. If prices remain at approximately $115/barrel, (many economists assume it will get more expensive before it gets less expensive) it will represent a 70% increase in the cost of crude over the 2021 average price. On its own, a 70% increase in the cost of fuel represents a roughly 10% increase in the cost of custom operations on average. 

The table below shows the expected change in the cost of custom operations as a function of different WTI Crude values. The February EIA Short Term Outlook (which was published prior to the Russian invasion of Ukraine) placed the 95% confidence bounds on 2022 forecasted average price of WTI Crude at $40/barrel and $60/barrel. The cost of fuel and labor account for a different percentage of each custom operation’s cost, so the change in the cost of fuel impacts each category differently. If the cost of fuel remains at $115/barrel and wages do increase 5% year over year, we can expect all custom operations to cost 10% more than in 2021, with the cost of grain harvest up 10%, the cost of tillage up 12%, the cost of planting up 8%, the cost of chemical and fertilizer application up 6%, the cost of forage harvest up 19%, and the cost of hay baling up 12%. If you don’t utilize custom operators, you may also view these figures as the expected increase in cost to conduct these operations yourself. 

Change in Cost of Custom Operations, 2021-2022, based on Different WTI Crude Prices and 5% Wage Increase 

Benavidez, Justin. “How much will the cost of custom operations go up this year?“. Southern Ag Today 2(11.3). March 9, 2022. Permalink

From planting trees to conducting timber sales, there are many things for landowners to consider when owning a timber property. Many forest landowners think about taxes only after they had a timber sale. However, there could be tax implications for each timber activity. It is important to conduct tax planning carefully. 

Here are a few tax tips for forest landowners to consider.

1.         Know the classification of your timber holding

Your timber holding classification is the first step in figuring out the federal income tax consequences of your timber activities. The classification determines which tax rules are applicable. Timber holding generally could be classified as one of the following three types: 1) property for personal use or as a hobby (not-for-profit); 2) property held as an investment; or 3) property held in a trade or business. Generally, you will get the best tax advantages if you materially participate in a timber business.  

2.         Understand timber sale income and capital gains tax

When you have a timber sale, you are taxed on the net income, rather than the gross proceeds. You are allowed to subtract selling expenses, timber depletion allowance, and yield tax from the revenue to get the net taxable gain. In most cases, the income from a standing timber sale is taxed at favorable long-term capital gains tax rate (0%, 15%, or 20% depending on the taxable income) if the timber has been owned for more than one year. If your timber is inherited, the gain is considered long-term in nature regardless of how long you have owned the timber. 

3.         Take advantage of the reforestation tax incentives

Eligible forest landowners may deduct up to $10,000 (married filing jointly) in qualifying reforestation expenditures per year per qualified timber property and amortize the rest over 8 tax years. You make the deduction against taxable income from all sources. 

4.         Recover operating expenses and carrying charges

If you materially participate in the timber business, you can fully deduct ordinary and necessary expenses associated with carrying on the business. For 2018 through 2025, forest landowners who hold timber as an investment are not allowed to deduct eligible operating expenses as itemized deductions. You may consider capitalizing (adding to basis) certain forest management expenses and carrying charges with proper tax elections. Timberland property taxes can still be fully deducted if you itemize. 

5.         Keep track of timber basis

Timber basis is generally the amount of capital investment in the timber. If the forestland was purchased, the original timber basis is the amount of the total acquisition costs allocated to the timber. If the property was inherited, the timber basis generally is its fair market value on the decedent’s date of death. If the property was received as a gift, the basis is generally the donor’s basis plus the gift tax. 

6.         Claim timber casualty loss deduction when a natural disaster hits

Timber loss caused by a casualty event (e.g., hurricane, storm, fire) may be tax-deductible. A forest landowner may deduct the lesser of the basis or the decrease in the fair market value of the affected timber block caused by the casualty.

7.         Consider excluding cost-sharing payments

Some conservation-oriented cost-sharing payments from qualified government programs qualify for partial or full income exclusion.  

8.         Take advantage of the Qualified Business Income (QBI) deduction if applicable

If your timber business has received ordinary income from selling cut timber products, pine straw, live trees, or other products, you may consider taking the QBI deduction. It is available for tax years 2018 through 2025. 

9.         Smooth out timber income over years

You may consider using an installment sale approach (lump-sum contract) or a pay-as-cut contract to smooth out your timber income over several years if such an arrangement can minimize total taxes. 

For more details on these tax tips as well as others, please see the publication: https://www.timbertax.org/publications/fs/taxtips/TaxTip2021.pdf.

Disclaimer

The material herein is for general informational and educational purposes only and is not intended as financial, tax, or legal advice. Please consult with your tax advisor for advice concerning your particular tax situation. 

Li, Yanshu. “Tax Tips for Forest Landowners“. Southern Ag Today 2(10.3). March 2, 2022. Permalink