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Verbal Farm Tenancy Protection in the South

When one inherits or purchases an interest in open farmland – particularly between March and November in the South – chances are someone is growing crops or pasturing livestock on it. Often, there is no written agreement between landowner and farmer. Statistically we know that the majority of farm tenancies renew annually (ERS, 2016), which may support anecdotal observations that verbal farm tenancies are common. Such “handshake” agreements provide no written record of the bargain struck between landowner and farmer as to rent and term. For farmers working multiple parcels with different owners, keeping the bargains straight may pose a challenge. As land changes hands between owners due to inheritance or sale, questions emerge including the farmer’s rights to crops and fixtures, the apportionment of rent between successive owners, and circumstances of renewal.

Given the relative vulnerability of the farmer in this equation, states’ landlord-tenant policies have evolved to provide farmer access rights through the harvesting and sale of their crop and its profits – known as emblements – in the event a landowner or successor tries to move them off and bar access. All southern states have some form of farm tenancy laws, varying in their specificity and determination of tenant rights. Such statutes may supply length of term (e.g. South Carolina) and prescribe termination notice periods required to prevent automatic renewals, often of one month or greater (e.g. Mississippi). Some laws allow a landowner to terminate a tenancy before planting, as in Alabama. The status of improvements – called trade fixtures – placed by the farmer can also come into question, and Georgiaprovides that any items on the parcel at the close of term become property of the landowner. Most such laws ensure payment of rent with a priority lien on crops in favor of the landowner. At the moment, there is no comprehensive source locating and describing farm tenancy laws for the southern states, however, this article serves as a summary of issues such laws might address, using North Carolina as an example. To locate your state’s farm tenancy law, try the search terms “farm” or “agriculture”, “tenant” or “tenancy”, and “[state] Code.”

Regardless of statutory protections, farm tenancy disputes require verbal sworn testimony in court to resolve, and otherwise require judicial interpretation of vague statutory language, so resolving disputes can be costly. Better practice dictates some form of writing to clarify the issues described above. Though farm leases can be a lengthy treatment of rights and responsibilities, or very short statement of place, rent and term, they serve as the clarifying record of the bargain which likely reduces disputes and expense to both landlords and farm tenants.

Brannon, Robert Andrew. “Verbal Farm Tenancy Protections in the South“. Southern Ag Today 2(23.5). June 3, 2022. Permalink

June 3, 2022
The Imminent Menace of Sanitary Barriers in International Trade

Animal disease outbreaks have severe economic consequences, especially for international trade. A recent example was the identification of two atypical cases of bovine spongiform encephalopathy (BSE) in Brazil in early September 2021. Although Brazil’s BSE status did not change within the World Organization for Animal Health, severe sanitary restrictions interrupted Brazilian beef trade. Egypt and Saudi Arabia halted beef imports from Brazil for two weeks. China and Hong Kong, which account for about 60% of Brazil’s beef exports, suspended beef imports from Brazil for more than three months. In the month following the notification of the BSE cases, international shipments of Brazilian beef were 49% lower compared to the same period in 2020. Consequently, domestic prices of live animals decreased by 8% in September, and 11.8% in October 2021, leading to the most unfavorable cattle market conditions in Brazil since 2000.

As in the case of Brazil, identification of animal disease is an imminent risk for the U.S., simply because diseases can be difficult to control and have widespread consequences. This risk is demonstrated by the current outbreak of avian influenza in the U.S., which has affected 24 states so far and led to restrictions on American poultry products imported by Canada, Mexico, and China. The extent of the economic damage from this current outbreak is still unknown.

Countries that are major exporters of animal products, such as the U.S., are substantially impaired by sanitary barriers when animal disease outbreaks occur. Trade diversion to other suppliers can cause significant export market losses, as observed during the 2000’s after the BSE outbreak in the U.S. Animal disease events in Brazil and the U.S. highlight the importance of understanding risks within agricultural systems in terms of the direct impact of disease on animal health and food safety, as well as the amplified international trade impacts.

Figure 1. Monthly Beef Exports and Cattle Price Index in Brazil in 2021

Source: ComexStat. 2022. Brazilian Ministry of Development, Industry and Foreign Trade; and Center for Advanced Studies on Applied Economics (Cepea). 2022. University of Sao Paulo.
Links: http://comexstat.mdic.gov.br/pt/home; https://www.cepea.esalq.usp.br/en/indicator/cattle.aspx

Menezes, Tais and Amanda Countryman. “The Imminent Menace of Sanitary Barriers in International Trade.” Southern Ag Today 2(23.4). June 2, 2022. Permalink

June 2, 2022
Inflation and Interest Rates

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

Data Source: St. Louis Federal Reserve Bank, FRED Economic Data, https://fred.stlouisfed.org/.

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.

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

June 1, 2022
Pricing Hay for Profit

Hay production is one of the largest and most economically significant agricultural enterprises in Alabama with 700,000 acres farmed producing 2,170,000 tons of product valued at $217,000,000 (USDA-NASS).  Hay is used as livestock feed for cattle, horses, and small ruminants. Hay can also be used as bedding, mulch, decoration, and numerous other uses. Price ranges for hay sales often depend on variety baled, the size and structure of bales, and the quality of the bale.

Prices of inputs used in agricultural production have increased in 2022 throughout the United States. Fertilizer, chemical, and fuel costs have increased significantly, leading to even more questions as to how producers should price hay to their hay consumers (and likewise what livestock producers should be willing to pay). The costs of nitrogen, phosphate, and potash used to produce a round bale of bermudagrass hay has increased 95% from May 2021 to May 2022.

Know Cost of Production

Hay producers must know their cost of production, including both fixed and variable costs. They must also determine the minimum profit margin they are willing to accept for their product. Both cost of production and acceptable profit margin will vary greatly among producers and careful consideration should be given to both.

Cost of production can be broken down into two segments: variable costs and fixed costs. Variable costs are the costs that change as our production changes, such as fertilizer. Variable costs only occur if we produce.  However, as producers increase production, the amount of nutrients removed from the soil will also increase and therefore the cost of maintaining production and fertility will increase significantly.

Based on the ACES Enterprise Budgets for round bale bermudagrass hay, variable cost of production has increased 64% from May 2021 to May 2022.  While this is driven primarily from higher fertilizer prices, one can see that all other costs, except the price of the soil test, has increased.  We estimate the 2022 variable cost of production to be $71.88 per 1000-pound bale, up from $43.87 in 2021.

Fixed costs on the other hand will occur whether producers are actively farming or not. An easy example of fixed costs would be land taxes and depreciation – both of these happen whether the producer spreads fertilizer, cuts hay, or doesn’t do anything.  Producers should take into account all of the equipment, land, tax, insurance and other fixed costs that are often ignored when budgeting costs for hay production.

Consider Profit Margins

There are factors beyond the cost of production that also need to be considered when pricing hay. The profit margin that producers are willing to accept is a necessary consideration. Margins can be a percentage of costs or a dollar value per unit of production and is based on the amount of profit one expects or needs on a given enterprise unit. This will vary significantly by producer and situation. Ultimately each producer must assess his own cost of production and his own acceptable profit margin when pricing their hay – and each producer might be different than his neighbor.

While a price should first consider the cost of production and profit margin, one must also consider what consumers will be willing to pay. Purchasers of hay are going to consider alternative feeds and the relative price of those alternatives. If the price of alternatives has not increased much, consumers may be willing to switch to other products. Calf prices will dictate what a buyer is willing to pay.  Competing products may also simply be hay from an alternative seller in a neighboring county or farther geographic location. Long-term relationships with buyers may also be circumstances where a producer may choose to limit their expected profit margin to keep current customers happy. Finally, dry weather that may reduce current or expected future supply of hay will lead to higher prices.

Kelley, Ken, Adam Rabinowitz, Max Runge, and Wendiam Sawadgo. “Pricing Hay for Profit.” Southern Ag Today 2(23.2). May 31, 2022. Permalink

May 31, 2022
Managing the Price Risk Gap between December Corn Futures and Projected Crop Insurance Prices

Since the projected crop insurance price was established at the end of February, a substantial price gap ($1.51 ¾ per bushel as of May 18^th) has opened between the current December futures contract price and the projected crop insurance price (Figure 1). The futures rally has been fueled by numerous factors – Ukraine-Russia, drought concerns in the U.S., lower planted acreage in the U.S., high input prices, strong global demand, and reduced global stocks. The strong upward trend in price has made producers hesitant to make sales or hedge price risk. Many producers have been reluctant to cash forward contract a large portion of their 2022 corn due to fears of missing out on higher prices and production concerns in drought affected regions in the South. Additionally, producers that traditionally use futures to hedge price risk are concerned with the potential for large margin calls if prices continue to appreciate.

Figure 1. December Corn Futures Contract Daily Close and the Projected Crop Insurance Price, January 3, 2022, to May 18, 2022.

A marketing tool worth considering is options. Options strategies can be made as complex or simple as the market participant desires. This article illustrates two examples. Alternative #1 is more complex, and Alternative #2 more basic. For the two strategies, the goal is to manage downside price risk on 15,000 bushels (three 5,000-bushel contracts) while allowing upside mobility in the futures price. We do not include basis in the analysis and all prices and premiums are as of May 18 for the December 2022 corn futures contract. Results shown are at option expiration when time value in the premium goes to zero.

The two alternatives examined are:

Alternative #1:

Sell one $7.50 put option for a premium of $0.75;

Sell one $7.50 call option for a premium of $0.75; and

Buy three $7.10 put options for $0.50.

The strategy results in a net zero premium to the producer (excluding transaction costs). Alternative #1 is subject to maintaining margin in a futures and options trading account.

Alternative #2:

Buy three $7.10 put options for $0.50.

The strategy costs the producer $0.50 per bushel up front (plus transaction costs), but no margin account is required.

Figure 2 depicts the outcome for both alternatives if December corn futures trade between $4.00 and $10.00. If the red dotted line (Alternative #2) is above the black line (Alternative #1), then Alternative #2 has a preferable outcome to Alternative #1, and vice versa. Based on the analysis there are two key December corn futures prices when the preference between the two alternatives switch – $6.00 and $9.00. Simply stated, if the December corn futures contract price is between $6.00 and $9.00, Alternative #1 yields a greater outcome than Alternative #2.

Figure 2. Outcomes for two options strategies at December corn futures contract prices between $4.00 and $10.00.

Both strategies can help manage price risk for corn producers. Alternative #2 sets a futures price floor at $6.60 ($0.70 above the projected crop insurance price) and allows the producer to participate if the December futures contract continues to strengthen. Additionally, the put options could be resold, and a portion of the time value recovered, prior to expiration if December corn futures prices remain high. Alternative #1 provides greater outcomes when the December corn futures contract is between $6.00 and $9.00; however, it does not set a futures price floor and comes with margin requirements.

The two alternatives described above are examples of how options can be utilized to reduce price risk in futures markets. For those producers new to trading futures and options, it is strongly recommended to work with a qualified broker or professional when examining potential strategies and outcomes.

Disclaimer: Comments are for educational purposes and are not meant as specific trading recommendations. The buying and selling of corn options involve risks and are not suitable for everyone. Working with a qualified broker or grain merchandiser is strongly suggested.

References and Resources:

USDA – Risk Management Agency. Price Discovery Tool. Accessed at: https://prodwebnlb.rma.usda.gov/apps/PriceDiscovery/GetPrices/YourPrice

Barchart.com. Corn soybean and wheat historical futures prices. Accessed at: https://www.barchart.com/futures/grains?viewName=main

Smith, Aaron. “Managing the Price Risk Gap between December Corn Futures and Projected Crop Insurance Prices“. Southern Ag Today 2(23.1). May 30, 2022. Permalink

May 30, 2022