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Tuesday, September 30, 2014

Grain Profitability 2014 and Beyond: How Bad Does it Look?

By Greg Halich, University of Kentucky Department of Agricultural Economics
Economic & Policy Update

The grain markets have dropped dramatically in the last 12 months, and the resulting effect on profitability may not be fully understood by farmers, landowners, and lenders. Figure 1 shows the December 2014 Futures contract from 2011 to 2014. Note that before early fall of 2013, this contract was trading mostly between $5-6/bu. This was the expected price for corn that most farmers were banking on during this time period. The current price for this contract is around $3.30/bu, or about $2/bu lower than the average contract price in 2011-2013. The price drop for soybeans (not shown) has been similar, coming down about $3/bu from its average in 2011-2013.The cash price for fall delivery has fallen under important psychological barriers in a number of locations: $3/bu for corn and $10/bu for soybeans.

Costs for a western Kentucky farm are estimated in Table 1 on soil that averages 150 bushels corn and 45.5 bushels soybeans. Machinery and labor costs include depreciation and overhead costs, as well as an opportunity cost for operator labor. Fuel costs are based on $3.40/gallon diesel and 15 mile one-way trucking to the elevator. Land rent is highly variable and will be discussed later.

Final corn and soybean prices used in this analysis are based on the December futures prices on September 22, 2014 adjusted for a typical harvest basis: $3.00/bu for corn and $9.30/bu for soybeans. Table 2 shows the expected gross return (does not include land rent) given the costs in Table 1 and these expected commodity prices. It does not include potential Farm Bill program or crop insurance payments (these will be discussed shortly). The expected gross profit is -$4/acre for corn and $150/acre for soybeans.

Assuming a 50-50 rotation the average gross return would be $73/acre. Net return would be calculated by subtracting out the land rent. In western Kentucky, much of the ground with this type of productivity is being rented for $200-300/acre. If we use a $250 land rent, the net return would be a loss of $177/acre (yes, that is -$177 net profit/acre).

For central Kentucky, this situation is even worse due to an increased cost structure in this region. Specifically, higher costs for nitrogen (urea is the main nitrogen source) and transportation (one-way hauling distance of 50-100 miles is typical in this region). After adjusting for these increased costs the expected gross profit in central Kentucky is estimated at -$44/acre for corn and $143/acre for soybeans. Assuming a 50-50 rotation the average gross return would be $49/acre. Again, net return would be calculated by subtracting out the land rent. In central Kentucky, much of the ground with the type of productivity is being rented for $175-275/acre. If we use a $225 land rent, the net return would be a loss of $176/acre.

If we assume this farm had an 80% revenue guarantee crop insurance policy and that they were at their normal APH yield level, the resulting crop insurance payouts would be $70-75/acre for corn and $0/acre for soybeans. With a 70% revenue guarantee, the resulting crop insurance payouts would be about $5/acre for corn and $0/acre for soybeans assuming they were at their normal APH yield level.

Potential payouts for the Farm Bill programs are more speculative, but with a few assumptions we can come up with a reasonable range. First, I’m assuming that Average Revenue Coverage (ARC) at the county level will be the most widely utilized program and thus will analyze just that program (although PLC has become much more attractive for corn in the last two months). Second, since the ARC program payout depends on county yields, I will analyze six representative counties: Union, Daviess, Todd, and Graves counties for western Kentucky, and Woodford and Clark counties for central Kentucky. I’ll look at a range of yields for both corn and soybeans. For the estimated 2014-15 marketing year prices, I’m below the mid-point of the WASDE estimates that came out in September as futures prices have dropped the last two weeks. Finally, I’m assuming the base acreage for the Farm Bill programs will make up 90% of planted acres in Western Kentucky and 25% of the planted acres in Central Kentucky. Table 3 shows the likely payouts for the ARC program. Note that in western Kentucky corn payments per planted acre (adjusted for base acreage) will likely be in the $55-65/acre range, and that for soybeans the final payment will depend heavily on yield. In areas with normal to good soybean yields, the payment will likely be in the $0-25/acre range; while in areas with low yields, the payment will likely be in the $25-45/acre range. Likely payments in central Kentucky are much lower due to the assumption that only 25% of planted acres are base acres. As a result, the likely payouts on a per planted acre basis will be $14-18/acre for corn, and $0-14/acre for soybeans. Note: these are rough estimates and are based on the best understanding of this program at this point in time (final regulations are not out yet).

Overall Profitability Estimates for 2014 Including Crop Insurance and ARC Payments:
Once we add in crop insurance and ARC payments, we can estimate overall profitability in both western and central Kentucky. I’m going to assume a 75% revenue guarantee for this purpose, average yields, and a 50-50 rotation of corn and soybeans.

Western Kentucky
Gross Profit   $73
Land Rent -$250
Crop Insurance $20
ARC Payment $40
Net Profit per Acre -$117

Central Kentucky
Gross Profit   $49
Land Rent  -$225
Crop Insurance  $20
ARC Payment  $12
Net Profit per Acre  -$144

Based on these assumptions, a grain farmer would be expected to lose about $120/acre in western Kentucky and $145/acre in central Kentucky. These figures are heavily dependent on the actual land rent and the figures used here were for illustrative purposes only. These totals also include non-cash costs of labor (roughly $25/acre) and depreciation/overhead (roughly $40/acre). Thus, on a cash-flow basis these loses would be closer to $50/acre and $80/acre in western and central Kentucky respectively.

Farmers that forward contracted for 2014, particularly if they did so before March, will be in better shape. Let’s look at the example where they forward contracted corn at $4.50/bu and soybeans at $12/bu. If they forward contracted 25% of their crop at these levels, this would increase their net profit $43.50/acre on average. If they forward contracted 50% of their crop at these levels, this would increase their net profit $87/acre on average. Based on my informal discussions with both farmers and elevators throughout the state, forward contracting for 2014 has been far below normal levels. The reason I have most often heard for this was that farmers were waiting for prices to go back up. They are still waiting. My guess is that few farmers had 25% of their crop forward contracted by the time spring planting ended.

Obviously, these negative returns cannot occur indefinitely, and cash rents will start to decrease as leases come up for renewal. But in the short-run we will likely see steep losses in the grain sector of Kentucky’s farm economy. Grain prices are projected to increase about $.60/bu for corn and increase about $.20/bu for soybeans in 2015 and 2016. With these price levels, overall profitability would increase about $40/acre (this includes likely drops in crop insurance and ARC payments), still leaving net profit solidly in the red.

Both farmers and lenders need to be prepared for this. Beginning farmers and farmers who expanded their operations significantly in the last few years are at the most risk. Both would have likely paid higher than average land rents to expand their operations. Beginning farmers would also have low overall equity and thus will have limited cash reserves to weather a financial storm.

There have been a number of reasons given why this potential grain farm crisis will not be as bad as that seen in the 1980’s: 1) farmers have had a number of very good years to build equity, 2) they are not nearly as leveraged as in the 1980’s, and 3) interest rates are much lower. I agree with all of these points. However, what I am most concerned about right now is a problem that does not seem to be getting much attention. During the last 3-5 years too many grain farmers have been buying an excessive amount of new equipment and other large capital expenditures. These farmers will have abnormally high machinery cost structures for depreciation and overhead. Although there are no statistics to quantitatively back this up, I’d be willing to bet that collectively, Kentucky grain farmers have added the capacity to farm 20-30% more land than they could have just five years ago. The result will be a continued battle for acreage. The only way to pay for all this new equipment is to farm more acreage. In the short-run, as long as they are covering their variable (cash) costs these farmers will continue bidding up land rent. As a result, rents will not come down as quickly as would otherwise be expected, and the bleeding will continue until enough capacity has left the game (i.e. bankruptcies). I hope that I’m wrong, but I fear this is the most likely scenario over the next 2-4 years unless commodity prices quickly rebound. Greg Halich can be contacted at or 859-257-8841.

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