By Lauren Turley, University of Kentucky Department of Agricultural Economics
Economic & Policy Update
If you have spoken with a farmer in the last month, I can almost guarantee one topic of conversation was the futures market. Cattle farmers are reaping the record high beef prices, while grain farmers are on the other side fretting, as grain prices have decreased to the lowest levels seen in several years. Grain producers have been projecting budgets for the upcoming years and realizing that something has to give. Expected returns are not high enough to cover all of the costs and provide a return to operators.
Most Kentucky grain producers have realized record returns the last three years and should have built equity in that time. However, it does not make it any easier to see the negative returns that are projected for the future. There may be some cost savings in 2015 if fertilizer price declines, as is expected. Other crop input prices are not expected to decrease. One major direct cost that should be examined is land rent, most likely the largest per acre cost for producers on ground that is not owned. In western Kentucky, competitiveness has taken rents to the next level. Many rents have been negotiated on a three or five-year term, thus the producer may be locked in at that level for the upcoming years. With slipping commodity prices, expectations would be a decline in rents going forward.
In Kentucky, from 2008 to 2013, average cash rents increased by 90%, according to USDA annual cash rent data. From 2009 to 2013, there was a 59% increase going from $93.50/acre in 2009 to $149/acre in 2013. Cash rents rose in recent years due to increases in land and operator returns, corresponding with the increased grain prices. Despite lower grain prices since fall of 2013, cash rents held steady for 2014. Throughout history, it has been demonstrated that rents may go down, but not usually by very much and not very often. Rents that are being negotiated now will likely be lower, and rightly so. Rent should decrease because of the projected lower returns; however, commodity prices are much more volatile than cash rents and farmers are at risk of losing farmland if landlords are not willing to accept lower cash rents. It is essential for producers to realize that not farming high cash rent farmland may be the best alternative to getting in a “bidding war”. There are some cash rents that may not need to be adjusted; either as a result of the rent being relatively low, or if the cash rent has lagged behind the increase in agricultural returns. Setting the cash rent for farms is difficult as the crop price and yield are unknown when the rental agreement is made. Rents will not always correspond to actual returns.
Other options to cash rents are crop-share agreements or flex leases. In the Ohio Valley area of Kentucky, crop-share rental agreements are the dominant rental agreement. In this arrangement, revenues, and sometimes direct costs, are shared between the land owner and the farmer. The share would depend on the type and quality of ground. With this agreement, the landowner is at risk just like the farmer, but there is an opportunity for the landowner to reap in the benefits of a stronger market or better production year. This year, farmers have become very interested in flex leases. With this type of lease, there is a floor, or minimum cash rent, and an opportunity for the landowner to receive a “bonus” under various circumstances. For example, a “bonus” may be paid if the gross revenue is higher than a trigger revenue, or if yields are higher than the trigger yields. If land owners are willing to share in some of the risk associated with production agriculture, they could receive higher average returns.
Grain producers need to begin looking at budgets for the upcoming years and determining if costs can be cut. Reality is setting in, and it looks like we will be seeing less than $4 corn for at least a couple of years. If rental agreements are up for renewal, conversations should be held with landlords to negotiate and talk about the options. The costs and returns should be analyzed. Cash rents have received much attention in the last couple of years, but as margins are squeezed, what will happen to cash rents is uncertain. If you have any questions about rental agreements, feel free to contact any KFBM specialist.