U.S. Agriculture: Challenging Times Ahead
Seven Impacts Of ‘High Corn’
Regardless of how we got here, what’s clear is that commodity prices in general — and corn prices in particular — have been well above historical norms for most of the past five years. This period of high prices has caused several impacts that feel good in the short term but sow the seeds of distorted valuations and mal-investment (which ultimately don’t feel nearly as pleasant). These long-term impacts fit into seven primary categories:
1. New Technology Introduced into Agriculture. Technologies which generate an incremental few bushels of corn are very difficult to justify when prices are low. At higher prices, however, farmers can quickly justify the expenditure. The boom in biologics, specialty fertilizer and enhanced seed all provide evidence of this technology induction effect. A related phenomenon we are observing is technology migration from high value coastal crops to the Midwest. This is by far the most desirable and sustainable impact of the price boom, as these technologies will probably be around far longer than temporarily elevated corn prices.
2. New Land Introduced into Production. The value of corn and soybeans has resulted in significant acreage expansion in these crops. In many cases this acreage came from other crops such as wheat, oats, barley, and sorghum, but a great deal of this acreage came from conservation reserve (CRP) acreage that was rolled out of conservation and into production. After five straight years of increases, in 2013 farmers planted the most acres of corn since 1936.
3. Demand Rationed Among Existing Users. Some of the loudest critics of ethanol have been livestock producers, for an obvious reason. The spike in corn prices over the past five years has resulted in significant profit declines for livestock producers, extraordinary efforts to incorporate alternatives like DDGSs into rations, and downsizing of herds to cope with decreased profitability.
4. Increased Farm Income. Farm income has spiked in recent years as enhanced corn profitability drifted down to the bottom line. U.S. growers have reaped record profits over the past several years, ironically even in the drought year of 2012, due partly to dramatically higher prices and partly to lucrative crop insurance payments.
5. Higher Seed, Chem and Equipment Sales. Sales of inputs, from fertilizer to chemicals to seeds to equipment, have all risen dramatically over the past five years. Part of this growth was volume growth due to greater acreage, but a substantial portion was unit pricing growth for primary inputs.
6. Increased Ag Asset Prices, Especially Land. We have all been reading for several years about the dramatic increases in farmland prices, with quality Midwest farm ground fetching $12,000 to $15,000 per acre. Cash rents have doubled with many growers paying $350 to $500/acre.
7. Outside Investment in Agriculture Stimulated. Outside ownership of farmland is increasing dramatically, with institutional and private investors buying substantial quantities of farmland. Private equity and venture firms have also substantially increased their investment in the sector.
Waning Ethanol Support
For those following the news on the RFS, a great debate is underway on whether U.S. government support to ethanol will be decreased. Regardless of the outcome of this debate, it seems the presence of the RFS has been largely priced into commodity markets, which means the only logical impact of a reduction in the RFS is a further decline in corn pricing.
This is critical as the markets have adjusted to a “new normal” of 13 billion gallons of corn ethanol.
The majority of the impact of this volume has already been built into the markets, which means the most likely impact of any changes to the RFS are downward as the market responds to less demand than what it had previously priced for corn in ethanol.
The high price of corn has had the impact that any economist would predict — expansion of supply and destruction of demand. More corn acres, both in the U.S. as well as abroad, have increased supply, as well as a deep focus on the development of yield enhancing technology. The livestock industry and corn export markets have borne the brunt of the corn demand destruction. Ethanol demand destruction is more erratic as variability in global oil prices, along with corn, determines the “spread” for ethanol production.
The Road From Here
Most importantly, the profit engine for producers is sputtering as higher land and input prices combine with reduced corn prices to dramatically shrink margins. At the likely contribution margin from corn production, today’s cash rents are simply unsustainable — cash rent negotiations between landowners and tenants is likely to be pretty painful this winter. We can also expect dramatically tighter production margins to negatively affect input and equipment sales volumes and pricing strength going into 2014. Recent declines in corn prices, when combined with better protein prices, should enhance livestock profits along with corn demand.
In economic terms, the ag market has “gotten ahead of itself” and we can expect a year or two of correction while we undergo some demand expansion and supply contraction, the exact opposite of the past few years. By 2016-17 a more sustainable long-term bull market built on global demand is likely to emerge after our secular agricultural uptrend experiences a cyclical correction.