Comparing Current and 1970 Farm Prosperity: Production Response

Carl Zulauf, Professor, and Nick Rettig, Undergraduate Student
Ohio State University, May 2013

Overview: This post is the fifth in a series that contrasts and compares the farm prosperity of the 1970s with the current period of farm prosperity. It examines the response of corn, cotton, soybean, and wheat production during the two periods of prosperity, both in the U.S. and the rest of the world. These 4 crops are examined because they have the largest quantity and value of exports among U.S. crops. The previous posts in this series are available here, here, here, and here.

Analysis: These variables are examined for both the U.S. and world: (1) harvested area, (2) production, and (3) yield per harvested area. Source of the data is the United Nations, Food and Agriculture Organization, available at http://faostat3.fao.org/home/index.html. As with most posts in this series, a benchmark average value is calculated for 1968-1972 and 2001-2005. These periods predate the 1970 and current period of farm prosperity, respectively. Five year averages are used to dampen the variability that can exist if a single year is used as a benchmark. The latest year for which information is available is 2011, the 6th year after 2005. The 6th year after 1972 is 1978. There is no definitive way to decide when to start the period of prosperity or what period to use as a benchmark, but our choices are reasonable. While the current period of prosperity is still on-going, 6 years is long enough for an initial comparison.

World Production Response: Economic principles suggest production should expand more rapidly during a period of prosperity since revenue is higher. This implication is examined by comparing the average annual rate of growth in production between 1968-72 and 1978, between 2001-2005 and 2011, and between 1978-1982 and 2001-2005. The latter period spans the end of the 1970 period of prosperity and the period preceding the start of the current prosperity. In general, growth rates in production are higher during the two periods of prosperity (see Figure 1). World cotton production between 1968-72 and 1978 is an exception. In addition, the growth rate of world soybean production is basically the same during the current period of farm prosperity as between 1978-1982 and 2001-2005. One reason for the low growth rate of cotton production during the 1970 period of prosperity is below average U.S. yield in 1978. However, this situation also underscores that a general period of crop prosperity does not mean the degree of prosperity is the same for all crops.

Figure 1 also reveals that, excluding cotton, average annual increase in world production has been slower between 2001-2005 and 2011 than between 1968-1972 and 1978. In particular, soybean production has grown slower. This finding may come as a surprise given the attention devoted to Chinese soybean demand. A factor contributing to this finding is that world soybean production averaged 240 million metric tons in 2007-2011 vs. 44 million metric tons in 1968-72. Higher growth rates are easier to obtain when production is small for no other reason than production is expanding from a small base. In contrast, the annual increase in quantity of soybeans produced was more than double between 2001-2005 and 2011 than between 1968-1972 and 1978 (11.1 vs. 5.2 million metric tons per year). Nevertheless, the annual percent growth rate is so much smaller during the current prosperity that other factors are likely at work. The most likely is the growth in distillers dried grain from increasing ethanol production. Distiller dried grain can partially substitute for soybean meal in feed rations, with the amount of substitution varying by animal species and stage of development.

U.S. Contribution to World Production Response: Figures 2 through 5 present the share of increase in world production and in world harvested area accounted for by the U.S during the two periods of farm prosperity for each crop. Shares are presented for both production and harvested area because weather affects area less than production (yield) in a given single year.

The story that emerges for both production and area is similar. Therefore, the following discussion will focus on harvested area. Between 1968-1972 and 1978, the U.S. accounted for 24%, 38%, 51%, and 52% of the increase in world harvested area of wheat, cotton, soybeans, and corn, respectively. In comparison, the U.S. contribution between 2001-2005 and 2011 was -26%, -75%, 2%, and 18% for wheat, cotton, soybeans, and corn, respectively. Thus, a striking difference between the two periods of farm prosperity is the much smaller role of the U.S. in the world production response during the current period of prosperity. One reason for this difference is the smaller expansion in U.S. crop area during the current period of prosperity, which was discussed in a previous post available here.

A negative number means U.S. harvested acres declined. Thus, harvested area in the rest of the world had to increase more than for the world as a whole to offset the U.S. decline. To illustrate, area of cotton harvested in the U.S. declined by 3.3 million acres between 2001-2005 and 2011. Area of cotton harvested in the world increased by 4.4 million acres, meaning that harvested cotton acres increased by 7.7 million acres in the rest of the world.

Longer Term Perspective: A competitive advantage long held by U.S. crop production is its higher yield. However, this advantage has declined substantially since the late 1960s and has disappeared for wheat (see Figure 6). In addition, average soybean yield over 2007-2011 was slightly higher in Brazil than the U.S. The long term decline in competitive yield advantage has underpinned a drop in the U.S. share of world production, especially for soybeans (see Figure 7). The decline has continued during the current period of farm prosperity, reflecting the lack of expansion in U.S. harvested area. The decline in the U.S. role in world cotton production during the current period of farm prosperity is especially notable. The size of this decline in combination with the slightly higher U.S. share in 2001-2005 than in 1968-1972 is consistent with the argument that U.S. cotton policy was substantially distorting U.S. production during the early years of the 21st Century.

Summary Observations: A distinct difference between the current and 1970 period of farm prosperity is the much smaller role the U.S. has played in the expansion of world production of corn, cotton, soybeans, and wheat during the current period of prosperity. In addition, the yield advantage of U.S. crops has been in a long term decline. Consequently, the role of U.S. crop agriculture in world crop agriculture is smaller during the current than 1970 period of farm prosperity.

Everything else the same, a declining U.S. role in world production means that the natural hedge for U.S. production should decline. The natural hedge is that a decline (increase) in production by a country will cause price to increase (decline). These offsetting changes stabilize revenue. The more important a country’s role in world production the more likely that changes in its production will affect price, thus increasing the reliability of the natural hedge. Since the U.S. role is declining, the natural hedge should decline, causing the variability U.S. crop revenue to increase.

The long term decline in the long-standing competitive advantage of U.S. crop production resulting from higher yields needs to be discussed. Specifically, U.S. agriculture needs to ask itself what factors will maintain its international competitive advantage as its yield advantage declines. This discussion is critically important for wheat, but increasingly so for cotton and soybeans.

Even though it is declining, the U.S. currently has a sizeable yield advantage in corn. Nevertheless, it is reasonable to expect that, as the U.S. develops drought tolerant and short season varieties for its drought prone and northern production areas, it will also bring more land into corn production around the world and will increase production on existing corn land that has less than ideal production capability. The 2007-2011 ratio of U.S. corn yield to rest-of-the-world corn yield is 2.43. In comparison, the 2007-2011 ratio of U.S. corn yield to North Dakota corn yield is 1.30, suggesting that the rest of the world can significantly expand corn production even without increasing acres.

While the financial crisis and associated bankruptcies of the 1980s were a traumatic event for U.S. crop agriculture, the most important, long lasting impact of the 1970 period of prosperity on the U.S. crop sector likely was the stimulus it provided to produce soybeans in South America. Similarly, it is possible that the most important, long lasting impact of the current period of farm prosperity is the stimulus it is providing to produce corn around the world.

A declining competitive advantage for U.S. crops will ultimately reduce the relative advantage of U.S. farmland and thus the price it can command. History never exactly repeats itself. Just because U.S. farms have not taken on substantial debt (see previous post here) during the current period of farm prosperity does not mean that farmland prices cannot decline. As revenue per acre declines, the value of farmland will decline. Revenue per acre can decline because price declines but also because relative yield declines. In short, the U.S. crop sector may be as vulnerable as it was in the late 1970s. This time, however, the reason is not debt, but may be declining competitive advantage.

The next post in this series will examine the response of U.S. livestock production during the two periods of farm prosperity.

This publication is also available at http://aede.osu.edu/publications

Click here to read article with Tables & Figures.

Oil and Gas Landowner Association Groups

By: Clif Little, OSU Extension

Individual Landowners working together in groups with a common purpose to secure more favorable lease terms and/or signing bonus and royalty have been forming throughout the shale regions of the United States for some time. The premise of the associations is that, many individuals representing a potentially large mass of oil and gas related resource gain leverage in the negotiation process. Landowner groups vary greatly in their structure and cost. While all members may benefit from such associations, it may be the individuals with small, oddly located parcels that benefit the most. The groups can be committee led with voting rights of members, attorney led groups, relator led, neighbor groups and a variety of other arrangements. Before joining any group there are several points for property owners to consider.

First conduct a thorough research of your property title and determine if you own your minerals. This can be done with the assistance of an attorney and possibly with the assistance of a title abstract company. There have been several individuals who have joined landowner groups thinking they own their mineral interest only to discover after a deal was struck and upon title research, they do not. When this happens it can appear that the landowner group is misrepresenting what they have to lease which ultimately cost all members.

Once you have a professional opinion of clear title, attend landowner group meetings and learn about the organization before joining. Some of the factors to consider are; what is the cost? Groups usually take from 1-7% of the signing bonus and some take a percentage of the royalty. How long is your obligation? Once you commit to the group how many years must you remain and how do you get out? How do you renew membership? Can you negotiate with companies the association has been meeting with and if so is there a cost? How does the group inform members? Some landowner groups meet regularly, some by email. Do you trust the leadership of the group? Is an attorney involved in lease development and review? Does the group have a successful track record of signing with companies? Can you review the final lease before signing and opt out? Landowner associations generally share with their group the lease they will attempt to negotiate. However, the lease is negotiable and will most likely be changed before finalized. Just because a landowner association has a good lease doesn’t mean it would be a good group to join.

Landowner groups may specify a minimum amount of acreage you must own mineral title to before you can join. This acreage requirement can range from 1 acre to 50 acres or more. If considering joining a large landowner group, can your acreage be cherry picked out or is it an all-or-none group? Leasing companies have areas they believe will yield better than others in terms of production and may want to pull out individual landowners or lease at a different value/terms depending on your location.

How large is the landowner group allowed to grow? Group acreage size ranges from hundreds of acres to tens of thousands of acres. Just remember, the larger the group, the fewer companies will have the resources to pay the signing bonus, meaning less competition for the groups acreage. How does the association deal with growth?

Many associations have web sites which post their lease and by-laws. When oil and gas leasing starts in your area, so will the development of landowner groups. Attend these association meetings; learn about leasing and the group structure. Make no rash decisions about joining. In general, well organized landowner groups have managed to provide property owners with better lease terms in general. It is not essential to join a landowner group to get a good lease. Negotiating a lease on your own can be a slow and exhausting process which may take months or years to complete. For some, landowner groups have removed this burden. Finally, be sure and consult with your attorney before signing onto a landowner association group.

Market Distortion and Farm Program Design: A Case Examination of the Proposed Farm Price Support Programs

Carl Zulauf, Professor, Ohio State University, June 2013

Overview: This post examines the potential for market distortions caused by the price support programs currently proposed in the House and Senate 2013 Farm Bills. It is common for discussion of market distortion to focus on the level of price supports, but the degree of distortion reflects the interaction of all of a program’s parameters. One of the hot topics in business today is the role of product design. In many respects, this post is a discussion of policy design and the potential consequences of design decisions. The post builds on two recent posts by Nick Paulson, “Expected Price Support Payments for Corn and Soybeans” on June 6, 2013, available here, and “Comparison of Approaches to Price Support for the 2013 Farm Bill” on May 23, 2013, available here.

Comparison of Price Support Targets: Both the House and Senate Farm Bills propose price deficiency payment programs — programs that make a payment when the market price is less than a target price. Both bills replace the historical term, target price, with a new term, reference price. Moreover, the House renames the counter-cyclical target price program the Price Loss Coverage program. The Senate renames it the Adverse Market Payment program. These changes likely reflect a decision that the existing names have either acquired a negative connotation or send an undesired message. Part of good product design is the appropriate naming of the product.

In a deficiency payment program, the setting of the support prices is a critical policy design feature. In general, the House and Senate take different philosophical approaches in designing the level of the reference prices. The Senate largely takes a market-oriented approach. Excluding peanuts and rice, the reference price is 55% of an Olympic average of the 5 most recent crop marketing year prices (an Olympic average removes the low and high values when calculating the average). In contrast, the House takes the usual, historical approach of setting the reference price at a value that is fixed for the life of the farm bill. Fixed prices are largely determined by budget constraints and the political desire to assist some crops more than others. Thus, fixed prices have the potential to create outcomes that differ from the market.

One conclusion from years of research by academics into price forecasting accuracy is that a reasonable, often the best, forecast of future price is the current market price. Moreover, market price is a key determinate of the use of resources. This market-determined use of resources may or may not be seen as acceptable by policy makers. Therefore, a reasonable initial comparison is to compare politically-determined prices with recent market prices.

Figures 1 and 2 present the reference prices in the proposed House and Senate Farm Bills as a percent of the Olympic average market price from 2008 through 2012. A value of 100% means the reference price equals the Olympic average market price. The higher the percent the more likely the reference price will offer support above the market level. Thus, the House reference prices favor peanuts, barley, and rice. The price ratio is smallest for corn, then soybeans. While the rationale is not known why these two crops having the lowest ratio, it is possible that this policy design decision reflects the fact corn has been the primary beneficiary of the renewable fuels mandate, with soybeans potentially becoming a beneficiary if and when the biodiesel market expands.

The Senate reference prices favor peanuts and rice. Note that the Senate references prices have the same relationship to market price for all of the program crops except peanuts and rice, for which the Senate replaces its market-oriented formula with a fixed price.

The design decision to favor peanuts and rice in both bills is an attempt to address the concerns of southern farms about the loss of direct payments and their assessment that crop insurance does not provide adequate risk protection for them.

Other Program Design Considerations: Table 1 summarizes the key design parameters for the House and Senate proposed price support programs. Bolding is used to highlight key difference. Due to limited space, only one other design difference is discussed. Specifically, the House Farm Bill makes payments on 85% of planted acres while the Senate Farm Bill makes payments on 85% of historical program base acres. This difference can have substantial importance.

Given that the proposed reference prices are below the current market prices and vary in their relationship to current market prices, it is reasonable to postulate that a general decline in crop prices would result in the proposed price programs favoring the crops with the highest reference price relative to current market price. However, farms would have to be able to shift acres to the favored crops for the program impacts to be realized. By making payments on planted acres, the House facilitates the shifting of acres to crops with relatively higher reference prices. In contrast, by using historical base acres, the Senate bill potentially limits the ability to shift. For example, while the Senate Bill allows updating of peanut base acres, base acres of peanuts in 2010 were only 194,000 acres larger than the average of 1.3 million acres planted to peanuts in 2009 through 2012. For rice, base acres in 2010 are 1.4 million acres larger than the average of 3.0 million acres planted in 2009-2012. The base acre constraint on expanding rice acres is less binding than on peanuts but could still be effective if prices stayed low for a long enough period of time. On the other hand, the use of base acres is less of constraint for most of the other crops. For example, barley, the other crop favored in the House price support program, had 2010 base acres that were 5.2 million larger than the average of 3.2 million planted in 2009-2010. Thus, farms with barley base acres would have substantial leeway to expand barley acre in response to favorable farm policy prices.

Summary Observations: It is widely recognized that farm program support prices can affect the planting decisions of farms when market prices are less than the support prices. However, for these distortions to occur, farms have to be able to shift acres to the crops favored by the support prices. Both the proposed House and Senate reference prices potentially favor some crops, in particular peanuts and rice. However, market prices have to decline from current levels and stay low. The House proposed price support program facilitates the shifting of acres by making payments on planted acres. The Senate Bill constrains the ability of farms to shift acres by making payments on historical base acres. This constraint especially applies to peanuts but also rice. Base acres provide less of a constraint on distortion for the other crops that are favored in the House Bill. However, a policy design option to substantively limit distortion exists: require all farms to update base acres to the average acres planted in 2009-2012. Conventional thinking is that updating base acres is distorting. This view applies when market prices are below the support prices. However, updating base acres limits distortion when market prices are above the support prices by limiting the ability of farms to shift acres. Such a change would represent a radical change in policy design.

This publication is also available at http://aede.osu.edu/publications.

Click here to access the complete article which includes tables & figures

Crop Insurance and Prevented Planting

Source: RMA News Release (Springfield, Illinois)

Heavy rainfall, floods and cool temperatures across the Midwest have slowed planting this spring. For crop insurance, the final planting date for corn in Ohio is June 5. The final planting date for soybeans is June 20.

Here are some basic guidelines if you are unable to plant because of an insurable cause of loss by the final planting date. You may:

• Plant during the 25 day late planting period. There is a one percent reduction per day of your yield guarantee.
• Not plant a crop and receive a prevented planting payment.
• After the late planting period ends, plant the acreage to another crop and receive a reduced prevented planting payment.

The most important thing you can do if you are unable to plant the crop by the final planting date is contact your crop insurance agent to review your policy and options before you make a decision.

To qualify for a prevented planting payment, the affected acreage must be at least 20 acres or 20 percent of your crop acreage in the insured unit. Prevented planting is not available on group insurance policies (Group Risk Protection and Group Risk Income Protection).

Replant payments may also be available for land that was planted that does not have an adequate stand. Contact your insurance agent if you believe acreage should be replanted. Your insurance company must give you written permission to replant, abandon or destroy the crop.

Crop insurance is sold and delivered solely through private crop insurance agents. Contact a local crop insurance agent for more information about the program. A list of crop insurance agents is available at all USDA Service Centers or on the RMA web site at www.rma.usda.gov/tools/agents/.

Making the ACRE/DCP Election

Source: Chris Bruynis, Assistant Professor, OSU Extension, Ross County

I have been telling farmers all spring to wait to make the ACRE/DCP Election until late May and gather information about the crop condition and price outlook. Well that time is approaching. On 5/15/13 the harvest market price for corn, soybeans, and wheat were $5.64, $13.38, and $7.05 respectively. Yield estimates continue to be lowered due to the weather and delayed planting across Ohio. Using trend yields (see table below) and harvest market prices for 2013, ACRE should not make a payment in 2013 unless yield and/or average market price for the 2013 crop year changes significantly. However, the premium to enroll in ACRE is relatively small (>$4.00/acre), and one might still consider enrolling to mitigate risk of lower market prices during the upcoming market year (harvest to harvest). If anyone wants to discuss this issue further, I can be reached at 740-702-3200 or at bruynis.1@osu.edu.

acre-june2013

What is Driving Farmland Value?

By: Barry Ward, OSU Extension, Leader, Production Business Management, Department of Agricultural, Environmental, and Development Economics

Farmland values continue to increase by large amounts each year and have reached record levels in most states in the Midwest measured by both non-inflation adjusted (nominal) and inflation adjusted (real) values. Landowners, potential buyers, economists and many others have been evaluating this land boom and have been trying to evaluate whether the bull market is close to being over and if so, how much of a price correction, if any, will occur. Some in the business have been predicting the demise of this land bull market for the last two years. Alas, not yet. The Chicago Federal Reserve District reported that the year-over-year increase in farmland values (April 1, 2012 through April 1, 2013) within its district was 15%. Now that isn’t to say that a large northern hemisphere crop with accompanying lower prices and possible lower profits may cool off the land market, but there are other important factors to consider.

What are the continuing driving forces behind this escalation? Let’s examine a few of the key factors driving farmland values and some factors that may affect these values going forward.

Crop net income has been generally good to excellent for the last six years and is projected to be good again this year (pending fall grain prices). With the potential for a large crop due to large planted acreages, outlook economists have been predicting somewhat lower grain prices (if weather conditions return to a more typical pattern this year i.e. no widespread drought). With potential surplus supply, how will global demand react? Will lower corn prices stimulate the ethanol industry? Will lower soybean prices stimulate additional buying from China and other developing countries? Will lower feed prices allow for an expansion in domestic livestock production? This global supply/demand balance will ultimately dictate grain prices in the near term and will be a big driver in profitability.

The other key factor in crop profitability is cost. How will crop input costs change over the near term? Fertilizer and rental expense will likely be the input costs with the most near-term flexibility. Due to high margins in fertilizer mining and manufacturing during this previous 6 year period, additional infrastructure has been built or is being planned. This may allow for fertilizer supply to outpace demand and cause fertilizer prices to soften, especially if crop profit margins do weaken. Although landowners often resist when decreases in cash rental rates are proposed, persistent negative margins (2 years+) will likely move these rental rates lower…and then again it may take a longer period of negative margins to move these rental rates lower. This is a difficult one to judge.

Land values may continue higher or only level off even in the face of diminished or negative profit margins for the average producer. If the most efficient producers continue to see positive profit margins, the land bull market may cool off slower than some are predicting.

Predicting crop profits for the next 3 years is next to impossible with the many different variables in play, but knowing what factors are important in this complex calculation will allow each of us to incorporate those key factors in our decision making process.

Low interest rates have been key in the land bull market and with the Federal Reserve Bank indicating that it will not raise interest rates in the near term, this looks unlikely to be a large factor in a “cooling off” of the land market in the next three years. Although increased inflation (if it were to occur) would likely cause the Fed to change its tactics.

Farmers balance sheets continue to strengthen. The U.S. Farm Sector Debt to Asset Ratio was 10.6% in 2012. This compares to a 14.1% Debt to Asset Ratio for the farm sector in 2002. This strong financial position has been driven partly by an escalation in land values (the denominator in the equation –assets) but few will argue that the farm sector, especially the grain sector, is not in reasonably good “financial health”.

Outside Investors are still seeking investment alternatives including farmland. Investors outside of farming are still considering farmland as investment that may add value to their portfolio.

The supply of farmland is low. Farmland owners have been reluctant to part with this valuable asset and may be seeking the “top” in the market. Hence, land available for purchase is lower than normal. More dollars chasing fewer acres offered for sale equals higher land prices.

Land isn’t a commodity. We can’t go buy some in Alabama and move it up here to Ohio and plop it down next to our existing farm operation. Therefore, farmland being offered in your geographic comfort zone (area where you presently farm) might command even more of premium, especially when the farm sector is healthy.

Land isn’t a frequently traded asset. Land is not offered for sale every year or even every 10 years. There is no law that states it has to change hands every X number of years. Again, with a relatively strong farm sector, premiums bids may be offered if competing farms see a buying opportunity that may not present itself for another 3 or 4 generations. Farmers close to retirement may purchase this land for legacy purposes to secure continued survivability of their farm business.

The key to understanding land values and their possible directions won’t be just to listen to one or two experts tell you which direction the land market is going. Instead, this understanding will hinge on your knowledge of how these key factors and other will affect farmland values.

Midwest Land Values Strong in First Quarter of 2013 Interest Rates Remain Low

By: Barry Ward, OSU Extension, Leader, Production Business Management, Department of Agricultural, Environmental, and Development Economics

Farmland values continue to increase by large amounts each year and have reached record levels in most states in the Midwest measured by both non-inflation adjusted (nominal) and inflation adjusted (real) values. The Chicago Federal Reserve District reported that the year-over-year increase in value (nominal value) of “good” farmland (April 1, 2012 through April 1, 2013) within its district was 15%. Adjoining eastern corn-belt states Indiana and Michigan were included in this survey and showed yearly increases of 15% and 24%, respectively. Quarterly increases in the value of “good” farmland (January 1 – April 1, 2013) for these two states were 4% and 12%, respectively.

District cash rental rates are up 11% over 2012. According to this survey, Indiana cash rental rates are up 11%in 2013 while Michigan cash rental rates show a 2% increase. Interest rates on farm related transactions in the Seventh Fed District showed decreases from the 4th quarter of 2012. Interest rates on “operating loans” averaged 4.91% at the end of the 1st quarter of 2013 compared to 5.03% at the end of the 4th quarter of last year. Interest rates on loans for feeder cattle purchases averaged 5.12% at the end of the 1st quarter of 2013 compared to 5.24% at the end of the 4th quarter of 2012. Interest rates on real estate loans in the 7th Fed District averaged 4.6% at the end of the 1st quarter of 2013 compared to 4.7% at the end of the 4th quarter of 2012.

For the complete analysis of land values, cash rents, credit conditions and other economic indicators see the May, 2013 Edition of the Agricultural Newsletter of the Federal Reserve Bank of Chicago online at:
http://www.chicagofed.org/digital_assets/publications/agletter/2010_2014/may_2013.pdf