by Brent A. Gloy and David A. Widmar
As the New Year begins we thought that it would be useful to put together a list of some of the things that we will be watching in the coming year. This list has been shaped by the questions we have been asked as we’ve traveled around the country this fall and winter. Without a doubt, 2015 will be an exciting year. Below is a list of 9 questions we see production agriculture facing in 2015 and some of our thoughts on how these issues might unravel as the year unfolds.
1. What does ag profitability look like for 2015? 2014 was a financial roller coaster in the grain markets. Commodity prices fell hard going into harvest and then surprised with a late fall rally. When the Purdue University Crop Budgets initially came out in September, significant losses per acre were estimated. Going into 2015, commodity prices will be on the top of everyone’s mind
BG: The prospects for profits in the row-crop sector look better than they did just a few months back. We seem to have really shifted into a supply driven market. My sense is that the key factors for 2015 will be similar to most years, namely how many acres of various crops get planted and what will the weather hold. Given today’s stocks/use ratio for corn there will likely be upside if the things don’t cooperate. Alternatively, there is definitely downside for prices if we were to have another fantastic growing year. Overall the financial condition of the farm sector remains relatively strong.
DW: At writing, conditions in 2015 look remarkably similar to where we were a year ago as we looked into 2014 – I don’t think anyone would have guessed that three months ago. Things, however, can quickly change – to either direction- really quickly. Watch production and demand.
Even with the recent cattle market gyrations, 2015 looks like another good year in the livestock markets. Cattle will be concerned about lingering droughts and herd expansion, hog producers have PEDv at the front of their minds, and dairy are worried their record output prices are slipping away.
2. How much corn will be planted in 2015? Last year’s bumper crops replenished and began to add to commodity stockpiles. Yield estimates attract lots of attention throughout the growing season for good reason, but planted acres are critical in determining the potential size of the crop. If lots of acres go in, it would take a yield disaster to pull stocks down, and if too few of acres go in perfect growing conditions are needed. So what are the prospects for 2015, particularly with corn?
BG: The favorable prices of recent years have really driven a large shift toward corn plantings in the U.S. The plantings that produced last year’s record crop were actually down from previous years. Right now it looks like corn prices will be at a similar level to those in 2014 so I would expect to get a similar result. When I look at our crop budgets, the costs are similar to last year and prices are a bit lower. Unless one of those variables changes in the coming months I wouldn’t expect much change in plantings. If prices fall much further then look for some acreage shifts. As we pointed out in a post last year, one should follow planting intentions on the periphery of the corn-belt for indications of changes. It is pretty unlikely to see large scale shifts in the heart of the corn-belt, but I also wouldn’t be looking for expansion at current prices either.
DW: Nationally, about the same as 2014. U.S. corn acres were around 87 million acres in 2012 and 2013. Acres were down to 83.1 million in 2014. I would not expect another 4 million acre decrease for 2015. Locally, especially where the cash prices and local basis have been extremely weak, there could be a strong shift away from corn. This is especially true on the High Plains where there has been a large increase in corn production in recent year. Input suppliers or local corn buyers could see a significant shift in their particular geographies, so it will be important to carefully watch local markets.
3. What adjusts to alleviate margin compression? As commodity prices have fallen input prices have held pretty stable. This is creating a significant margin compression. What, if anything, will adjust in 2015?
BG: Overall, I expect that profits will take most of the hit. On the variable cost side of the equation I don’t expect to see much adjustment in 2015 as input prices such as fertilizer and seed have held fairly strong. Crop protection pricing will also likely be strong. Farmers may cut back on some inputs and cheapen up crop protection, but overall the biggest savings will come from crop mix changes. If prices stay low, then we might start to see some relief on fixed costs such as land rents and prices. Some of this may come in 2015, but if prices stay low look for even more in 2016. The process of adjustment in fixed costs appears to be starting but it will take time.
DW: The cost of production for corn and soybeans in the Purdue Crop Budgets from 2014 to 2015 are very similar. We have seen some expenses approach record levels, but not much relief is in store. On the farm, producers should carefully consider their operation and field conditions to evaluate opportunities to adjust application rates for seed and fertilizer, and carefully scout fields to get the appropriate crop protection coverage needed.
Some relief could come in the form of farm program payments. Given the Olympic Average nature of the ARC program, 2015 will likely have payout potential. However, payments for the corn crop planted in 2015 won’t come until fall 2016, not providing much relief. (Although it should be noted that a payment could be coming in the Fall 2015 for the corn crop planted in 2014, so that could make next fall interesting).
4. How much will farmland prices soften? The previous point makes the case that fixed costs will likely need to adjust to alleviate margin compression. So what are the prospects for farmland prices in the coming year?
BG: For the first time in many years, data suggest that farmland prices are now starting to soften. This makes sense given the reduced profitability in agriculture. Current levels of profitability just don’t support prices at all-time highs. The market appears to be in a precarious position in trying to resolve a lot of uncertainty on where crop prices might settle over the coming years. With the days of explosive demand growth from ethanol over, we have moved more to a supply driven market in the grains and supplies are now comfortable. This is a change from the previous years. There is clearly additional downside if commodity prices were to break further to the downside.
DW: Watch commodity prices and interest rates. If those stay stable, there will be a little softening. If commodity price falls and/or interest rates jump up, expect more significant adjustments. Also, lenders have been willing to cautiously finance farmland. If the lenders get concerned – and a few large failures would cause this – their interest and willingness to finance farmland might waiver leaving fewer potential land buyers to bid up prices.
5. So what about interest rates? Is this the year that they start rising and what impact might changes have on the ag sector in general and farmland in particular?
BG: The U.S. economic situation continues to improve and the Fed has now sent the signal that 2015 is likely the time for firming monetary policy. This likely means that short-term rates will move higher in 2015. Although the news of potential rate increases get all the attention, in the big picture rates are still quite low. Longer term rates are critical in the farmland market and 10-year rates continue to remain low. Farm borrowing rates also remain nearly as low as they have been in many years. So at the end of the day, I think that we should expect higher rates in 2015, but it currently doesn’t appear that rates will rise to the point where they put a serious crimp on the farm economy.
DW: In the U.S., things have been looking good. The unemployment rate has come down nicely while G.D.P. has been growing. If the economy continues to improve, expect interest rates to rise. What could hold back the U.S. economy is the global economy. Will Russia or the E.U. hold the U.S. economy back in 2015?
6. What happens to farm borrowings and how much credit risk is out there? The margin compression in the ag sector is likely to influence credit conditions in the sector. Are there things to worry about? The real amount of total farm debt (both operating and real estate) has increased steadily over the entire course of the farm boom. However, the dramatic increases in income and asset values kept the sector in strong financial condition.
BG: A recent survey from the Kansas City Federal Reserve indicates that demand for farm borrowings is increasing rapidly. I would continue to look for substantial ag loan demand and demand for credit in the coming months. As incomes fall, it is likely there will be some repayment challenges and potential interest rate increases will not help the situation. It will be critical to be judicious in the use and extension of credit in the coming year. While there will be some challenges in this area, it appears that the credit quality of the sector, although declining, remains relatively strong.
DW: While many point-out that current farm debt levels aren’t anywhere near the their level in the 1980’s, it’s important to think about the distribution of farm debt. How many producers are in high-leverage positions? There are probably more producers in the range than most want to think about. There were a couple of very large farms that failed after 2012, and that was with record incomes (yes, there was a drought, but incomes were very strong). A common feature of recent farm failures is significant debt held by input manufactures and retailers. As incomes fall, the need and demand for credit will increase and there will likely be a host of sources, traditional or non-traditional, that producers will turn to, pushing debt level higher.
7. What farm program will farmers choose and can farmers and agribusinesses expect large payments in 2015? The new farm bill presents farmers with lots of choices. The time for making a decision on the farm program is rapidly approaching.
BG: There are a lot of moving parts in this decision. Farmers will have to make some trade-offs in order to make the decision. On one hand, the PLC program provides the potential for large payments if prices go really low. On the other hand, the Olympic Average prices in the ARC-CO program are quite high and could make payments even if prices are above the PLC reference prices. Each farmer will have to do some evaluation of their own case and situation. My guess is that most will take the program that looks like it will pay the most right now. In terms of payment sizes, that is another good question. I would expect some payments from the program, but as we pointed out earlier, at least for ARC-CO the outsize yields in some areas may reduce the size of the payments received in 2015 below initial expectations. I have noticed that Purdue has recently put their estimate of the government payment to $35 per acre for high quality Indiana farmland.
DW: It seems like ARC-County will be a very popular program for a lot of producers. In certain regions and for certain crops, the alternative programs will have appeal. Either way, producers need to carefully look at their specific operations and ideas for the future. I think what has been most surprising about all of this is just how complicated and how complex the new farm bill program is.
8. How, when, and does global uncertainty resolve itself? From the E.U. and emerging economies to global conflict and disease, there has been lots of global uncertainty in recent years.
BG: These factors are so hard to predict but they all bear watching. The situation in Europe remains challenging. The E.U. central bank is trying to get things under control but it appears that considerable work remains. We should keep a close eye on things as they will likely influence everything from interest rates and exchange rates to demand for agricultural commodities in the coming months.
DW: This list of questions isn’t in order of importance, but if it was this would be in my top three things to watch. In my mind, global uncertainty is what makes things significantly different from the last few years. Russia banned agricultural imports from select countries (including the U.S.) making conditions really difficult for agriculture in the E.U. last year. Recently, Russia is facing a financial crisis on the heels of the oil price collapse, halted grain exports, experienced sky-rocketing interest rates, and saw the value of the Ruble crash; all this in the last year. The geopolitical landscape is in a period of unrest and bizarre bedfellows are emerging (Cuba and the U.S. relations improving?). Trade opportunities, or threats, could quickly surface. Unfortunately, there is no clear insight into when or how these uncertainties might resolve themselves. Low and falling oil prices will continue to create pressure on the economies and governments of those heavy dependence on oil and energy exports.
9. What about energy prices? How will this influence the ag economy?
BG: The declines in the price of oil have been dramatic and I think caught many people off-guard. Overall these declines are likely to benefit consumers, but they should also provide farmers with some relief on their fuel bills. While fuel isn’t a large expense category for farmers, its decline will be welcome. Longer term, fertilizer input costs are tied closely to energy costs so that provides some potential for optimism. It is not yet clear how lower gasoline prices will impact ethanol demand. It may put some pressure on ethanol prices, but if it spurs additional gasoline demand it may be positive for ethanol. Oil is a big market and it will be important to watch for unanticipated consequences of these declines. The story is yet to be written on how this all shakes out.
DW: It seems like there has been little to no efforts to cut oil production globally. This will keep the downward pressure on oil prices. Until demand jumps dramatically or production is cut, a long period of prices lower than the last 4-5 years can be expected.
Recently, these has been concerns about energy prices being too low and causing global financial and economic trouble. Something to keep an eye on.
A couple things we know for certain: some of this list will not pan out to be as important as we initially thought, some of this list won’t resolve itself and will probably make our list for important questions for 2016, and our 2015 Agricultural Year in Review will probably include big events not included here.
Throughout the year, we will be tracking and sharing updates on these issues and any emerging trends. For those interested, click here to follow our blog and stay connected as we will continue to post regularly agricultural insights.
Photo by Johnny Klemme