Crop production is an energy-intensive business. So, if there’s a silver lining in the collapse in energy prices, it’s the potential for trimming input costs from fuel, to seed, to fertilizer and chemical costs that are also energy-intensive from the production cost standpoint. Here is what we’ve observed in the energy cost side of the ledger since January when the bottom fell out for the global economy and took ag prices down with them:
· Crude oil prices actually went negative (worth less than zero) Apr 20, trading as much as a “negative $40” at the absolute low. It’s the first time in my 40+ years that I’ve ever seen price charts for crude oil with minus signs in front of them. Taking that into account, May crude futures dropped by 133% from January highs to the April 20 low.
· Distorted by those with long positions in crude oil desperate to exit ahead of May delivery and finding no buyers, the June contract is more representative of crude futures as a whole, and June is down 69% as of April 20 close. For comparison, diesel fuel futures are down 57% from Jan. highs as of April 20.
· Ethanol prices have fallen as much as 46% from January highs, and have recovered a bit on rising numbers of plant closures; but still down 36%.
· Unleaded gasoline futures have been as much as 74% lower than January highs, but closed on Apr 20 down 66%. At just .67/gal, spot gasoline futures are still 28% lower than ethanol futures at .93/gal.
· Natural gas is a key ingredient in the production of anhydrous ammonia and an important fuel for crop drying and NG futures have traded as much as 30% below January highs, but down only 12% as of Apr. 20.
Some of the best work on the lag between falling crop prices and input costswas done by the University of Illinois and Ohio State University several years back. Here is a bar graph showing the lag time between falling crop prices and input costs. I’m looking for similar work showing the impact of falling ENERGY prices on input prices, but this work is still relevant because the fall in crop prices is closely linked to the fall in energy costs.
Fertilizer costs react quickest, showing full 1-to-1 correlation with falling crop prices within the first couple years.
Next most responsive to falling crop prices are fuel costs for this 1981-2013 period studied. Notice there is about a 64% correlation in the first 2-3 years. This year of course, fuel prices are leading the charge lower in grains, trading places in terms of cause-and-effect!
Coming in 3rd in terms of cost responsiveness are seed prices. But there’s a long lag due to the long production cycles for seed. Only about 20% of a drop in crop prices is connected to cheaper seed prices for the first two years, and it’s only up to 65% correlation 4 years out.
Costs for chemicals, farm machinery, ag services, and rents have a l-o-n-g lag! As you see on this chart, they peak at only 40% correlation to lower crop prices four years out. Putting the linkage between falling crop prices and all farm input costs combined results in this bar graph from the University of Illinois and Ohio State work:
Based on this simple assessment, the following findings and implications are suggested by the ag economists behind the research:
· Input prices do adjust to crop prices.
· This finding implies that a natural profit hedge exists in farming in which input prices adjust with crop prices to maintain a profit level.
· The degree of adjustment in input prices to crop prices varies by input.
· Price of fertilizer has the strongest association with changes in crop prices, with crop chemicals having the weakest.
· Using the 2013 cost of production data from USDA, the highest ratio of fertilizer cost to total cost is corn at 23%. Sorghum and wheat are second, at 15%. The lowest ratio of fertilizer cost to total cost is soybeans at 8%. Thus, based on this simple relationship, corn appears to have the strongest natural profit hedge in terms of input price adjustment.
· Most of the adjustment in input prices is completed by year 5.
Overall, these observations imply farms need a 5-year plan to bridge the gap between major changes in crop prices and the resultant adjustment in input prices. This observation applies to both price increases and decreases.
If anyone reading this knows of research more directly examining the linkage between ENERGY costs and farm input costs, please let me know. I’ll make sure you’re the first to get whatever I pull from any “leads” you send me!
Also, please check out my website for an archive of past Bare Knuckles Ag columns. Should you need any custom research or grist for a “webinar” alternative to your events, contact Dan Manternach at www.
by Dan Manternach
President, Perfect Fit Presentations, LLC