Net Income Over Variable Expenses Picture Reverses

Ag economist says picture reversed from six months ago.

Published on: Dec 10, 2008

Even if you don't always like what Howard Doster says, give the retired Purdue University age economist credit for telling it like it is. He and his wife, Barbara, retired from Purdue's business department, operate their own farm coaching and farm management consulting business.

As corn prices started up two years ago, Doster was one of the first voices to cry out that tenants and landowners should renegotiate leases. His point was that landowners wouldn't get enough of the pie at current negotiated rents. He says he based his observations on crop budgets.

Instead of net income or net income over variable costs, he refers to contribution margin. It's the term he prefers to describe what's left for land rent, labor and management after you subtract out direct variable costs from gross revenue. Direct variable costs include seed, chemicals, fertilizer and other direct costs.

Two years ago crop budgets, using increased crop prices and then still reasonable input costs, began showing increased contribution margins for both corn and soybeans. Doster typically relies on Purdue University Crop budgets released by the Purdue age con department to fix costs.

Not everyone liked to hear his message. Unfortunately, many stopped listening once they heard the part about 'renegotiate leases and pay your landlord more.' Doster went on to suggest alternative leases that would let owners take part of the crop and weather risk. But phrases like 'you'll lose farms to neighbors or people outside your own county willing to pay more if you don't renegotiate' didn't set well with some folk.

Doster was excited last summer, as crop prices peaked, pointing out that contribution margins were reaching historic levels for '09. The only problem was that most grain companies, sensing that markets were extremely volatile and out of kilter, cut off forward contracting more than a year in advance. Farmers for a while could no longer lock in '09 crop sales last summer using just simple forward contracts. Many resumed offering them later, but only after prices had settle down some.

Fast forward to December '08. In the meantime, the U.S. and world economy nosedived. Oil plummeted and corn prices followed. Farmers across the state reported local cash prices of $3.20 average last week. Some say their marketing gurus are talking corn in the high '$2' range before prices bottom out. Input costs are showing weakness, especially all fertilizers except potash, but it's yet too early to tell how far products will drop, especially key fertilizer products for corn growers. And both some retailers and farmers are locked into high-priced fertilizer, or setting on piles of it in their warehouses, after purchasing it when it seemed like the thing to do when crop prices shot up day after day on the Chicago Board of Trade during early summer.

Now to his credit, Doster is back in the news, singing a different tune,. This time, he believes contribution margin is too low, and he's making that clear. And instead of predicting farmers will lose farms by raiding farmers form other counties, he's telling landowners some farmers may not be able to make good on already promised rent payments for '09 at the established levels. And going even further, he suggest that unless crop price and input dynamics change soon, some land, the poorer land in Indiana, may not be farmed in Indiana in '09.

That may seem like a stretch, and it's certainly about face from an ag economist who figures contribution margins almost daily as price information changes. It reflects just how far and how fast crop commodity markets have dropped in one year's time. Input prices have a ways to go down yet overall to get back to lower levels most were at when corn prices were stuck in the $2-$2.50 per bushel range. Back at those prices, even with government support, Doster noted cash rents were too high.

What he's promoting now is the same thing he was promoting before prices collapsed, only the reasoning is different now. He promotes any one of a number of flexible lease options, where tenants and landowners determine how much risk they can bear, then set up the rental agreement so that final rent is determined based upon price, yield and even input cost variations. This time he's suggesting it because otherwise, he fears tenants won't be able to pencil out profits in some cases, and may be reluctant to put out a crop on poor-performing soils.