It's no secret that farm input costs have been accelerating over recent months. Only recently have fuel prices begun to back down. Here's a skinnied-down look ahead offered recently by William Lipinski, CEO of Farm Credit East.
Farmers will incur significantly higher costs for fuel, petro-related inputs and purchased feed in 2011. Most other inputs are expected to increase by at least the rate of inflation – which has been very low.
Historic highs are likely to continue for corn, soybean and other grain prices at least until 2011 harvest prospects become more certain. With continued elevated global grain demand, it's good news for those produces. For dairy farmers, egg producers and other livestock producers purchasing feed, this is a major cost pressure that'll continue to drag on operating margins.
Interest rates: Through the end of 2011, they'll likely be low and stable. However, they won't remain at these levels indefinitely. Lots of events or even changes in government policy might cause them to begin rising.
This is a major wild card in the farm outlook over the next several years. Borrowers should continue to educate themselves as to the opportunities and benefits to fixing rates for some or all of their debt as part of their total risk management strategy.
Dairy profitability: This should be a favorable year for Northeast dairy farm profitability based on a return to historically strong milk prices and despite expected higher input costs. But it's important to remain cautious.
Milk production costs may return to near-record 2008 levels. And pricing circumstances could change quickly. Current prices are largely dependant on the strength of dairy exports. Global demand is up. Yet domestic consumption is down.
Total U.S. milk production is also on the rise with plenty of milk cow replacements waiting to come online. Without the strong export market, milk prices would already be down. Fortunately, most producers that grow their own feed experienced an excellent growing year in 2010, and that'll carry them well into 2011.
Agribusiness: Depressed demand for housing-related industries has resulted in several producers exiting the nursery, turf and softwood lumber business in response to these challenges. Those continuing have made substantial adjustments including reducing production, cutting costs, developing value-added business opportunities and otherwise positioning themselves as survivors.
Due to high unemployment and underemployment, consumer spending won't quickly return to pre-2007 levels,. Even for consumers who are employed, the current focus on increased savings, paying down debt and the lingering effect of the loss of wealth from sharply lower residential values makes for a restrained view on discretionary spending.
Fundamental risk shift: Recent uncertainties and greater difficulty in forecasting has led the most astute producers to focus more on managing risk exposure. Today, they better understand their margins and are using various risk management tools for both input costs and farm products.
Similarly it has led to rethinking the desired level of financial liquidity in their business, the right amount of debt and how much reserve debt capacity is appropriate. It also has them rethinking the timing of the next major business expansion.
Farm Credit East is noticing a significant movement of producers voluntarily paying down debt early whenever they have excess funds. This is in contrast to pre-2008 when they might well have used excess funds to expand their business, and take on additional debt in order to leverage available funds.
Operating margin, the difference between price per unit received and cost of production spent per unit, has taken on even greater significance in the current climate:
Producers with strong operating margins relative to the industry average generally have the best staying power within their industry. When their industry turns downward, they're among the last to incur losses. When the industry turns upward, they're positioned to earn the most profits.
Understanding operating margins on a real time ongoing basis is critical to effective use of any risk management tools. Absent this crucial information, use of risk management tools is ineffective at best and potentially damaging.