AG Executive

The Approaching Storm
by Darrell L. Dunteman

2004 was a tremendous year for practically all sections of North America and all enterprises be it dairy, other livestock or grain. We now need to be looking forward to 2005. What is likely to happen in 2005?

Obviously one of the first concerns for grain operations in the Southern two-thirds of North America is the Asian Soybean Rust. Our readers in the South may be assured that rust will be a factor in 2005. As we progress north, some producers will see problems with the rust from five years out of ten up to possibly no exposure in the Northern tier of soybean producing states. Producers are going to need to either use a good crop scouting service or be more vigilant in their own fields because there is a very narrow window of treatment for soybean rust. The experts have essentially said that you have two to three days to spray once rust is discovered. Some individuals have even considered doing the spray as a preventative measure but I have not seen evidence that would be a cost effective method of dealing with rust. Will it affect your marketing strategy for 2005?

It does not appear that the market is yet very excited about soybean rust. First, it is still an unknown as to what kind of damage we might experience, but the over all factor still boils down to the relative profitability of the various crops that you may decide to plant on your farms in 2005 as well as what happens in Brazil. We have a burdensome carry out of soybeans in North America and one of the marketing experts that I talk with from time to time reminded me that soybeans should really be priced lower than they currently are but explained the price has been propped up because of a good demand for soybean oil.

Regardless of what cropping pattern that you use on your operation, the common consensus is that 2005 income, when expressed on an accrual basis is likely to be 50% of the 2004 results, depending what area of the North America that your farm is located. Many operations in the Midwest have experienced above average yields for the last two years. Will those yields continue? Odds are that our yields will be lower in 2005 when compared with the previous two years. Our projected Our projected prices for crops are also likely to be lower for the 2005 crop. Pay particular attention to your marketing advisors and make sure that you are considering price a portion of your 2005 crop now. Some observers would say that bean prices on the Chicago Board of Trade are now above what they may be as we approach the mid-point of 2005. Corn is less certain and is dependant on exports and how much corn we are processing into ethanol. Some individuals are also concerned about a potential shift in acres to corn from soybeans in order to try to minimize the risk of rust. In the North tier of soybean producing states there maybe even a push into more beans if you believe that our production will be drastically reduced. However, if we look at the same number of acres that we planted in 2004 and took a five percent yield drop, you would still find that we have a burdensome carry out at the end of the 2005 growing season. So, in summary, pay particular attention to your marketing program for 2005 and expect that your net farm income for 2005 will be lower than the last two years.

There are some other clouds gathering on the horizon. The biggest question that will effect net farm incomes and will affect land prices, and potentially indeed the entire net income of the agricultural sector, is what will happen when we reach 2007. In 2007 we will be operating under a farm program. The “experts” are all concerned about what will happen to even our current farm program in 2005 due to the budget deficits currently experienced by the US Government. I firmly believe that we would not have the program today if Congress would have deliberated for another six months.

A number of groups are looking at the amounts of money being thrown at the agricultural sector and believe that the support of the agricultural industry is a waste of money.

Another factor as we analyze government programs is that the WTO and their ruling against cotton will continue to be a problem for the way that we calculate government supports. The WTO ruling seems to indicate that our counter-cyclical payments as well as our LDPs make the United States less responsive to world demand because our prices for a number of commodities are essentially guaranteed. When prices decrease, LDPs and counter cyclical payments increase. So, in world opinion, the LDPs and counter-cyclical payments are giving our farmers incentive to keep producing subsidized commodities.

Unfortunately, our friends in the South because of cotton and rice are the ones to be hit harder than the corn and soybeans that we see in the Northern United States. The end result is that we are likely to experience an adjustment phase in the agricultural industry in the next five to ten years.

Government program payments made up approximately 24% of actual net farm income during the period of 1970 through 2003 for the average midwestern farm. Farms in the South and parts of the Western United States normally had a larger share of their net income created by government program payments. The government program payments affect both the price of land and cash rents. Landlords want “their share” of the program payments since they often view these payments as “free money” for producers. Farmers and non-farm investors have relied on the government program payments to cash flow additional purchases of land. How do government program payments affect the price of land? Figure 1, from a study by Terry Kastens and his associate Dr. Dhuyvetter from Kansas illustrate their observations of the portion of 2004 agricultural land value that is attributed to government program payments. As you can see the largest impact of government program payments is in Texas, Oklahoma, Arizona, New Mexico and Louisiana. These five states are heavily dependent upon government program payments due to cotton and rice. California and Nevada, on the other hand, are affected the least due to a large amount of non-program crops.

What does this all mean? The bottom line is that if we reduce government program payments, we are going to see a fall in farmland value. Figure 2 is also from the Kastens and Dhuyvetter study and illustrates the reduction in land values, based on 2004 values, the authors believe we will see if we see a reduction in government program payments.

Sooner or later, the government will reduce the payments for program crops. When that happens net farm income will fall and we’ll see a decrease in cash rents as well as farmland since the remaining income will not support farmland values at their current levels. If agricultural producers have less money to spend, the land market will cool off. Non-farm investors will exit the markets as they may find it a better strategy to pay the income taxes and invest in other sectors of the economy.

How does this affect Ag Executive readers? We need to be planning for the future. We need to get our financial house in order and be prepared to weather a few rough years. We need to be cleaning up our financial statements by refinancing short-term debt against our real estate.

We now have equity in our farm real estate. When farm incomes fall, land prices will fall. It’s not likely we will be able to refinance against land because we will lose our equity after the loss of government program payments. If you have little term debt and little farm operating debt you will be in a better position to get through the coming tough years.

We are not talking about taking on new debt. We are suggesting placing the debt against farmland to “mine” the equity now rather than trying to refinance when all of our neighbors are in trouble and the lending institutions are not capable of working with everyone. You want to put yourself at the top of the list by having the cleanest financial statement.

Are we suggesting you place all of your operating line against real estate? No! If you refinanced all your operating debt you would incur additional interest expense because you would be borrowing your operating line for twelve months when many producers have an operating line for a few months. We would suggest that you take a look at the funds that you borrow borrow for the last three months of your year. Pay down the operating line so that you borrow funds only during the last three months of your taxable year.

You are right. Ag Executive raised this alarm when we were waiting for the outcome of the 2002 farm program. We got lucky.. we were wrong. But today we are in the middle of an expensive overseas military action. And, the Environmental Working Group has a lot of time to launch an attack against those “nasty big farmers on the government dole”. Look for them to make aggressive attacks against the “Big Five” states we mentioned earlier in this article.

Don’t expect a lot of support from the non-farm voters because fewer and fewer voters have direct contact with the farm sector. They don’t care about cheap food arguments and are starting to place agriculture in the same boat as some of the subsidized big business. Even though agricultural spending is not as large of expenditure as health care and the military, it still represents a target for spending cuts. What if Ag Executive is wrong this time? Will you be hurt by taking the actions we are suggesting and cleaning up your financial statements? No!!! You will pay less interest due to better long-term rates. You can always pay off your long-term debt faster and still be in better financial shape than your neighbor. Taking the action that we are suggesting will not guarantee that you will survive the coming tight years, but it will improve the odds you will still be operating an agricultural business in 2015. Plan now to meet with your financial advisers and map out a strategy to help you be successful in the future!!

Ag Executive will be devoting additional resources in the coming months to assist you remain successful in agriculture. Drop us your thoughts and give us ideas to pass to your fellow producers on ways you plan to structure your operations for success.

Darrell L. Dunteman is an agricultural financial consultant and accountant located in Bushnell, IL. Mr. Dunteman may be contacted at (309) 772-2166. ■