Michigan Farm News

Market Outlook: Dr. Jim Hilker

Columnists, Markets & Weather

2018-09-15 Dr. Jim Hilker

David Ricardo came from a London stockbroking family, made most of his considerable fortune from speculation during the financially turbulent Napoleonic war-era, cashed in and retired to an English country estate.

In his leisure he made two important contributions to our understanding of agricultural markets. One was to develop the law of comparative advantage which underpins the view that international trade is generally beneficial to both trading countries.

Although a landowner, he advocated for the repeal of Britain’s grain tariff laws and his logic on the benefits of trade was influential in eventually opening up European markets to North American grain. The other contribution, that of cash rent determination, is the matter of this article.

Ricardo’s view of cash rent in agriculture is based on the assumption that land is essential for crop production. Moreover, it holds that land is the single most important factor in production.

To understand the importance he attached to land rents, consider an example corn land budget under alternative assumptions as laid out in Table 1. The table is intended as illustration, so please forgive the economist’s tendency to disregard such details as crop insurance, how rotation needs affect rent, etc. Labor costs have been inserted to account for returns to both management and operation effort.

With expected yield at 170 bushels per acre, a spring-time locked-in forward price at $3.50/bushel and an assumption of no program payments, Scenario A involves expected revenue at $595/acre and costs at $400 leaving the residual, or surplus, at $195/acre.

As all costs have been paid for except that of acquiring access to the land, then this amount could be paid out in order to break even. It is the amount that the owner-operator can ascribe to returns on owning the land and it is the amount that the renting operator might be prepared to pay as cash rent.

Scenario B continues to hold program payments at zero but has a higher forward price, namely $4/bushel. We assume that the operator, whether owner or not, will increase fertilizer inputs in response and so expects 172 bushels/acre. The residual then becomes $283/acre. Ricardo’s view was that rent should increase by this difference, or $283-$195=$88/acre. Most of this comes from the price increase but some also comes from adjustments to production. Of course, the above logic should also work in reverse. Were the corn price to decline to $3.00/bu. then cash rents would decline by an amount just short of 0.5x170=$85 when one allows for a bit of a pull-back in inputs and yield.

Scenario C returns to the price and yield expectation assumptions in Scenario A but introduces a $20/acre program payment that is not tied to production, as in the direct payments that were in place between the 1996 and 2014 farm bills.

As the $20 is received regardless of production choices, all costs are held fixed and yield remains at 170 bu./acre. The $20 passes through entirely to the residual, which increases from the Scenario A value of $195/acre to become $215/acre. Comments on Scenario B* are deferred until after comparing scenarios B and C with A.

As with most theories, including Newton’s theory of gravity, Ricardo’s theory of cash rent can be picked apart upon closer inspection. What is it about land that, in Ricardo’s view, allows the owner to be the residual claimant on the profit effects of good and bad shocks?

His view was that land is the ultimate scarce resource for crop production and scarcity provides the owner with strong bargaining power. His view was that, upon allowing enough time to adjust, the other factors in production, including nutrients, seed and labor/management, could be readily replicated or diverted from outside agriculture.

Consequently their prices would not shift as a result of a change in crop sector profitability. But much has changed in crop production since Ricardo’s day. Is Ricardo’s extreme stance on the special nature of land really tenable?

The assumption is likely largely true for some inputs. For example, nitrogen is abundant in the atmosphere. The cost of fixing it depends largely in the price of natural gas and is unlikely to vary too much with crop prices or government payments. However, for other inputs there are stronger grounds for debate. The few seed companies do compete with each other, limiting their bargaining power.

But that competition is far from perfect because there are so few; because they also own important scarce resources in the form of patents and elite genetics; and because firms with specific hybrids/varieties well-adapted to a region may dominate the local market. More so than, say, 50 years ago, seed companies can bargain for some of any additional surplus in the sector.

Bargaining power is also likely present in the tenant labor/management input. Modern crop production is a technologically and cognitively challenging business where prospective tenants will differ greatly in how they are positioned to extract profit from the land.

Better management is also a scarce resource and, because it is scarce, can expect to obtain some of any additional surplus.

In addition, location of tenant home base and transportation costs matter when seeking to make best use of expensive cropping equipment.

In reality the landlord has available only a limited number of prospective tenants to bargain with. With crop land in less crop-intensive areas, say on the Corn Belt’s periphery, tenants may have more bargaining power when compared with those competing for Central Corn Belt land.

The small number of landlord-tenant matches also means that cash rent responses are likely sluggish. Formal fixed-rate cash rent contracts may extend to multiple years. In addition, when commodity prices move to a persistently higher range, landlords may be reluctant to press a good tenant for an upward adjustment. When prices fall, tenants may worry that efforts to bargain down the rent will lead to loss of very accessible crop land.

Scenario B* adjusts to allow for some bargaining power on the part of seed companies and prospective tenants as markets settle down to a new long-run equilibrium.

In B* the effect of a $0.50/bu. corn price increase relative to Scenario A still creates the same surplus but only about half of it ultimately passes through to the landlord. Upon allowing time for adjustment, fifty percent pass-through is around about what academic research on the matter finds.

Similarly, the alternative to Scenario C would be for the tenant to share some of the extra surplus. In the case of a government payment, though, seed and other input-side companies would have little leverage to share additional surplus because demand for these inputs should not change by much when payment is not tied to production.

Ricardo’s rent theory has found applications elsewhere in agriculture: for example in understanding water rights as well as the right to produce or market quotas for milk, tobacco or peanuts. Before Uber upended the medallion system in big city taxi markets, the approach was a very useful way to understanding medallion pricing.

Seats on trading exchanges can also be viewed this way. In each case, however, closer inspection will reveal that the market is a little more complicated so that less than 100% of profit shocks will pass through to the owner of the right. So what do you think? Maybe two thumbs up to Ricardo for a thought-provoking way to think formally about the matter, and one thumb up for the validity of his claim?

 Market-Outlook-Table1_September 15
Click to enlarge 

Acknowledgement: This work was supported by the Elton R. Smith Endowment in Agricultural and Food Policy.  

Columnists, Markets & Weather

2018-09-06 Dr. Jim Hilker

Is the story about the large corn and soybean crops coming this year the fact that the five corn and soybean crops ever have been the past five years, and/or the tariffs on grains?

And then, there is the large world corn and soybeans crops this year, but short wheat crop. Of course, they are all significant factors, but the tariffs are what is making the market risky.

The harm from the tariffs is real, whether the trade war is justified or not. And there is a possibility of longer-run effects as well, such as an increase in the investment in agricultural infrastructure in other parts of the world.

Corn 

On Aug. 10 the USDA/NASS released the first-of-the-year survey- based forecast for 2018 U.S. corn production at 14,568 million bushels based on Aug. 1 conditions. This would be the third-largest crop on record, just barely smaller than last year, 18 million bushels, 0.1 percent. The report indicated a record yield of 178.4 bu/ac, 1.8 bu/ac, 1 percent higher than last year’s record. 

Illinois was projected to have an average corn yield of 207 bu/ac, with Iowa pegged at 202 bu/ac. The planted and harvested acres were based on the June Acreage Report, which showed planted corn acres down 1.2 percent and harvested acres down 1.1 percent.

The forecast is based on a large sample of farmer-reported yield projections collected from all states, and field-measurement objective yields in the largest corn producing states. The report assumes normal weather from Aug. 1 through harvest.

To this point, moisture has been a bit less than normal, which may bring the final yield down a bit, but we are still looking at a huge corn crop this fall.

Michigan’s 2018 corn yield was forecast at 158 bu/ac, down one bushel from last year, and three less than the record 162 bu/ac in 2015.

Michigan is expected to harvest 1.85 million acres, 50,000 acres less than last year, and the fewest since the high of 2.38 million in 2012. Production is forecast at 292.3 million bushels, down 8 million from last year, the lowest since 2007, and 66.5 million below the record 358.8 million set in 2015.

The USDA/WASDE also released updated Supply and Demand Estimates on Aug. 10. They can be seen in Table 1. 

At this point, 2018-19 total use is expected to be up from last year. Feed use is projected to be up 75 million bushels, based on more livestock units, and ethanol use is expected to be up 25 million bushels, with other uses being up 20 million bushels. 

Exports are expected to be down 50 million bushels, mostly based on larger world production. At this point the effects of tariffs are not clear, but remember Mexico is our largest buyer of corn. 

So with lower total supply and more total use, ending stocks are projected to be down 344 million bushels, which lowers the stocks-to-use ratio from 13.6 percent to 11.2 percent. This leads to a projected $3.60 annual average 2018-19 price versus the $3.40 price for 2017-18. In Michigan the basis is fairly strong. If you have a lot of 2017 crop remaining, perhaps consider pricing on market rallies.

Wheat

The August crop production numbers showed U.S. wheat production down less than 1 percent, 4 million bushels, from the July report, but up 7 percent from 2017. 

Food use, feed use, and exports are expected to be up in 2018-19, with exports being the big increase, up 224 million bushels. The increase in exports is due to world wheat production being down about a billion bushels, mostly due to smaller crops in the EU and Russia.

Michigan 2018 wheat production was forecast at 39 million bushels, up from 33.575 million bushels in 2017. Michigan’s 2018 yield is forecast at 78 bushels per acre, down 1 bushel from last year. But Michigan harvested 500,000 acres in 2017 versus 425,000 in 2017.

The wheat basis in Michigan is fairly strong, which is saying the market wants wheat. And while the market is willing to pay a bit for storage, it won’t cover the cost of most.

Consider pricing some/much of remaining 2018 wheat on rallies, especially if we rally back to the high. And consider pricing some 2019 wheat on rallies past the previous highs.

Soybeans 

The August crop production report forecasted the third record U.S. soybean crop in a row, 4,586 million bushels. The yield is projected to be 51.6 bu/ac, up 2.6 bu/ac from last year, and second only to the record 52 bu/ac in 2016.        

Harvested acres were projected at 88.9 million, down 0.6 million and the second- highest on record. This number came from the June Acreage Report. 

Michigan is projected to have a yield of 46 bu/ac, up 3.5 bushels from 2017, but below Michigan’s record yield of 50.5 bu/ac set in 2016. Michigan is expected to harvest a record 2.29 million acres, up 20,000 acres from this past year. This would put Michigan’s projected production at 105.34 million bushels, which would beat out the 104 million bushel record set in 2016.

The above numbers help put 2018-19 U.S. total projected supply at a record of 5,040 million bushels, up 325 million bushels from 2017-18. The updated USDA supply-and-demand report indicates that total use will be down a bit from last year’s record, but will be a moving target depending on how the tariff situation plays out.

Crush is projected to be up 20 million bushels, but exports are projected to be down 50 million bushels, which leaves total use down 50 million bushels. This leaves ending stocks at a massive 785 million bushels, easily surpassing the 2006-07 record of 574.

Ending stocks-to-use is projected to be 18.4 percent of use, up from last year’s 10 percent.

The USDA projects an average annual 2018-19 price of $8.90/bu, down from $9.35 last year. Seems high to me without the tariffs coming off fairly soon.

Remember, tariffs do not mean we won’t export soybeans to China, our largest market normally taking over 60 percent of U.S. exports. It means Brazilian soybean prices will be 24 percent more than U.S. soybeans. Giving a market recommendation with the present situation is pretty much impossible.

Columnists, Markets & Weather

Dr. Jim Hilker | MSU | August 30, 2018   

Is the story about the large corn and soybean crops coming this year the fact that the five corn and soybean crops ever have been the past five years, and/or the tariffs on grains?

And then, there is the large world corn and soybeans crops this year, but short wheat crop. Of course, they are all significant factors, but the tariffs are what is making the market risky.

The harm from the tariffs is real, whether the trade war is justified or not. And there is a possibility of longer-run effects as well, such as an increase in the investment in agricultural infrastructure in other parts of the world.

Corn

On Aug. 10 the USDA/NASS released the first-of-the-year survey- based forecast for 2018 U.S. corn production at 14,568 million bushels based on Aug. 1 conditions. This would be the third-largest crop on record, just barely smaller than last year, 18 million bushels, 0.1 percent. The report indicated a record yield of 178.4 bu/ac, 1.8 bu/ac, 1 percent higher than last year’s record. 

Illinois was projected to have an average corn yield of 207 bu/ac, with Iowa pegged at 202 bu/ac. The planted and harvested acres were based on the June Acreage Report, which showed planted corn acres down 1.2 percent and harvested acres down 1.1 percent.

The forecast is based on a large sample of farmer-reported yield projections collected from all states, and field-measurement objective yields in the largest corn producing states. The report assumes normal weather from Aug. 1 through harvest.

To this point, moisture has been a bit less than normal, which may bring the final yield down a bit, but we are still looking at a huge corn crop this fall.

Michigan’s 2018 corn yield was forecast at 158 bu/ac, down one bushel from last year, and three less than the record 162 bu/ac in 2015.

Michigan is expected to harvest 1.85 million acres, 50,000 acres less than last year, and the fewest since the high of 2.38 million in 2012. Production is forecast at 292.3 million bushels, down 8 million from last year, the lowest since 2007, and 66.5 million below the record 358.8 million set in 2015.

The USDA/WASDE also released updated Supply and Demand Estimates on Aug. 10. They can be seen in Table 1.

At this point, 2018-19 total use is expected to be up from last year. Feed use is projected to be up 75 million bushels, based on more livestock units, and ethanol use is expected to be up 25 million bushels, with other uses being up 20 million bushels. 

Exports are expected to be down 50 million bushels, mostly based on larger world production. At this point the effects of tariffs are not clear, but remember Mexico is our largest buyer of corn. 

So with lower total supply and more total use, ending stocks are projected to be down 344 million bushels, which lowers the stocks-to-use ratio from 13.6 percent to 11.2 percent. This leads to a projected $3.60 annual average 2018-19 price versus the $3.40 price for 2017-18. In Michigan the basis is fairly strong. If you have a lot of 2017 crop remaining, perhaps consider pricing on market rallies.

Wheat

The August crop production numbers showed U.S. wheat production down less than 1 percent, 4 million bushels, from the July report, but up 7 percent from 2017. 

Food use, feed use, and exports are expected to be up in 2018-19, with exports being the big increase, up 224 million bushels. The increase in exports is due to world wheat production being down about a billion bushels, mostly due to smaller crops in the EU and Russia.

Michigan 2018 wheat production was forecast at 39 million bushels, up from 33.575 million bushels in 2017. Michigan’s 2018 yield is forecast at 78 bushels per acre, down 1 bushel from last year. But Michigan harvested 500,000 acres in 2017 versus 425,000 in 2017.

The wheat basis in Michigan is fairly strong, which is saying the market wants wheat. And while the market is willing to pay a bit for storage, it won’t cover the cost of most.

Consider pricing some/much of remaining 2018 wheat on rallies, especially if we rally back to the high. And consider pricing some 2019 wheat on rallies past the previous highs.

Soybeans

The August crop production report forecasted the third record U.S. soybean crop in a row, 4,586 million bushels. The yield is projected to be 51.6 bu/ac, up 2.6 bu/ac from last year, and second only to the record 52 bu/ac in 2016.        

Harvested acres were projected at 88.9 million, down 0.6 million and the second- highest on record. This number came from the June Acreage Report. 

Michigan is projected to have a yield of 46 bu/ac, up 3.5 bushels from 2017, but below Michigan’s record yield of 50.5 bu/ac set in 2016. Michigan is expected to harvest a record 2.29 million acres, up 20,000 acres from this past year. This would put Michigan’s projected production at 105.34 million bushels, which would beat out the 104 million bushel record set in 2016.

The above numbers help put 2018-19 U.S. total projected supply at a record of 5,040 million bushels, up 325 million bushels from 2017-18. The updated USDA supply-and-demand report indicates that total use will be down a bit from last year’s record, but will be a moving target depending on how the tariff situation plays out.

Crush is projected to be up 20 million bushels, but exports are projected to be down 50 million bushels, which leaves total use down 50 million bushels. This leaves ending stocks at a massive 785 million bushels, easily surpassing the 2006-07 record of 574.

Ending stocks-to-use is projected to be 18.4 percent of use, up from last year’s 10 percent.

The USDA projects an average annual 2018-19 price of $8.90/bu, down from $9.35 last year. Seems high to me without the tariffs coming off fairly soon.

Remember, tariffs do not mean we won’t export soybeans to China, our largest market normally taking over 60 percent of U.S. exports. It means Brazilian soybean prices will be 24 percent more than U.S. soybeans. Giving a market recommendation with the present situation is pretty much impossible.

 

Index

 

Blogs & Columns

 

Columns

Market Outlook: Cash rent determination: Do you and a gentleman farmer-economist agree?

Dr. Jim Hiker | September 15, 2018

 Jim Hilker png(1)David Ricardo came from a London stockbroking family, made most of his considerable fortune from speculation during the financially turbulent Napoleonic war-era, cashed in and retired to an English country estate.

Weather Outlook: More rain in September; mild winter?

Jeff Andresen | September 15, 2018  

Jeff Andresen pngA broad upper-air ridge across the Upper Midwest led to a very active weather pattern across Michigan and the Great Lakes region during the last week of August and first week of September, with significant rainfall across most areas of the state.

Field Focus- September 15, 2018

Your Field Focus reporters are busier than ever now that the dog days of summer have yielded to the harvest season. Before long, they’ll be wrapping things up and looking for a paycheck, which under current economic conditions might be a little shorter than expected. But like farmers twice their age, they’ll persevere and give you a fresh harvest report in a couple weeks…ime to send you these reports.

Weather Outlook: Chances of rainfall increasing?

Jeff Andresen | August 30, 2018

Jeff Andresen pngOccasional rounds of scattered showers and thunderstorms brought welcome moisture to sections of Michigan during the first half of August, but most areas received only limited relief from prolonged dryness.

Market Outlook: Real tariff farm

Dr. Jim Hiker | August 30, 2018

 Jim Hilker png(1)The harm from the tariffs is real, whether the trade war is justified or not. And there is a possibility of longer-run effects as well, such as an increase in the investment in agricultural infrastructure in other parts of the world.