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Are the Good Times Really Over for Good? The Future Direction of the US Ag Industry

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Editor’s Note: Barclay Rogers is chief executive of Good Earth Irrigation, a data analytics startup focused on identifying sustainable irrigation opportunities. On a quest to understand the forces at play in the agricultural economy, and to assess the role that agtech could play in this economy, Rogers has written a two-part in-depth analysis for AgFunderNews. He may be reached at barclay.rogers@goodearthirrigaiton.co or via LinkedIn.

Barclay Rogers
Barclay Rogers

“We are agreed that the real and lasting progress of the people of farm and city alike will come, not from the familiar cycle of glut and scarcity, not from the succession of boom and collapse, but from the steady and sustained increases in production and fair exchange of things that human beings need.”[1]

So declared President Franklin D. Roosevelt upon signing the Agricultural Adjustment Act of 1938, which ushered in an era of supply control in US agriculture that lasted for nearly 60 years until supply controls were removed as the dominant feature of commodity price support in the Federal Agricultural Improvement and Reform Act of 1996.[2]

The first in a two-part series on the likely fate of the agriculture technology (agtech) sector during the current downturn in the broader agricultural market, this article explores the speed with which we are likely to recover from the current collapse in the agricultural sector.

Will demand bounce back so that we achieve high levels of farm profitability again in the near future? Will commodity price increases result from decreases in supply that are likely to occur over a longer time period? Or will farm profitability be restored through production cost savings as opposed to commodity price increases? In both Part 1 and Part 2, we explore the questions through the lens of US corn production, which is the single largest crop in America.[3]

Increased Corn Demand Is Largely Attributable to Ethanol Requirements

US corn production grew from 9.2 billion bushels in 1996 to a projected 14.4 billion bushels in 2016. Over the same time period, domestic corn usage grew from 7 billion bushels to 12.2 billion bushels, with the vast majority of the domestic growth owing to an increase in corn used for ethanol. In 1996, none of the US corn supply was used for ethanol production, but by 2016 a whopping 5.3 billion bushels — 37% of the entire US corn crop — were used to make ethanol. Interestingly, exports have remained fairly constant with 1.8 billion bushels exported in 1996 compared to 1.9 billion bushels projected to be exported in 2016. Even at their peak in 2007, exports totaled 2.4 billion bushels, corresponding to roughly 18.5% of US corn production for that year.[4]

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Data Source: USDA World Agricultural Supply and Demand Estimates (WASDE)

Agriculture’s recent boom years, therefore, are largely attributable to ethanol production. Biofuel mandates were initially set by Congress through the Renewable Fuel Standard (RFS) at 9 billion gallons in 2008, rising to 36 billion gallons in 2022, with no more than 15 billion gallons from corn-starch ethanol.[5] The corn ethanol limit of 15 billion gallons set by the RFS has essentially been reached, with total corn ethanol supply averaging 14.9 billion gallons over the period 2011 to 2015.[6]

Stated differently, since 2011 approximately 5 billion bushels of corn have been used each year to make ethanol, and this amount is likely to remain unchanged as the corn ethanol mandates have reached their statutory limit.[7] If one excludes ethanol production, corn usage, including exports over the period 1996 to 2016, has ranged from 6.4 billion to 9.8 billion bushels per year with an average of 8.8 billion bushels per year.[8] In fact, corn usage excluding ethanol was 8.8 billion bushels per year in both 1996 and 2016.[9] In short, in the absence of a statutory change to the RFS, corn demand is likely to remain relatively constant for the foreseeable future.

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Data Source: USDA World Agricultural Supply and Demand Estimates (WASDE)

Corn Production Is Likely To Remain High Notwithstanding Price Decline

Demand, of course, is only one side of the equation, and things get even more interesting when one looks at the supply side. US corn supply consists of domestic corn production and imports. Domestic corn production is a function of corn acres planted and yields. Corn plantings increased from 79.2 million acres in 1996 to 93.6 million acres in 2016, and corn yields increased from 127 bushels per acre to 168 bushels per acre. Total US corn production, therefore, increased from 9.2 billion bushels in 1996 to 14.4 billion bushels in 2016, corresponding to a 56% increase in production over this 20-year period.[10] Imports have remained a relatively small part (less than 1%) of US corn supply. [11]

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Data Source: USDA World Agricultural Supply and Demand Estimates (WASDE)

Farmers responded to increased prices, resulting from higher demand due to ethanol requirements, by increasing corn acres. Corn plantings jumped from 78.3 million acres in 2006 to 93.6 million acres in 2007 following the introduction of the RFS, and have averaged 91.1 (ranging from 86 to 97.3) million acres since then. Increased plantings coupled with increased per acre yields resulted in a 37% increase in US corn production from 10.5 million bushels in 2006 to 14.4 million bushels in 2016. Interestingly, corn plantings fell by a mere 4% — from 97.3 million acres to 93.6 million acres — from their peak in 2012 to today, notwithstanding a 51% drop in corn prices (from $6.89 in 2012 to $3.35 today).

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Data Source: USDA World Agricultural Supply and Demand Estimates (WASDE)

In short, supply appears to be relatively inelastic, at least with respect to price decreases. Interestingly, corn plantings increased from 78.3 million acres in 2006 to 93.6 million acres in 2007, corresponding to 19.5% growth in a single year, thus evincing great flexibility in farm-level production capacity. The relative stickiness of corn production in the face of falling prices, therefore, appears to have less to do with structural issues — such as machinery changes or grain handling logistics — and more to do with an absence of better crop options.

Agriculture suffers from the fallacy of composition, which is the error of assuming what’s true of a member of a group is true for the group as a whole.[12] It is logical for each farmer to produce as much of the highest value crop as possible, but such production maximization leads to oversupply in the market. One needs to simply observe the fact that US corn production continues to increase, despite a leveling off of demand, to see the fallacy in operation. Each farmer wants to maximize his corn production as it is a relatively high-value crop, but the corn price continues to fall as supply overwhelms demand.

Where To From Here?

This, of course, is the very problem that agricultural support programs sought to solve through supply control from the great depression in the 1930s until the great liberation of the 1990s. Supply control today is much more difficult than it was in the 1930s, however, owing to the robust global trade in agricultural commodities. If the US were to curtail production in an effort to boost prices, another country would likely increase production and harvest the gains associated with higher prices. This dynamic is a classic game theory problem and it’s a major contributing factor to the fading influence of OPEC as individual countries seek to maximize their own returns despite adverse effects on the broader oil economy.[13] The demise of OPEC is simply the fallacy of composition writ large.

Purdue Crop Budgets and Purdue Cash Rent Surveys. Average productivity soil, rotating corn using revised budgets (where available) were used to estimate revenues and variable production costs. Average quality land was used for cash rent estimates.
Purdue Crop Budgets and Purdue Cash Rent Surveys. Average productivity soil, rotating corn using revised budgets (where available) were used to estimate revenues and variable production costs. Average quality land was used for cash rent estimates.

It appears that we are in for sustained hard times in the agricultural sector. Farm incomes are projected to be negative in 2016 owing to the lag effect between input costs and revenues. Purdue University estimates that the corn production costs have increased from $378 per acre in 2007 to $628 per acre in 2016, with the bulk of the increases resulting from increasing land rents ($90 per acre rise, corresponding to 65% increase) and seeds ($80 per acre rise, corresponding to 186% increase). Over the same time frame, Purdue estimates that corn production revenues have increased from $581 per acre to $594 per acre ($13 per acre rise, corresponding to a 2% increase). In 2007, corn farmers made $202 per acre on average; in 2016, they are projected to lose $34 per acre.[14]

Purdue Crop Budgets and Purdue Cash Rent Surveys. Average productivity soil, rotating corn using revised budgets (where available) were used to estimate revenues and variable production costs. Average quality land was used for cash rent estimates.
Purdue Crop Budgets and Purdue Cash Rent Surveys. Average productivity soil, rotating corn using revised budgets (where available) were used to estimate revenues and variable production costs. Average quality land was used for cash rent estimates.

Conclusion

No industry can sustain long-term losses.[15] Nevertheless, it is difficult to see significant increases in corn prices; demand for corn ethanol has reached its statutory limit and supply control appears untenable in a global marketplace.[16] Instead of rising prices, the agriculture industry is likely to experience declining unit production costs as farmers increase efficiencies and put pressure on suppliers to reduce prices. Indeed, in the oil industry, US shale oil producers have driven down production costs as opposed to significantly cutting back on supply in response to lower oil prices over the past several years.[17] Expect much the same from US farmers.

In Part 2, we explore the role that the agtech sector may play during these tight economic times in the agricultural market.


Footnotes

[1]For information on the Agricultural Adjustment Act of 1938, see http://fdragriculturaladjustmentact.weebly.com/.

[2]For information on the Federal Agricultural Improvement and Reform Act of 1996 (also known as the Freedom to Farm Act), see http://www.ers.usda.gov/media/933651/aib729a_002.pdf.

[3] Corn grown for grain accounted for 87.4 million acres out of a total of 242.1 million acres of U.S. row crop production in 2012.  Soybeans, which are often grown interchangeably with corn and frequently exhibit similar economics, accounted for an additional 76.1 million acres; consequently, the combined corn and soybean market comprises roughly 67% of all U.S. row crop production.  One may therefore derive a pretty clear view of the U.S. farm level economics by evaluating U.S. corn supply and demand dynamics.  See   https://www.agcensus.usda.gov/Publications/2012/Online_Resources/Highlights/Farms_and_Farmland/Highlights_Farms_and_Farmland.pdf

[4] The figures in this paragraph come from the USDA World Agricultural Supply and Demand Estimates (WASDE) database.  See http://www.agmanager.info/marketing/outlook/WASDE/default.asp#.

[5] The Renewable Fuel Standard was first established in the Energy Policy Act of 2005 and was expanded in the Energy Independence and Security Act of 2007.  See Renewable Fuel Standard:  Overview and Issues, http://www.ifdaonline.org/IFDA/media/IFDA/GR/CRS-RFS-Overview-Issues.pdf.

[6] The USDA reported corn ethanol production based on data collected by the U.S. Department of Energy, Energy Information Administration.  See http://www.ers.usda.gov/data-products/us-bioenergy-statistics.aspx.

[7] USDA World Agricultural Supply and Demand Estimates (WASDE) database, http://www.agmanager.info/marketing/outlook/WASDE/default.asp#.  Indeed, the USDA predicts that corn ethanol will fall in the U.S. over the next decade.  See http://www.ers.usda.gov/media/2017463/oce-2016-1.pdf.

[8] Id.

[9] Id.

[10] Actual production is less than acres planted multiplied by yield because approximately 10% of planted acres are not harvested each year.

[11] The figures in this paragraph come from the USDA World Agricultural Supply and Demand Estimates (WASDE) database.  See http://www.agmanager.info/marketing/outlook/WASDE/default.asp#.

[12] For a definition of the fallacy of composition, see http://www.oxforddictionaries.com/us/definition/american_english/fallacy-of-composition,

[13] For an exploration of some of the dynamics in the oil industry, see http://www.economist.com/news/finance-and-economics/21697268-america-not-opec-decides-fate-global-oil-markets-drill-will.

[14] The figures in this paragraph come from the Purdue Crop Budgets and Purdue Cash Rent Surveys.  Average productivity soil, rotating corn using revised budgets (where available) were used to estimate revenues and variable production costs.  The average quality land was used for cash rent estimates.  See https://ag.purdue.edu/commercialag/Pages/Resources/Management-Strategy/Crop-Economics/Crop-Budget-Archive.aspx; https://ag.purdue.edu/agecon/Pages/Purdue-Agricultural-Economics-Report-Archive.aspx.

[15] Stein’s Law states that “If something cannot go on forever, it will stop.”  See Herbert Stein, What I Think: Essays on Economics, Politics, & Life, https://www.goodreads.com/work/quotes/736687-what-i-think-essays-on-economics-politics-and-life.

[16] USDA projects moderate growth in corn demand over the coming decade resulting from increasing demand for animal feed and exports due to steady global economic growth.  See http://www.ers.usda.gov/media/2017463/oce-2016-1.pdf.

[17] For a good assessment of increased efficiencies and declining production costs in the shale oil industry, see https://www.federalreserve.gov/econresdata/notes/feds-notes/2016/unraveling-the-oil-conundrum-productivity-improvements-and-cost-declines-in-the-us-shale-oil-industry-20160322.html.

[i] Are the Good Times Really Over by Merle Haggard, Copyright V1951P284-289.

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