September 28, 2023

Contributed by Ben Palen, Ag Management Partners

In March of this year, I wrote an article (www.globalaginvesting.com/op-ed-is-a-resetting-underway-in-agriculture), in which I opined that certain conditions were pointing towards adjustments from the highly prosperous conditions of the last three years. Having lived through various agricultural cycles in my lifetime, the change in conditions was not a big surprise, but what  caught my eye was the nature of some of the factors involved. 

When I began to make an outline for this article, the approach was very simple. On one side of the ledger were the pluses, and on the other side were the minuses. I had no preconceived notions of how many items would appear in each column. As part of my approach, I watched various macro and micro trends over the past six months – shifts that are reflected on my “ledger”. I have also spoken to people throughout the ag sector ranging from farmers, to bankers, to grain merchants, and investors. On occasion, what was not said was as informative as what was said.  

The only plus-item of significance was the decline of input prices, notably for some fertilizers and for certain popular herbicides (although there are now some hints that things could turn in the other direction). The minuses were numerous, and in no particular order they included weakening grain prices, greater competitions from South America and other regions, a doubling of interest rates as compared to a year ago, signs that the tech advances of the past few years may have reached a peak (at least for the foreseeable future), diminished government support for agriculture, and the impacts of climate change.   

There is one factor that appears near or close to the top of my list of concerns, and that is demand for commodities. We in the world of ag have gotten very good at producing high yields. Indeed (and this is a topic deserving its own consideration), some, including myself, would argue that we have lost sight of the most important financial factor for a farmer — the unit cost of production. How can we grow something if we cannot sell it for a profit? That is a question being debated at the moment within California’s almond industry, but the issue is much broader. I recognize that unlike a handful of companies that might make cookies, there are hundreds of thousands of farmers in the U.S. who make individual decisions about what to grow, and how much to grow. We cannot flip a switch and shut down the cookie factory, as it were. The world cannot live hand-to-mouth for its basic food items, yet in some respects, the production technology has gotten ahead of itself in regard to the basic question that I am raising.  

The other part of the demand factor is connected to world population trends. It was not long ago that the consensus was that as populations grow, the world’s ability to feed itself was questionable for several reasons: weather, soil and water degradation, etc. Now, there are signs that population trends, notably in China — the world’s largest importer of farm commodities — are going in the opposite direction. 

Another factor that is at or near the topic of my list of big-picture concerns is the possible greenwashing  that may be occurring when speaking of “sustainable” and now “regenerative” agriculture. There is nothing inherently wrong for the ag world to be a strong advocate of these approaches. I fear, though, that we have gotten ahead of ourselves, as enormous amounts of capital have poured into the sector based on promises tied to these keywords. Sustainable and regenerative agriculture may indeed be key to solving our carbon and climate issues, but it would be wise not to rush the promotion of grand ideologies until there is more clarity. 

The upshot of the above is that virtually all sectors in agriculture are back to reality — whether we like it or not — against a backdrop of increased capital needs, somewhat inexplicably high land prices, and cash returns that for 2024 are expected to be lackluster at best.    

Let me illustrate the last point. This year, the per-bushel revenue guarantees for corn and hard red winter wheat per the federal crop insurance programs were $5.91 and $8.77, respectively (with some slight adjustments depending on location). For 2024, the announced price level for wheat is $7.34. It is too early to say for corn, but many folks are suggesting a number close to $4.50. New crop (2024) wheat is trading in Eastern Colorado/Western Kansas for about $6.50 a bushel. The decline in some input costs is nowhere close to keeping up with the sharp decline in revenue. These numbers are about as clear of an indicator as I know of pointing towards a resetting of expectations.  

In reviewing the carefully constructed budgets for the two noted crops as published by the University of Illinois and Kansas State University for this year, and making some adjustments for lower input costs and lower grain prices in 2024, there is no scenario where the crops cash flow next year absent an extraordinarily high yield.  

For the wheat example, the returns swing from a positive $120/acre to a loss of about $30/acre. Using a true opportunity cost number of 5 percent, that loss is in reality closer to $100/acre. For corn on highly productive land in Central Illinois, and with the U of I price assumption of $5 corn, the return after land costs is a negative $99/acre at normal yields. A .50 cent per bushel fall in corn prices would move that negative number to over $200/acre. I should note that those budgets are constructed using a modest opportunity cost for money as a line item. No reasonable person would construct a budget for any business leaving out that opportunity cost factor. It is especially hard to ignore when one can put money in the bank and earn around 5 percent.

In another article that I wrote last year, I borrowed Alan Greenspan’s famous phrase about “irrational exuberance” to describe some of the eye-popping land sales that were making headlines. Have we learned any lessons this year? One would hope so. But there are outliers of which I am aware, such as a lease of a large tract of organic land for a rate more than twice the area rate, or the effort of another farmer to expand his operation by more than 20,000 acres by offering a rental rate that is three times the going rate for the area. The concern in situations such as these, is that investor expectations can be raised to unrealistic levels, thus making it challenging for other farmers to tap into capital markets for purposes of expanding their operations. In a sector that needs to nurture young farmers, how could they be expected to survive when these sorts of deals are in the market?   

The examples that I noted are but two of many; they are not unique to geography or crop. While I am not predicting a sharp downturn in land prices, I see a softening. It is all well and good to have a big balance sheet figure for land values. Balance sheet values do not pay for inputs. The real question is whether that land will produce a cash flow while standing on its own at current prices? That is unlikely for many growers in 2024, and especially for those who have a lot of rented land. It is one thing to do “cost averaging” on a land portfolio that has been built up over time, but that luxury is not available to a grower with many rented acres who can do little more than shave a few dollars off here and there from input costs. I know that there are those who will disagree with my thoughts on land prices. But the numbers speak loudly. 

In my view, we will not return to conditions such as we saw in the 80s. But we are going to see a resetting of expectations from all sectors in agriculture. Betting on a continuation of the last three years is not a winning strategy in my book. It appears to me that  “fair weather investors” will fall by the wayside — something that we are already seeing signs of, notably at the smaller investor level. At the institutional investor level, the anecdotal evidence is that the transaction pace for farmland has slowed to a crawl. In the pork sector, a massive contraction is underway, speaking to my point that we are really good at producing lots of goods. We are not so good at matching supply and demand. I think that the entire sector must focus on finding new ways to utilize the products that we grow, and on new users. We need to be prepared for a period of slower growth, greater risk, and a reality check that “sustainable” and “regenerative” strategies, while promising, and mostly legitimate, may not be the only answer. Note that I did not say they are fundamentally flawed. They hold much promise. But there appears to be too much of a gold rush, and sadly, some claims have been made that just do not fulfill their promises.   

It is not all doom and gloom. But we have to pay close attention to the demand issues. I am hopeful that all of us will take a step back as this fall harvest season winds down, and realize that we can either be swept up in a resetting that may not be pretty, or we can be proactive and realize that “‘change is a-comin'”. Expectations must change. The sector would be well served if that happens. 

ABOUT THE AUTHOR:

Ben Palen is a fifth generation farmer with experience in many aspects of agriculture, including projects in the United States, Africa, and the Middle East.  The focus on all projects is sustainable practices based on a mix of boots on the ground work and selected use of agtech tools.

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