Margin compression in agriculture could lead to lower net incomes, decreased rental rates
Two K-State agricultural economists discuss how low commodity prices might affect producers.
Released: Feb. 18, 2016
MANHATTAN, Kan. – The agricultural industry is entering a period of margin compression, in which revenues are depressed and costs remain elevated, according to Brian Briggeman, Kansas State University associate professor of agricultural economics and director of the Arthur Capper Cooperative Center. As a result, farming profits are expected to be thin, and net incomes are projected to be down in 2016.
Producers can also expect lower commodity prices this year, Briggeman said. For example, the average predicted farm price for corn by the U.S. Department of Agriculture for 2015-2016 is $3.60 per bushel, a 10-cent decrease from the average in 2014-2015.
An overall poor economic outlook for agriculture this year also means landowners should expect that leasing producers will want to renegotiate their cropland leases, according to Mykel Taylor, K-State Research and Extension agricultural economist.
Taylor’s report, 2016 Kansas County-Level Cash Rents for Non-Irrigated Cropland, shows that from 2015 to 2016, estimated cash rental rates decreased from an average of $38.75 to $25.71 per acre in northwest Kansas, $30.18 to $19.28 per acre in west central Kansas and $22.03 to $13.29 per acre in southwest Kansas.
Those estimated cash rental rates decreased in the last year from $69.31 to $49.23 per acre in the north central region, $53.79 to $37.91 per acre in central, $42.61 to $29.67 per acre in south central, $119.50 to $103.48 per acre in northeast, $63.84 to $54.69 per acre in east central and $31.64 to $27.08 per acre in southeast.
The projected dryland rental rates in past years have been accurate for the average producer but are not an exact indication of what rates every farmer will pay in 2016, according to Taylor.
“These are not necessarily the rental rates that you would observe out in the state; what they are is our best guess for what somebody could afford to pay for ground based on our estimates of current production costs, a 20-year historical yield and commodity prices,” she said.
Contributing factors and predicted effects
Commodity prices have come off of their recent highs, and production costs remain elevated. As a result, profit margins have narrowed, which creates profit margin compression. Factors contributing to this tightening of margins include burgeoning supplies and a slowing demand for agricultural products, along with higher production costs and expenses associated with new technology developments, according to Briggeman.
Producers should not be expecting additional increases in interest rates in the immediate future due to turmoil in international markets, low oil prices and concerns about inflation in the United States being too low, Briggeman said. Producers might have a harder time getting loans, however, because lenders will likely want more information from customers. Tighter financing and higher credit standards are directly tied to periods of margin compression.
Getting through a period of margin compression comes down to the individual management of an operation, he added. Producers should focus on building liquidity to stave off downside risks, rather than trying to expand and overextending themselves. In addition, producers need to know their per-acre costs of production, because that will help them lock in profit opportunities when they arise.
“Producers do not have to completely sit on the sidelines,” Briggeman said. “They need to be mindful of how they deploy their capital at this time. It comes down to, ‘What can I control within my operation, and how do I best do that?’”
Among the items that may or may not be in a farmer’s control are leasing agreements. Farmers who are renting land might not actually pay rates as low as the predicted amount, for fear of losing the land they are currently leasing or because they locked in rental rates when they were at their peak a few years ago, according to Taylor. As a result, there may be conflict between landlords and tenants if these rates are now too high as agricultural profits decrease.
Since half of the land in Kansas is leased, there is potential for impact statewide; good communication is a significant factor in working out potential conflicts, she said.
“Approach this as something where you want to try to work through it with your existing tenant, if you have a good relationship,” Taylor recommended. “You should be able to find some middle ground that is still relatively affordable but does not undermine the landlord’s need for income.”
If it is not possible to find a rate that both the landowner and producer can afford, however, then some producers may be forced to walk away from their current leases, she added.
“That will happen,” Taylor said. “Rental rates are sticky, because we don’t move off of those rates quickly. But, you have to deal with economic reality. This isn’t a producer-specific problem; this is being driven by low commodity prices.”
K-State Research and Extension is a short name for the Kansas State University Agricultural Experiment Station and Cooperative Extension Service, a program designed to generate and distribute useful knowledge for the well-being of Kansans. Supported by county, state, federal and private funds, the program has county Extension offices, experiment fields, area Extension offices and regional research centers statewide. Its headquarters is on the K-State campus, Manhattan.