Kohl's notes
Prices for many crops skyrocketed in 2007. Is this a
bubble that producers should be cautious about in 2008,
or is it just ‘the new normal’?
In my view, the current farm business environment has elements that I would be
cautious about. One of the key issues driving higher crop prices, of course, is the
growth of alternative energy. This in turn is driven by high prices for oil, which in
turn are driven by strong demand from India and China. If demand in India and
China drops, the price of oil comes down and the alternative energy economy will
feel the pain. Indeed, some of the shine has come off biofuels already. Of the nine
U.S. alternative energy plants on the drawing board at the beginning of 2007, three
were cancelled by the following fall. The numbers no longer added up, and investors
were unwilling to fund construction.
A second factor encouraging higher crop prices is the changing dietary habits of
developing countries. Again, if these economies slow, demand for crops will be
reduced and the price will reflect this.
Personally, I get concerned when I see the strong growth in farmland prices that
has occurred in many parts of North America. Producers who buy land at these
prices are committing to a fixed-cost structure that is uncompetitive with
agricultural producers like Brazil.
Market conditions are likely to be more volatile in 2008 than we have seen for
quite some time. Volatility can bring risk, but it can also deliver opportunities.
When wheat is at $9 per bushel, everyone who grows wheat will tend to look
pretty smart. If somebody sold wheat at just $6 per bushel, they might be kicking
themselves for leaving money on the table. I recommend taking a longer-term view.
Producers who have a disciplined marketing plan, who understand their production
costs by enterprise, and who can lock in a reasonable profit will do well over the
next three years.
There’s no way to know where crop prices are heading next. But if I were buying
land, I’d want to “cash flow it” based on $5 wheat. If prices are higher than that,
I’d be using my retained earnings to strengthen the balance sheet as much as
possible. If prices continue to be strong, you’ll be able to bullet-proof your
operation for several years to come. Stable profits would be a “new normal” that
many producers would look forward to.
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