Fayetteville, Arkansas
October 8, 2008
From farm to market, agriculture
is holding its own during the current economic crisis, even
though a credit crunch is sending ripples of stress throughout
the industry, say agricultural economists with the
University of Arkansas
System’s Division of Agriculture.
The greatest area of stress in the agricultural economy may be
grain elevators, which rely heavily on loans to invest in
commodity futures, and in the livestock and poultry sectors, U
of A economists said.
Bruce Ahrendsen, professor of agricultural economics and
agribusiness, said that most agricultural businesses, especially
farmers, are generally in good shape because they have solid
assets — meaning land.
“The balance sheet has been strong for farms, particularly those
owning farmland,” Ahrendsen said.
Colleague Bruce Dixon, professor of agricultural economics and
agribusiness, cautioned that livestock and poultry producers are
more susceptible to economic difficulties than producers of
plant crops because meat prices have not risen as dramatically
as grain prices.
Dixon said credit is at the heart of the trouble in the U.S.
economic system. The collapse of once strong banking companies
has shaken confidence in loan markets.
“Banks are not lending to each other, something that banks
normally do all the time,” Dixon said. “That restricts money
available for loans to individuals and businesses.”
Those credit troubles could spill over into agriculture,
Ahrendsen said. Dixon and Ahrendsen agree that farmers could
begin feeling the impact of tightened credit in 2009 when they
apply for loans to buy fertilizer, fuel and other production
inputs.
Production costs have been rising with the price of oil and
natural gas, not only because tractors and combines need fuel,
but also because production of many fertilizers is energy
dependent. In addition, Ahrendsen said, many fertilizers are
produced overseas and the cost of importing them has risen
sharply as the dollar has weakened against foreign currencies.
For producers of rice, corn, soybeans and wheat, crop prices
have risen sufficiently to offset higher production costs, but
prices can fluctuate dramatically.
“Energy is a double-edged sword for agriculture,” Dixon said.
“When fuel prices come down, it may reduce input costs, but
lower fuel prices make biofuels less profitable relative to
petroleum based fuels.”
If demand for corn declines, Dixon said, the price farmers get
for their crops goes down. More corn in the food markets would
lower demand for other food crops, causing their prices to drop
as well. As farmers’ profit margins narrow, there could be a
higher demand for credit as farmers seek bigger loans to cover
their operating expenses, and they could run up against the
shrinking availability of loan funds.
Grain elevators are particularly vulnerable to the credit crunch
because they rely on futures markets to hedge their commodity
contracts with farmers, said Andrew McKenzie, associate
professor of agricultural economics and agribusiness.
Elevators serve as “middlemen” in the agricultural market
system, McKenzie said. They buy grain crops from farmers and
hold them in storage until selling them for livestock feed, or
to food processors.
When crop prices are favorable, farmers enter into contracts
with elevators as much as two or three years in advance so they
can sell their crops at those higher values even if current
prices fall, McKenzie said.
If crop prices fall, farmers benefit from having locked in
higher prices, but the elevators face losses, McKenzie said. To
hedge against such losses, elevators hedge in the futures
markets at values equal to their contracts with farmers, he
said.
The idea is that losses from lower crop prices will be offset by
higher profits from futures holdings, McKenzie said. Conversely,
losses from changes in futures will be offset when crop prices
rise higher than contract prices with farmers.
Credit is essential in futures trading, McKenzie said. Investors
are required to pay a percentage of the current futures prices
for their holdings, or positions, usually 5 percent or less.
This upfront payment is known as margin money. Although it is a
small fraction of the actual value of a futures contract,
because elevators deal in large volumes of grain this can still
represent a large dollar commitment.
“You have to have a lot of cash on hand to get into the futures
market,” McKenzie said. Elevators usually borrow that cash from
banks.
When futures prices go up, McKenzie said, futures brokers issue
margin calls — demands that futures investors pay the difference
to maintain the same percentage of the going prices. Those
margin calls are often in the millions of dollars, and that
means going back to the bank.
“Elevators don’t usually have that cash on hand,” McKenzie said,
“so they need a good line of credit.”
McKenzie said crop prices have been rising dramatically for the
past year and a half. Rising crop prices also made the futures
market more attractive to index and pension funds, which like to
invest in long-range futures positions. Their investments drive
futures prices even higher.
“Those margin calls have come large and fast,” he said.
As the credit market tightens during the ongoing economic
crisis, loans for futures investors are drying up, McKenzie
said. Holding futures positions will become increasingly
difficult and may cause smaller elevators in particular to get
out of the futures market he said.
“This makes elevators reluctant to offer farmers long-range
contracts,” McKenzie said. “At some point, elevators didn’t want
to book crops one or two years out.”
In many cases, elevators will only offer contracts for six month
in advance, McKenzie said. Some will not offer advance contracts
at all, or will charge fees to offset risks. The negative impact
of the credit crunch backs up all the way to the farmer, who is
squeezed between rising production costs and the inability to
lock in high crop prices.
“Elevators play a crucial role in getting food from the farm to
the grocery store,” McKenzie said. “That role has been
compromised.”
In this time of volatile crop prices and a banking crunch,
McKenzie said elevators have to look at new ways to market
grain. In the meantime, he doesn’t want to blow the situation
out of proportion.
“Most elevators are hanging in there, operating in the
traditional manner,” McKenzie said. “But it’s becoming
increasingly expensive to do so.”
“Elevators across the board have done a heroic job of
maintaining our market system,” McKenzie said.
“Consumers may be seeing higher food prices, but there have been
no food shortage scares. Food is still getting to the stores,”
McKenzie said. “That’s at least in part because of the
remarkable job the elevators have been doing.” |
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