Category: Inputs

KFMA Relative Expenditure Indexes

 Background

In AgManger publication GI-2017.4, the price indexes for major expense categories was discussed so that farmers could see how expenses have changed over time. This previous publication focused solely on the USDA price index (a national price index). This USDA index puts the cost of an input on a scale relative to some base year. It is not examining how much farmers are spending on an input, only the cost of an input per unit over time.
This publication builds on AgManager publication GI-2017.4 by examining the price indexes of inputs used by farmers in Kansas. Data from expenditures of farmers in the Kansas Farm Management Association (KFMA) program was used to build the indexes shown here. Because actual expenditures are used, the results are different from those shown by the USDA. The USDA focus is on cost per unit while this study focuses on cost per category where the number of units used is allowed to vary.
In this publication, the broad expense categories of fertilizer, fuel, hired labor, machinery, and seeds are examined to see how these expenditures have changed since 1977 and 2006. To create this baselines, the expenses in the baseline year are set to 100. The percentage change in expenditures for an expense category is then computed for each year and these percentage changes are used to adjust the baseline index.
Another difference in this publication is that the KFMA expenditures were already adjusted to real dollar terms before computing the indexes. Unlike publication GI-2017.4, where the CPI index was needed to show how expenses had changed relative to inflation, the expense index lines in the figures below already reflect an inflation adjustment. Thus, any line showing above 100 is increasing faster than the inflation rate.

Results

Results are shown for price expenditure indexes for fertilizer, fuel, labor, machinery, plus an index for total crop production expenditures per acre. Results are shown with a baseline start of 1977 and 2016 and also for eastern, western, and central parts of Kansas. The machinery expenditures used here includes management depreciation (actual decline in the market value of machinery), the interest cost of dollars invested in the machinery, repairs and maintenance, and also the fuel cost.
In eastern Kansas, nearly all expenditures have matched the inflation rate since 1977 (see Figure 1). The only exception is for seed expenses which have tripled since 1977. Contrast this to the USDA price index where machinery costs increased the most. This difference can be explained by how farmers have adjusted their machinery use. While an individual piece of machinery is certainly more expensive, size advantages, new technologies, and the use of reduced tillage have all led to the actual machinery expenditures not changing very much over 40 years.

Figure 1. Index of KFMA Expenditures for Eastern Kansas Since 1977

Figure 2 shows the expense expenditures in eastern Kansas since 2006. This figure shows that all expense categories except fuel have increased by 50%. 2006 was the start of a period of high grain prices so most likely, farmers were still profitable with these higher prices. The higher grain prices likely led to more intensive farming as well which is why the fertilizer expenditure shows the second biggest increase when the actual price for a unit of fertilizer did not increase very much. Now though, with grain prices back at low levels again, these higher expenses are affecting the profitability of many farms.

Figure 2. Index of KFMA Expenditures for Eastern Kansas Since 2006

Figures 3 and 4 show the expense expenditures for central Kansas. Fertilizer use now shows the largest increase in expenditures since 1977 with seeds the second largest. Starting with a base year of 2006, seeds have been the most expensive. These two figures are likely showing how the crop mix has changed in the drier parts of the state. Higher corn prices have led to more corn acres which increased the seed and fertilizer expenses.
Another difference between eastern and central Kansas is difference in labor expenses. In eastern Kansas, labor actually saw the largest increase in expenditures since 2006 while in central Kansas the labor expenditures matched the inflation rate.

Figure 3. Index of KFMA Expenditures for Central Kansas Since 1977
Figure 4. Index of KFMA Expenditures for Central Kansas Since 2006

Figures 5 and 6 show the expense expenditures for western Kansas. The same trends seen in central Kansas are apparent here too. Fertilizer and seed expenditures have increased the most due in part to a switch away from wheat acres and to more intensive farming.

Figure 5. Index of KFMA Expenditures for Western Kansas Since 1977
Figure 6. Index of KFMA Expenditures for Western Kansas Since 2006

Discussion

As noted in the discussion of the USDA price indexes, seed costs need to be monitored especially closely. Seed expense per unit as provided by the USDA have increased the most since 2006. Seeds are also one area where it is especially difficult to adjust spending. While machinery expenses and cash outflow can be controlled to some degree by delaying equipment purchases, seeds will always be needed to grow a crop. There may be options to lower plant populations or use a lower priced seed but be sure to check with agronomists about the consequences of these types of actions.

Predicting Fertilizer Prices

Current situation

Fertilizer is a major expense item for farmers, currently accounting for around 20% percent of crop production expenses. As shown in Figure 1, the percentage of fertilizer expenses to total crop production expenses has varied across the state of Kansas both by region and by year. Western Kansas tends to apply less fertilizer as a percentage of total crop expenses than either central or eastern Kansas. Western Kansas has seen their fertilizer expense as a percentage of total crop expense increase over time, however, while the other two areas remain more constant.

Figure 1. Fertilizer Cost Percentage by Region of Kansas (from KFMA data)

From a dollar per acre perspective, fertilizer expense has ranged from $10 per acre to $70 per acre (in real dollars) depending upon the region of the state and the specific year. The western third of Kansas has seen fertilizer expenses of $10 to $40 per acre while the other two areas have seen fertilizer expenses from $20 to $70 per acre. Fertilizer expenditures per acre across all three areas of Kansas were at their low points from 1987 until 2005. Since then, fertilizers expenses per acre have risen until 2012. This increase in fertilizer costs per acre can probably be attributed to higher fertilizer prices, a shift in the crop mix to more corn, and higher grain prices which resulted in more fertilizer use. Since 2012, fertilizer costs per acre have declined for likely the same reasons they increased. Even with this decline, fertilizer costs per acre are double what they were back in the mid 1990’s (in real dollars). Figure 2 shows these real dollar fertilizer expenditures per acre for Kansas Farm Management Association farms across the three regions of the state.

Figure 2. Fertilizer Cost in Real Dollars per Acre by Region of Kansas (from KFMA data)

With current low grain prices (and the resulting lower profitability), producers need to manage their expenses very closely if they want an opportunity to earn any profits this year. Fertilizer is a good candidate for analysis, given that fertilizer is a major expense item both in absolute dollars and as a percentage of total production costs. If farmers could predict fertilizer prices 6 months to a year in advance, they could time their purchases to minimize costs, adjust their crop mix to account for either higher or lower fertilizer prices, and plan with their lenders to adjust operating loans to account for potentially higher or lower fertilizer prices.

Predicting anhydrous ammonia prices

Predicting nitrogen fertilizer prices is possible since the price of anhydrous ammonia is positively correlated with both the price of oil and corn. Nitrogen is one of the most important fertilizers in the production of corn, grain sorghum, and wheat so predicting anhydrous ammonia prices will cover a majority of the fertilizer expenses on a farm. Other nitrogen fertilizers start with ammonia so forecasting anhydrous ammonia provides an indication of prices for the other nitrogen products. In addition, anhydrous ammonia is positively correlated with other fertilizers besides nitrogen so correctly predicting anhydrous ammonia will give some indication of the price direction of other fertilizers.

Anhydrous ammonia is positively correlated with the corn price and the price oil because these two products represent something about the demand and supply of anhydrous ammonia fertilizer. Economic theory tells us that higher prices for an output will cause producers to produce more by using more of the production inputs. Thus higher corn prices lead to more nitrogen fertilizer per corn acre (i.e., increased demand for nitrogen fertilizer). Also, a higher corn price will lead to more corn acres (which uses nitrogen) and fewer soybean acres (which doesn’t need nitrogen fertilizer). Figure 3 shows the relationship between the national anhydrous ammonia price and the national corn price since 2010 on a monthly basis. This monthly correlation is 0.84. National anhydrous ammonia prices come from the fertilizer reports published by Progressive Farmer (https://www.dtnpf.com/agriculture/web/ag/home) National monthly corn prices are from USDA Quick Stats.

Figure 3. Monthly Anhydrous Ammonia Prices vs Monthly National Corn Prices

The supply side of anhydrous ammonia is represented by the oil price. Ammonia is produced as a result of a catalytic reaction from burning natural gas (the hydrogen) and the nitrogen in the air. Thus, the expectation is that lower natural gas prices should lead to more production of ammonia. However, the correlation between monthly natural gas prices and monthly anhydrous ammonia prices is low (0.01). This may be because natural gas prices are more volatile than other oil products. Schnitkey Schnitkey, G. "Anhydrous Ammonia, Corn, and Natural Gas Prices Over Time." farmdoc daily (6):112, Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, June 14, 2016. used yearly prices of corn and natural gas in a model to predict anhydrous ammonia prices and found that yearly natural gas prices worked well in a prediction model until 2008 when the correlation between natural gas and anhydrous ammonia became lower. Figure 4 shows the historical monthly prices of anhydrous ammonia and natural gas. Even allowing for a lag in the natural gas price didn’t improve the correlation.

Figure 4. Monthly Anhydrous Ammonia Prices vs Monthly Natural Gas Prices

With monthly prices, the use of oil as opposed to natural gas provided a stronger correlation to anhydrous ammonia. Oil and natural gas can be substitutes for each other in certain situations and have a 0.59 correlation. The correlation between oil prices and anhydrous ammonia prices is 0.55. However, a visual inspection of oil and anhydrous ammonia historical prices indicates that anhydrous ammonia prices tend to lack oil prices. This is not surprising as ammonia producers need some time to adjust production to account for changes in their input prices. Testing of various oil price lags revealed that a 10 month lag in oil prices provided the best fit to anhydrous ammonia prices. With this lag, the correlation between oil prices and anhydrous ammonia increases to 0.74. Figure 5 shows the historical monthly prices of anhydrous ammonia, oil, and the oil price lagged by 10 months.

Figure 5. Monthly Anhydrous Ammonia Prices vs Monthly Oil Prices and Lagged Oil Prices

Model to predict anhydrous ammonia prices

With the corn price representing the demand for anhydrous ammonia and the oil price representing the supply for anhydrous ammonia, a formal regression model was developed using ordinary least squares. This model resulted in the following equation:

Anhydrous ammonia ($/ton) = 293 + 47.38 * corn ($/bu) + 2.09 * oil-10 mo lag ($/barrel)

This regression result has an adjusted R-squared of 0.86. An R-squared this high is usually considered a strong fit. Figure 6 shows the actual anhydrous ammonia price vs the predicted anhydrous ammonia price.

Figure 6. Actual vs Predicted Anhydrous Ammonia Prices

Predictions for 2017

During 2016, producers saw five-year lows in most fertilizers (See Figures 7, 8, 9, and 10 for historical prices of anhydrous ammonia, urea, MAP and potash). Given that nitrogen fertilizer prices are dependent upon corn prices and oil prices this result is unsurprising as oil and corn prices were low during 2016.

Going forward into 2017, producers are likely to see some increases in fertilizers prices due to higher oil prices. The model to predict anhydrous ammonia prices is based on a 10-month lag in oil prices. Thus, at the end of 2016, fertilizer prices were based on an oil price of $37.50 per barrel (spring of 2016 oil price). Oil is already at $52 a barrel and the futures market is indicating that oil prices could be in the mid-50’s this summer. Thus, a $15 increase in oil prices could add another $30 a ton to the anhydrous ammonia price by fall.

The other part of the price forecast concerns corn prices. A $0.10 change in the national corn price will move the predicted anhydrous ammonia price by $4.74 per ton. Unlike the forecast with oil prices (which is lagged by 10 months), the corn price effect has no lag. Thus, predicting anhydrous ammonia price movements with corn prices is trickier as we don’t know these yet.

Other fertilizers are likely to increase during the course of 2017 as well as there is a strong positive correlation between anhydrous ammonia prices and the other fertilizer types (see Table 1).

Figure 7. Historical Monthly Anhydrous Ammonia Prices by Year

Figure 8. Historical Monthly Urea Prices by Year

Figure 9. Historical Monthly MAP Prices by Year

Figure 10. Historical Monthly Potash Prices by Year
Table 1. Correlation of Monthly Fertilizer Prices Since 2010

Diesel Prices for 2017

Current Situation

Diesel prices the last two years have behaved much differently than they did a few years ago. Diesel prices used to peak in the spring and fall and were at their lowest in January and February. For the last two years, diesel prices have either increased or decreased the majority of the year. Also, from 2012 through 2015, highway diesel prices were much higher than they were in 2015 and 2016. Whether fracking is the cause or if there is some other factor in play, pricing patterns have been noticeably different these past two years.

Figure 1 below show the highway diesel prices by week for the last five years. The last two years have seen prices move in opposite directions. During 2015, prices declined nearly the entire year. The decline actually started during the fall of 2014 and continued through February of 2016. During most of 2016, diesel prices continued their slow rise.

Figure 1. 5 Year Weekly Highway Diesel Prices

Although diesel prices ended 2016 at their high point for the year, prices are still low when looking at a five year history of diesel prices. The question for farmers is what are diesel prices going to do in 2017. With grain prices low, farmers will really need to watch their expenses closely.

When to Purchase Diesel Fuel

There are two questions to address. First when might be the best opportunity to purchase diesel fuel during the year and what might happen to prices during the course of 2017. To answer the first question, the seasonality of diesel prices might provide some guidance. The seasonality of diesel prices is shown in Figure 2. Here, the monthly price is compared to the average yearly price to determine the difference. The last five years of monthly diesel prices were then averaged by month to get a monthly seasonal price difference. The black bar is this average while the purple points are the seasonal differences in a given year.

Figure 2. Monthly Seasonality of Diesel Prices

As shown in the figure, March tends to have the highest price in a given year that typically is $0.10 higher than the yearly average price. In four of the last five years, the March diesel price has been above average. The exception being last year when March had nearly the lowest price of the year.

From a farmer perspective, high prices just before spring planting could present problems. If farmers are filling their tanks at that point, they could be paying more than necessary. Farmers would likely pay less for diesel by filling their diesel tanks at the end of the year.

December has the lowest price of the year on average although there is a wide variation in the December seasonality. In 2016, Diesel prices were actually the highest in December. Still, in four of the last five years, December diesel prices were either near the yearly average or below the average.

August is an interesting month for diesel prices as this month’s seasonality shows very little seasonality. In all of the past five years, the August diesel price has been nearly the yearly average price.

Price Predictions for 2017

As might be expected, diesel prices and oil prices are highly correlated. Using the last three years of weekly oil and diesel prices we can develop a model that estimates diesel prices as a function of oil prices. The future oil prices can then be used to gauge where traders think diesel prices are headed.

The model used in this analysis predicts a $0.27 increase in diesel price for a $10 increase in oil price. The current crude oil futures quotes for the rest of 2017 peak at $56. This is $4 above the December oil price. Thus, diesel prices could rise another $0.10 during 2017. Of course this price projection assumes no big shocks to the market occurring. If this projection is accurate then farmers could expect higher prices in 2017 when compared to 2016. Still diesel prices would be below where they where from 2012 through 2014.

Gasoline Prices for 2017

Current Situation

Gasoline prices the last two years have been much lower than they were in the three preceding years. Gasoline prices typically follow a seasonality pattern where prices peak in the summer time and are lower in the winter time. These seasonality patterns corresponding to typically higher demand as many consumers in the U.S. are traveling.

Despite lower gasoline prices the last two years, prices still followed the basic seasonality pattern although prices in 2016 didn’t change much during the year. As explained in AgManager.info publication GI-2017.1, diesel prices were also lower the last two years but the seasonality patter was not consistent. Thus the changes that have occurred over the last two years seem to be affecting diesel differently than gasoline.

Figure 1 below shows the gasoline prices by week for the last five years. Consumers were likely very happy with gasoline prices in 2016 as this was the lowest price year in a long time and prices did not fluctuate much at all during the year. In many places, consumers saw gasoline below $2 a gallon for at least some parts of the year.

Figure 1. 5 Year History of Gasoline Prices

A bigger concern going forward though is what do these low prices mean for oil production. There is some evidence that from 1994 to 2014 there was a rightward shift in the supply curve (http://oilprice.com/Energy/Crude-Oil/The-2014-Oil-Price-Crash-Explained.html ) which has led to lower prices. However, low prices certainly do not encourage more drilling of oil and could actually lead to the supply curve moving back to the left if oil producers profits are so low that producers shut down production. Oil demand and oil supply are inelastic so any shifting of the supply curve results in big price changes. Boom and bust cycles are not that unusual in the oil business so consumers should not be all that surprised when gasoline and diesel prices change rapidly.

Seasonality

As mentioned above, gasoline shows a strong seasonality pattern where prices are higher in the summer. The seasonality pattern is much stronger than it is for diesel fuel. Typically, gas prices will reach their peak in May or June (see Figure 2). Most farmers don’t use enough gasoline and gasoline doesn’t store as well as diesel either to take advantage of this price seasonality.

Figure 2. Seasonality of Gasoline Prices

Price Predictions for 2017

Just like for diesel fuel, the price of gasoline is closely tied to the price of oil. As shown in AgManager publication GI-2017.1, oil prices are expected by traders to reach $56 this summer. That would add another $0.08 to the price of a gallon on gasoline. Thus, gasoline could be slightly more expensive in 2017 when compared to 2016 but still likely below the levels from 2012 to 2014. Again, any shocks to the market could change prices dramatically.