Agriculture may see more volatility over the next decade than it has in the past 30. That means more opportunity, says David M. Kohl, professor emeritus, agriculture and applied economics at Virginia Tech.
“Volatility creates opportunity,” Kohl said as keynote speaker at the second annual Rural Economics Outlook Conference in Stillwater, Okla. “But producers also have more opportunity to fail,” he said. “The extremes get you in trouble.”
He calls those extremes “black swans,” birds that are rare but show up occasionally to make life interesting.
Possible black swans for agriculture include oil, sovereign debt issues, social unrest and other factors such as weather. He said the oil issue “will not go away, but in Oklahoma it’s also a revenue source.”
But oil prices too high will damage the economy. “Oil at $200 a barrel will create a world-wide recession,” he said.
In fact, six of eight recessions in the past 50 years were due to oil. Some 70 percent of oil produced is from a military or politically sensitive area. And 60 percent of fertilizer is dependent on those same areas.
Consumer reaction to oil prices is predictable, Kohl said. “At $3 to $3.50 a gallon for gasoline, consumers lock up. At $4 a gallon they shut down.”
Kohl said farmers and ranchers have to develop management strategies that offer some protection against the black swans.
He also said agriculture needs to watch the emerging BRICS nations—Brazil, Russia, India, China and South Africa— that will affect global markets. “All five have increasing demand for food, fiber and fuel,” Kohl said.
“The long-term viability of these nations will be defined by the way they handle adversity.” He also noted that several of these nations are looking to invest in agricultural production in the Southern Hemisphere to “add another source of food, fiber and fuel.”
The BRICS will also face economic challenges in the next ten years. Kohl said that if emerging nations enter a recession “for an extended period of time,” commodity prices are likely to collapse.
He referred to the current economic climate as a “Swiss cheese economy, with strong areas and black holes.”
Developed nations face some “headwinds in the second decade of the 21stCentury,” Kohl said. Challenges include public debt, an aging population and entitlements that countries may no longer be able to afford.
Game changers for agriculture include some tailwinds, positive forces, such as “islands of prosperity for row crops in the Upper Midwest and Canada, export potential for China and Asia, ethanol, low value of the dollar, good weather (for the Midwest), bullish land values and low interest rates.”
He said grain markets are in an “eight-year super cycle where weather and markets lined up. That can be a problem if producers are undisciplined. It is not a new normal, however.”
Headwinds include the livestock sector and problems for the Southern and Coastal ag areas. Input costs, consolidation, regulation, liquidity, equity declines and volatility also pose challenges.
Consumer perception of agriculture also may sway legislators. “The perception is that farmers are all fat cats,” Kohl said. “That’s a disconnect,” with reality.
He expressed concern for the U.S. economy, especially a growth rate of less than 2 percent. “The Fed likes 3 percent to 4 percent and it should be 8 percent to 10 percent with all the stimulus. Inflation is under control in the United States but we need to watch it.”
Kohl said the United States needs the “economic heart to put the economy in order. From 2000 to 2006 we didn’t know we were slipping.”
Even with the potential for excellent opportunity for agriculture over the next decade, Kohl suggested several challenges that bear watching. Those include: 1) volatility of the global market; 2) normalization of deviation (expecting a new normal. “Special conditions are not normal and will not last forever.”); 3) young lenders and producers who have never faced a downturn in agriculture; 4) the agriculture business cycle; 5) and the penchant for making decisions on tax returns instead of on accrual-adjusted records.
He said agriculture is not currently in a credit bubble but an asset bubble because of land values.
Early warning signs for the ag sector include a total U.S. farm debt to net farm income ratio greater than 10:1 and GDP growth of BRICS less than 3 percent.
He said warning signs for producers include: more than five different sources of credit, debt to asset ratio above 50 percent, working capital to revenue below 20 percent, and growing too rapidly. “If it grows too fast, then it’s a weed,” he said.
He said the same about land values. “Now, 89 percent of the value for (farm) assets is in land. Every time we have a war and every time we have a super cycle, land values go up. If it grows too fast, it’s a weed.”
He said land value corrections could happen with a global economic downturn, tightening of government policies, renting/growth oriented farms where all profits go for expansion leaving none for liquidity, and large blocks of land available in an area.
Points to ponder
Kohl offered a list of questions farmers should answer before they decide to expand or buy more land.
- Have you been profitable in the last three years?
- Will the land/ expansion result in greater than 50 percent equity?
- Do you have working capital to revenue of 33 percent or more after expansion?
- Will overall profitability after expansion exceed interest rates?
- Will overall profitability after expansion result in return exceeding inflation?
- Will overall profitability after expansion result in return exceeding weighted cost of capital?
Kohl said if a producer could answer yes to four of the six questions, buying the land would probably be a good idea. If yes answers get only two checks, don’t buy it, he said.
Water will become an increasingly important issue. “We will fight wars over water.”
Whatever the next decades hold, Kohl advised farmers and ranchers to be prepared. “Build strong working capital and cash reserves,” he said. “Develop a sound risk management program including marketing, hedging and crop insurance. Watch financial leverage.”
He recommended maintaining sound financial records and following a systems approach to management.
Farmers should “prepare for a five-year down cycle,” Kohl said.