Farmers are dealing with the worst inflation in decades as they work to ensure that they turn a profit this year amid soaring input costs.
Inflation affects nearly every sector of the economy. The agriculture industry must perform a balancing act because as the cost to grow and harvest crops has increased, so has the price of the commodities they sell, which increases profits for farmers.
Last year was lucrative for farmers, according to the Agriculture Department, which has said that net farm income, a broad measure of profits, is expected to have grown by $23.9 billion, or a healthy 25.1%, in 2021 compared to 2020. However, the USDA predicts that net farm income will contract by 4.5% relative to last year, although it will still surpass the inflation-adjusted average from 2000 to 2020.
Inflation across the board is up much more than last year. Consumer prices increased 7.5% in the 12 months ending in January, which is the fastest pace of inflation since 1982. As a result, the Federal Reserve is preparing to raise interest rates for the first time in years to drive down prices, with an initial interest rate hike expected next month.
Several factors are at play for farmers facing down inflation in how successful their 2022 will be, given the higher costs.
Vincent Smith, a nonresident senior fellow at the American Enterprise Institute and the director of agricultural policy studies, said the prices of a lot of farm equipment have gone up more than the average pace of inflation, something that cuts into the bottom lines of farms and ranches.
He pointed out that the price of automobiles has increased almost entirely because of the global semiconductor shortage and said the scarcity is also affecting farming equipment. For reference, according to the most recent inflation report, used-car prices have ballooned by 40.5% year over year.
“If you buy a new combine harvester today, it’s full of chips,” he told the Washington Examiner. “They have the same sort of supply chain disruption issues that anyone producing a mechanized piece of equipment like a car has.”
While one of the most apparent price increases that affect farms is for seeds and farming equipment, another somewhat overlooked factor driving up costs is the explosion in energy prices.
The most recent inflation report, released earlier this month, found that overall energy prices have increased by a mammoth 27% since last year, a much faster clip than price increases for goods such as eggs, oranges, and chicken.
Farmers need a lot of energy to keep their farms running, including fuels such as diesel to run tractors. Unfortunately, the average price increase of all types of gasoline is up 40% from January 2021. But soaring energy prices also affect the farming industry in more complex ways.
Smith said the most important and most heavily utilized fertilizers for farms are now nitrogen-based urea fertilizers.
Natural gas is a very substantial portion of the cost of producing any nitrogen fertilizer like urea.
“The run-up in natural gas prices … has increased fertilizer production costs both in the U.S. and elsewhere and is part of the story about why nitrogen fertilizer prices, in particular, have shot up,” Smith explained.
He said that higher commodity prices also drive demand for fertilizer, which further inflates its costs.
“When the price of corn is $5 or $6 a bushel, the demand for nitrogen fertilizer, which is a key input into corn production, tends to go up pretty substantially,” Smith said. “There’s been an inward movement in the supply curve because of higher costs of production, and there has been an outward movement in the demand for nitrogen fertilizer because of the surge in corn prices, in particular, but also prices of other grains and commodities that use nitrogen fertilizer.”
The USDA estimates that fertilizer makes up 36% of the operating cost for farmers growing corn, 35% for wheat, and 30% for sorghum.
Smith said it was worth noting that many producers of corn and soybeans and other commodities bought their fertilizer in June and July of last year for this year because they gauge the markets and market forecasts when making purchasing decisions. Thus, they might be insulated, at least for now, from the higher market prices.
David Sacco, a practitioner in residence at the University of New Haven’s finance department, explained that proper planning by farmers is crucial to how well they will do this year in the high-inflation environment.
“If you basically bought all of your inputs over the course of the last year and you didn’t lock in the sale price of your crops via futures contracts or forward sales, then you’re probably benefiting somewhat,” Sacco told the Washington Examiner. “If you hedged the revenue from your crop sales using futures and now you’ve seen inputs go up … then obviously it’s going to hurt you.”
The impact of inflation is not across the board and depends on the commodity getting sold.
For example, while the prices for some agricultural goods have shot up, dairy product prices have not gone up too much, which could hurt dairy farmers who still must grapple with the higher input costs. Milk prices have only increased 1.1% and cheese prices have only increased 1.2% over the past year, according to the most recent data from the Bureau of Labor Statistics.
“Broad swaths of the sector did very, very well,” Smith said of last year. “There are a few areas within the sector where the prices that farmers get for what they sell has not kept pace with their increasing costs.”
American Farm Bureau Federation Chief Economist Roger Cryan recently said that in a general sense, it is good news for farmers that commodity prices are so high right now.
“Prices are looking pretty good for many of the benchmark crops and animal products. So despite higher prices for fertilizers and chemicals and other inputs, farmers’ market returns should be higher in 2022,” Cryan said.
“Inflation is a big concern, and we’re hoping that the Federal Reserve Bank will follow through on their promises to rein that in,” he added.
While predictions on how much the central bank will raise the federal funds rate this year vary, the general trend is that the Fed will move more aggressively than what was thought just weeks ago.
In the short term, Sacco said farmers may feel some pain from the Fed’s decision to hike interest rates because borrowing costs will increase alongside those rate hikes.
“Farmers, they definitely use a lot of credit,” he said. “Because they’re borrowing money to pay for seed or inputs or whatever, the first thing they’re probably going to see is a rise in their borrowing costs because interest rates go up.”
Sacco also said that given the soaring levels of inflation and how accommodating the Fed has been since the start of the pandemic, it is unlikely that the central bank will be able to raise rates and bring down inflation smoothly.
“Inflation is kind of out of control right now, and the only way that they’re going to be able to sort of slow it is to really slam the brakes on things, which unfortunately is going to cause a lot of pain for certain sectors, and I would expect that sector to be hit pretty hard,” he said.
