Energy costs impact ag production

Expert says to watch anhydrous prices this fall and lock them when
Like other sectors of the U.S. economy, agriculture has also kept a weary eye on energy prices.
While gasoline prices, hovering near $2, catch the attention of consumers, agricultural producers must also watch fertilizer, natural gas, and, often, propane prices to gauge the effect of fluctuating costs on their bottom lines.
Recent volatility in energy prices has left many producers worried and wondering what, if anything, can be done to mitigate higher energy costs.
Four influences. Energy costs directly affect row crop producers in four ways: nitrogen fertilizer costs, drying costs, hauling charges, and fuel costs.
Each of these differs in the effect on profitability as well as the ability to minimize exposure to the price risk.
Nitrogen costs. Nitrogen fertilizer costs consist of two components: the cost of the natural gas needed to produce the fertilizer and the cost of transportation and storage, which is relatively stable.
Recently, natural gas prices have become significantly more volatile as domestic U.S. production has grown only slightly in the last five years, and are unlikely to increase dramatically during the next five years.
However, much of the electric generation capacity being built and planned will consume natural gas, increasing domestic demand at a rate higher than domestic production will match.
Increased imports and rationed demand are expected to make up the difference.
Additionally, the higher price of oil is also pushing up prices of natural gas, as a partial substitute.
To an average Ohio farmer, increases in natural gas prices over the last two years have increased fertilizer costs by roughly $5 an acre of corn, or about 3 percent of variable costs.
The impact of increased drying costs, due to higher natural gas, propane, and electricity prices is less severe, about $2 an acre of corn.
Fuel costs. Fuel costs, specifically diesel, are the other major energy cost incurred by farmers.
Fuel is used not only for on-farm machinery, but also for transportation of the harvested product to market.
In the last year, prices for both “on-road” and “off-road” diesel fuel have increased by about 25 percent, increasing the cost of operating farm machinery by an average of $1.80 an acre for corn and $1.10 an acre for soybeans.
Fuel for transport will cost an additional $1 an acre for corn, and 25 cents an acre for soybeans.
For an average Ohio farmer, the higher prices will increase direct costs by approximately $10 an acre of corn and $1.40 an acre of soybeans.
It is likely that higher energy costs will also be felt indirectly, through higher chemical and machinery costs, but those increases are much harder to predict.
Nitrogen. Unfortunately, there are limited options for coping with higher energy prices on the farm.
The largest cost increases occur from higher fertilizer and drying charges.
While fertilizer has already been applied for the current year, the high prices should be a motivation for reassessing nitrogen application rates this fall and next year.
Many producers continue to apply more nitrogen than needed, and a reduction to the recommended rates will be even more profitable with high nitrogen costs.
There is less that can be done with drying costs; most producers already take advantage of air drying to the extent that it is possible, so it is unlikely that higher drying costs can be avoided.
The situation for fuel costs is much the same.
Managed? These prices also beg the question of whether energy cost risk, like that of the commodity prices themselves, can be profitably managed.
The answer is yes and no.
For most farmers, the only available risk management instruments for energy costs are forward contracts for fertilizer and fuel.
In the past, approximately two-thirds of nitrogen fertilizer was priced prior to use.
While the rising volatility in natural gas markets has made these forward contracts even more desirable, it has also made them less attainable.
For three months last fall, most elevators and fertilizer distributors were refusing to lock prices on anhydrous.
The only avenue for pricing at that point was to take physical delivery and store the fertilizer on the farm until use.
This is an unattractive option both from a cash-flow standpoint as well as a safety standpoint (the recent thefts of anhydrous increase the risk of accidents or losses on the farm).
Therefore, I would recommend starting to watch anhydrous prices this fall as they become available, and lock them when possible.
(The author is a grain marketing specialist with Ohio State University Extension and Department of Agricultural, Environmental and Development Economics.)