Contract farming may reduce risks

A big question circulating among farmers these days seems to be: Will I make enough money in 2008 to be able to afford the risks involved in raising a crop in 2009.

Collapses in the futures market, with some bankers limiting loans to 30-60 days, has ramped up the risk factor, especially for grain farmers.

Add to marketing risks, production costs have gone out the window with potash, nitrogen and phosphate-based fertilizers leading the charge. These astronomical increases alone will cause farmers to look closely at the fertility requirements of various crops before making 2009 planting decisions.

Richard Brock, president and founder of Milwaukee-based Brock and Associates and author of the Brock Report says an option may be more and more contract farming. Going more toward the Brazilian model, he says, would be a poor option for many U.S. farmers, but may be the only way some will stay in business.

It’s a very simple model. “One of the major grain companies furnishes the farmer with all their seed, chemicals, and all the fertilizer the grain company deems necessary to grow the crop. The grain company buys all the contract farmers’ grain, and if there is anything left at the end of the year, the farmer gets a check,” Brock explains.

“For some growers that system works. I’ve seen grain growers in the Midwest who have made it work real well. One grower went from 1,500 acres to 10,000 acres. They work on a smaller margin, but the margin is locked in,” Brock says.

“If a farmer can’t get contracts with local grain merchandisers and they don’t want to hedge the commodity themselves, contract growing is an option,” he says.

“We are already seeing grain growers in the Southeast contracting directly with hog and poultry operations. And, in the Midwest a number of corn farmers contract their crop directly with ethanol plants. That’s not exactly following the Brazilian Model, but it’s a good example of how contract farming gets started,” Brock says.

In the Southeast, poultry companies are facing tough times in getting feed at a cost that keeps production in line with the price they are receiving in the marketplace. The initial response has been to reduce the number of birds produced. The margins are so thin most poultry producers can’t afford to stay in business producing fewer birds.

In a case like that, even a small poultry company would still want to buy large volumes of grain and they would want delivery spread over a relatively long period of time. Given the desperate situation of poultry integrators, they are likely to want to make a deal with a group of farmers to provide the grain they need.

In the Southeast, where there is a long-standing grain deficiency, this type contract farming is more feasible, Brock contends.

Another Southeast industry, the catfish industry is in danger of going out of business all together, because of high feed costs, coupled with high energy costs related to harvesting, processing, and shipping catfish.

Catfish producers would need grain at a lower volume than large, highly integrated poultry operations and would seem to be another source of direct contracting for grain farmers in Alabama, Mississippi and Arkansas.

Ethanol production is likely to keep the bottom up on corn prices. The key is getting their primary feedstock, corn, at a cost that will make ethanol production, and subsequently ethanol prices comparable to gasoline. “Ethanol plants have been a good course of contract farming for many growers in the Midwest. If ethanol plants come on line, as planned in the Southeast, there should be an outstanding opportunity for growers to contract most or all of their corn,” Brock says.

“Despite increases in seed, fuel, fertilizer, pesticides, land rent and other production factors have gone up dramatically, grain farmers are still looking at making more profit than at any time in the past five years,” Brock says.

Everybody is concerned about the rise in input prices, but the reality is that rural America is making a lot of money. The margins are still there, Brock adds.

“What I’m more concerned about than the rising cost of inputs is how long $5.50 corn and $12 a bushel beans are going to last. Grain farmers are in a good position as long as we maintain these prices, but I don’t know if these prices are going to last,” he says.

In the Southeast, Brock predicts the cotton industry will make a slow comeback in the next few years. “The high price of cotton oilseed, the good global demand for high quality cotton and the loss of production the past few years all bode well for U.S. cotton growers, Brock says.

The big threat to U.S. cotton production probably comes from India, Brock says. India has a huge reserve of land that can produce cotton at high levels under irrigation. They have increased acreage somewhat, but have increased production more by applying technology and doubling and tripling the per acre yield of cotton.

“Soybeans and wheat are a different story. The U.S. doesn’t have the comparative advantage in these crops that we have in the Midwest for corn. There are many, many areas of the world that grow wheat and soybeans as well or better than we do. That’s the case with most crops,” Brock says.

At the grower level, Brock stresses that farmers need to make better decisions. “They tend to make decisions in marketing using 20/20 hindsight. In today’s market they can’t afford to do that,” he says.

Farmers need to accept they are going to be wrong a lot with marketing decisions — it’s more important to not be wrong ‘big’. The important thing is to recognize how to make decisions.

“There is so much risk on the table that growers can’t afford to buy inputs at high prices and not sell commodities at high prices. They need to lock in prices on both sides of the equation to take the risk out of it. The risks the next couple of years is buying inputs at a high price and not selling the outputs at prices high enough to cover input costs,” Brock stresses.

He points out that most farmers are not adept at marketing, though most think they are. He contends paying a reputable marketing agent for information that will help the grower make better marketing decisions is a good start to being able to manage high input costs and ever-changing commodity prices.

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TAGS: Management
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