Outside of COVID-19, the headlining news is the economic recovery and rapidly rising prices on things like homes, vehicles, and building materials, as low interest rates and consumer confidence drive demand for goods. However, as we move into an inflationary period, there are some new challenges for crop marketing, especially as it pertains to forward contracting future year’s crops.
Inflation is not necessarily a bad thing for agriculture. In fact as producers, we are pretty well protected since the value of crops goes up in value as the inflationary pressures drive them. Our non-farming friends and associates who rely on hourly or salaried wages are in much bigger trouble if inflation heats up because they will require pay raises in line with the rate of inflation in order to maintain their buying power. As sellers of commodities like corn, wheat, soybeans, or canola, farmers can expect to see commodity prices to have at least a loose correlation to inflation.
In the June 2021 consumer price in-dex report, Canada reported strong price growth, and raised expectation for an annual inflation rate of 3.6%. This is the highest inflation rate that we’ve seen in Canada in nearly a decade.
There are a few quirks in the way in which the consumer price index is calculated, which makes it ineffective as a business planning tool. One of these quirks is that the index does not consider taxes of any kind as part of a product’s price. For example, since April, Canadians have been paying 8.8 cents per litre of carbon tax on all of their gasoline purchases, plus the 13% HST, on the carbon tax portion of the price. It adds up to a 10 cent per litre increase in the price of gasoline when you’re paying for it at the pumps. But since that price increase is entirely caused by taxation, it doesn’t figure into the consumer price index, and therefore would not be considered inflation in fuel prices.
The more appropriate benchmark for estimating the impact of inflation on our farm businesses is the producer price index. The PPI monitors costing on equipment, services, and materials that businesses use in order to produce or manufacture goods. Agriculture and Forestry is a sub-category in the producer price index. In the June report, the U.S. producer price index estimated an annual rate of inflation of 4.2%. Most notably, when considering the changes over the past 7 months, producer price inflation has risen at 0.6 % per month for the past seven consecutive months, suggesting that if the curve doesn’t flatten we could see a higher than 7 % inflation rate over the next year.
This ties back to marketing Ontario crops. As we start seeing elevators post prices for 2023 crops, we’re going to need to view those prices with some consideration for what our 2023 cost of production might be. For the sake of simple math, if we assume that the producer price inflation is going to level out at 5%, then our cost of production will be 10% higher in 2023 than it was in 2021, which would make a $14.50/bu sale of soybeans for 2023, the buying power equivalent of making a $13.05/bu sale of soybeans in 2021.
I do not want to suggest that there will not be good opportunities to forward contract future year’s crops. However, it’s more than clear now that the economy has moved into a period of inflation which will result in both a higher cost of production and a greater need for the farm business to create a bigger cost of living wage for the family. Eye-balling future year’s prices against last year’s costs is likely to result in a margin crunch.
In terms of a farm marketing strategy, focus primarily on 2021 crop marketing and if you are entertaining opportunities for 2022 or 2023 sales, figure in some inflation protection into your price expectations. If you’re tempted to make 2022 sales, make certain that you’ve got an extra 4% or 5% gross margin factored into the price that you’re selling.
Since the value of raw material commodities goes up along with inflation, cash sales in the spot market effectively have the inflation built into the price. (It would be safe to say that a portion of the grain price increases which we’ve seen over the past 7 months is a direct result of price inflation).
The danger is in getting sales locked in for periods where your business does not have costs locked in. Specifically, that risk lies in making 2022 and 2023 crop sales. In those situations, producers are going to need to cover their inflation risk by extracting a premium on the price.
Steve Kell operates a crop farm in Simcoe County and is a former grain merchant for Parrish and Heimbecker Ltd.