1. Potato Economics: Potato Markets, Marketing & Cost of Production Potato Science PLSC 490/590 Lecture 20 April 8, 2014 Paul E. Patterson Extension Agricultural Economist pattersn@uidaho.edu http://web.cals.uidaho.edu/idahoagbiz/

2. 2 A short lesson in economics Market-based economies: supply & demand Overview of potato markets & marketing Overview of developing cost of production estimates Uses of cost of production Example of Idaho cost of production Objectives

3. 3 Economic systems answer 3 basic resource allocation questions: 1- What? 2- How? 3- For whom? Shall goods and services be produced Economic Overview Economic systems: Market-based economies (capitalist) Centrally planned economies (socialist) Mixed

4. 4 $ Quantity Demand Supply P1P1 Q1Q1 Market-based economies: supply & demand set price

5. 5 What are things that you want to know before you produce a crop? Economic Overview Market Analysis can provide answers to important questions: Supply & Demand Trends Prices What to produce? Where to sell? When to sell?

6. 6 Demand Analysis : + & - Economic Overview Diet fads (Atkins) Health issues (obesity, fat, acrylamide) Demographic shifts (age, ethnicity) Income level Where meals are consumed (home or away from home) Form of meals consumed (processing and convenience) Price of product and price of substitutes What factors influence consumer demand for food? Consumer tastes & preferences

8. 8 Supply Analysis : + & - Economic Overview Commodity price and price expectations Price of alternative crops Input prices Technology Government policy & programs Environmental factors Weather, disease, pests What factors influence supply? Producer preferences & expectations

10. 10 Potato Market Structure & Market Channels Potato Market Overview What markets are available for potatoes and how are prices determined? Fresh: consignment, formula pricings Process Frozen: mostly pre-season, collective bargaining contracts, some open-market purchases Dehydration: some pre-season contracts, mostly sale of washed processes grade from sheds Seed: some multi-year & formula prices

11. Source: USDA.

12. Source: Patterson, industry sources, USDA.

14. Source: USDA.

20. 20 $ Quantity Demand Supply P1P1 Q1Q1 Market-based economies: supply & demand set price

21. $ Cost of Production & Supply Quantity Supply C2C2 Q2Q2 Q1Q1 C1C1 Q2Q2 C3C3...

22. 22 Does cost of production matter? Cost of Production Overview Does the market care how much it cost you to raise potatoes or any other crop?

23. 23 Overview Short run – cost of production does not matter Long run – cost of production does matter “Cost of production would have not effect on competitive price if it could have none on supply.” John Stuart Mill, 19 th century economist

24. Although potato production practices may be similar among different growers, each farm has a unique set of resources with different levels of productivity, different production problems, and therefore different costs.

25. How much does it cost to raise potatoes? It Depends: Acre vs. Cwt Location Variety Farm Size Storage Conventional vs. Organic Water Source & Irrigation System

26. How much does it cost to raise potatoes in Idaho? It Depends:

27. Region UI CAR Estimates$/ac Field-Run Yield$/cwt SWI RB w/ Fumigation$3,770530$7.11 SCI RB$2,892410$7.05 SCI RB w/Fumigation$3,289455$7.23 EI-S RB$2,563375$6.83 EI-S RB w/Fumigation$2,862415$6.90 EI-N RB$2,360350$6.74 Idaho 2013 RB Production Costs: no storage Cost to grow, harvest, and sort.

28. Measuring Cost of Production Traditional uses:  Farm-level decisions & analysis  Policy & government program analysis  Performance analysis

29. Overview of Costs & Returns Enterprise budgets  Commonly used to characterize costs & returns What is an enterprise  An enterprise is any coherent portion of the farm business that can be separated and analyzed as a distinct entity (profit center)  An enterprise uses inputs & incurs costs while producing either products or services Traditional production unit  Acres (hectares) for crops  Head for livestock

30. 30 Because CAR estimates are typically structured for an enterprise, they are frequently referred to as enterprise budgets An enterprise may produce more than one product, making it difficult to focus only on a single commodity Examples:  A wheat enterprise produces grain and straw  A seed potato enterprise produces seed and tops  A dairy enterprise produces milk, calves and cull cows Overview of Costs and Returns Estimates

31. 31 An enterprise can be defined broadly or narrowly  Broad classification: dairy, beef, crops  Narrow classification: milk, calves, wheat, potato, barley, sugarbeets, etc. An enterprise can be structured differently for different types of analysis Most frequently, an enterprise is defined on a commodity basis Overview of Costs and Returns Estimates

32. 32 CAR estimates can also be categorized by the type of management system Management system combined with a commodity:  Conventional tillage vs. No-till winter wheat  Irrigated spring barley vs. rain fed spring barley  Potato production with or without storage  Roundup Ready Sugarbeets These designations are useful and help avoid confusion Overview of Costs and Returns Estimates

33. 33 Time frame of CAR estimates:  Can be based on historical data – looking back  Can be projected data – looking forward Time Frame of CAR estimates:  Typically 12 months, or a production cycle  Can be longer or shorter  An orchard or a vineyard would require a longer time period Overview of Costs and Returns Estimates

34. 34 Scope of CAR estimates:  CAR estimates can represent a single farm, the average of a group of farms in a region or nation, or a composite or model farm  USDA often develops an average or composite CAR estimates to evaluate policies  Universities normally develop CAR estimates for a model farm to evaluate alternative technologies and cropping systems, as well as market opportunities Overview of Costs and Returns Estimates

35. Cost of Production Revenue:  Price x Yield  Correspondence between price and yield  Field-run or paid Costs: Operating (variable) Ownership (fixed)

36. Cost of Production Operating costs typically vary directly with production and involve inputs consumed in one production cycle (typically one year): seed, fertilizer, chemicals, fuel, water, labor, etc.

37. Cost of Production Ownership costs typically don’t vary directly with production and involve inputs (depreciable assets) lasting more than one production cycle: machinery, irrigation system, breeding livestock, and sometimes management, owner/operator labor and land

38. 38 Two basic means of calculating cost of production Cost of Production 1. Farmers allocate costs based on accounting records Track, accumulate and then allocate costs Structure of chart of accounts is critical Some costs can easily be assigned to a given crop or field, while other costs cannot Allocation procedures are needed Machinery operating expense: fuel, repairs, etc. Machinery ownership costs

39. 39 Two basic means of calculating cost of production Cost of Production 2. Universities Generate Costs Budget generator software “generates” cost for field operations specific to a crop Machinery operating expenses are generated for each operation and accumulated for the enterprise Labor, fuel, repairs and ownership costs Difficult to calculate enterprise specific “overhead” expenses, such as legal, accounting, utilities, etc.

40. 40 U of I Cost of Production Estimates Historical not projected Crop costs & returns estimates “published” biennially in odd-numbered years 75 - 80 crop enterprise budgets 4 regional areas: Northern Southwestern (Treasure Valley) Southcentral (Magic Valley) Eastern Idaho Dryland & Irrigated

41. 41 U of I Procedures & Assumptions Typical or representative costs of production estimates, not average Based on grower surveys, sequence of operations, not cost data from growers Model farm for each region or sub region

42. 42 U of I Procedures and Assumptions Economic costs, not accounting (cash) costs Opportunity cost (market value) Machinery: 75% of replacement cost new Management: 5% of total costs Overhead: 2.5% of cash operating expenses Land: crop specific 1-year cash rental value Surface water, avg. price by region Pressurization only, per acre-inch water applied

43. 43 U of I Crop Budget Format Portable Document Files, or PDFs 8 – 14 page format Background & assumptions page Cost per acre with detailed list of inputs, quantities & prices Cash flow and machinery summary Sensitivity analysis Ranging analysis Monthly storage costs (potatoes only)

44. 44 U of I Crop Budget Format Excel spreadsheets Cost per acre with detailed listing of inputs Sensitivity analysis One crop per worksheet One file per region or sub-region Crop Enterprise Budget Worksheet data files Cost per acre with detailed listing of inputs Sensitivity analysis One crop per worksheet One file per region or sub-region

45. 45 U of I Crop Budgets Yields Generally based on above average management and are consistent with input use Based on farm surveys, USDA county or regional yields, as well as expert opinions from extension specialists, county extension educators, fieldmen, etc.

46. 46 U of I Crop Budgets Input Prices Based on regional surveys conducted annually Northern Idaho Southwestern Idaho Southcentral Idaho Eastern Idaho Chemical fertilizer dealers, seed dealers, irrigation districts & canal companies, fuel distributors Published as AERS staff paper

47. 47 Sequence of Field Operations Based on surveys of farmers What they do, how they do it and when it is done Tillage, planting, cultivation, pesticide applications and harvesting Quantity of inputs applied, when and how applied Seed, fertilizer, herbicides, insecticides, fungicides, irrigation water

48. 48 Understanding Operating Costs Fertilizer – typically pounds of element, not product N, P2O5, K2O, Zn, micros Dry nitrogen – priced as urea (46-0-0) Liquid nitrogen – priced as solution 32 (32-0-0) Dry phosphorous – price from 11-52-0 with nitrogen valued at price of urea Liquid phosphorous – price from 10-34-0 with nitrogen valued at price of solution 32 Potash – valued at price of 0-0-60 (muriate not sulfate)

49. 49 Understanding Operating Costs Pesticides (chemicals) Herbicides, insecticides, fungicides, fumigants Detailed list of products, quantity & price Trade name, not common name Custom & consultants Input application: fertilizer & some chemicals Hand labor: onions Consultant: potatoes, onions, sugarbeets

50. 50 Understanding Operating Costs Irrigation Water assessment (irrigation district, canal co.) Irrigation system repairs: Center pivot - cost per acre-inch Concrete ditch & siphon tube – cost per acre Irrigation power - costs to pressurize only Cost per acre-inch Machinery Fuel – gallons per acre Lubricants – cost per acre Repairs – cost per acre

51. 51 Machinery Cost Calculations Based on engineering and economic equations built into the crop budget generator program Calculates machinery operating expenses Fuel, oil, lubricants, and repairs Machine time: hours per acre 8.25 ÷ (speed x width x field efficiency) Labor hours based on machine time x 1.2 Calculates machinery ownership costs Depreciation, interest and insurance (taxes if applicable)

52. 52 Understanding Operating Costs Labor hours per acre Machinery: tractor operators and truck drivers Irrigation: specific to irrigation system Other: unskilled labor used primarily at harvest Storage Potatoes & onions Other Crop insurance Assessments

53. 53 Understanding Operating Costs Operating interest Charged from month of application to harvest month Total operating costs per acre Total operating costs per unit of production based on yield used to generate gross receipts

54. 54 Understanding Ownership Costs Tractors & Equipment Depreciation, Interest and Insurance Calculated only on equipment used Capital recovery method of D & I over the useful life, not the tax life Based on 75% replacement cost new, adjusted using NASS machinery index

55. 55 Understanding Ownership Costs Land 1-year crop-specific cash lease, or cash equivalent based on crop share (northern Idaho) Includes irrigation system ownership costs Overhead 2.5% of cash expenses Management 5% of gross receipts

56. Cost of Production Uses of enterprise budgets:  Financing  Lease negotiations  Enterprise selection  Cost control and analysis  Marketing plans  Appraisals – income approach  Analyzing alternatives

57. 57 Potato Costs and Returns Estimates Seven potato CAR estimates statewideSeven potato CAR estimates statewide SWI-Fumigated: 1,600 acre farm, 500 acres potatoes SCI Fumigated & Non-Fumigated: 2,200 acre farm, 550 acres potatoes Eastern Idaho: Southern Fumigated & Non-Fumigated: 2,400 acre farm, 800 acres potatoes Northern: 2,400 acre farm, 800 acres potatoes Seed: 2,000 acre farm, 500 acres seed potatoes

58. 58 Potato Costs and Returns Estimates Base budget: Cost to grow, harvest & sortBase budget: Cost to grow, harvest & sort Detailed cost per acre with summary by major cost categoryDetailed cost per acre with summary by major cost category Cost per cwt for operating, ownership and total cost based on field-run yieldCost per cwt for operating, ownership and total cost based on field-run yield Storage: starts with base cost per cwt for both field- run and paid yield,Storage: starts with base cost per cwt for both field- run and paid yield, Adds cost per cwt storage ownership & repairs for both field-run and paid-yieldAdds cost per cwt storage ownership & repairs for both field-run and paid-yield Adds monthly storage operating costsAdds monthly storage operating costs

59. 2013Production Costs, Storage Ownership & Repair Costs, & Monthly Storage Operating Costs SWI Field-Run SWI Paid-Yield SCI Field-Run SCI Paid-Yield EI-S Field-Run EI-S Paid-Yield Base COP:$7.11$7.49$7.05$7.42$6.83$7.19 + Storage Owner.$7.62$8.02$7.56$7.93$7.34$7.73 + Storage Repairs$7.66$8.06$7.60$8.00$7.38$7.77 Oct$7.86$8.28$7.81$8.22$7.58$7.98 Nov*$8.03$8.45$7.98$8.40$7.75$8.16 Dec$8.12$8.54$8.07$8.49$7.84$8.25 Jan$8.20$8.63$8.15$8.58$7.92$8.34 Feb$8.28$8.72$8.24$8.67$8.00$8.42 Mar$8.37$8.81$8.33$8.76$8.09$8.51 Apr*$8.55$9.00$8.51$8.96$8.27$8.71 May$8.66$9.11$8.62$9.07$8.38$8.82 Jun$8.78$9.24$8.74$9.20$8.50$8.94 Paid-Yield = 95% of Field-Run Yield *Sprout inhibitor applied Storage Operating Costs: labor, power, chemicals, interest, shrink and insurance SWI = Southwestern Idaho, SCI = Southcentral Idaho, EI = Eastern Idaho

67. 67 If cost of production doesn’t matter to the market, should it matter to you? Summary How do you survive in a competitive commodity market? Are you losing money if you don’t cover your cost of production? Perhaps not. You may not, however, be getting a market rate of return on you labor, your management, and your equity.

68. 68 Become the low cost producer – forever. Summary Focus on producing the highest quality crop for the lowest cost per cwt Manage your production costs You can only manage what you measure It’s not how many potatoes your produce per acre, it’s ultimately how many dollars you produce per acre!

69. 69 $ Quantity Demand Supply P1P1 Q1Q1 Market-based economies: supply & demand set price

70. Questions? Comments

71. Internet Site University of Idaho – AERS Idaho Ag Biz http://web.cals.uidaho.edu/idahoagbiz/ Select Publications for potato reports -Includes annual cost of production comparison Select Enterprise Budgets for crop and livestock costs and returns estimates - Specify one or more: Year, Region, Crop, Format