Profitability Outlook 2012 Flex Leases Union County Grain Day January 27, 2012 Greg Halich Dept. Agricultural Economics University of Kentucky December, 2010.

Agricultural Economics Projected Profitability 2012 Evaluate range of commodity prices. Evaluate range of commodity prices. Estimate production costs. Estimate production costs. Compare returns to land rents. Compare returns to land rents.

Agricultural Economics Risk Management What if Commodities Collapse? 1) ACRE Program 2) Flex Leases

Agricultural Economics Agronomic Assumptions Corn Yield Soybean Yield Corn/Soybean Yield Ratio 125 bu41.3 bu bu48.0 bu bu54.3 bu3.23

Agricultural Economics Budget Assumptions Fertilizer Quantity (per acre) 150 bu corn: → 160 units N → 160 units N → 60 units P 2 O 5 → 53 units K 2 O → 53 units K 2 O 48.0 bu soybeans: → 34 units P 2 O 5 → 53 units K 2 O → 53 units K 2 O

Agricultural Economics Budget Assumptions Fertilizer Quantity (per acre) 175 bu corn: → 170 units N → 170 units N → 70 units P 2 O 5 → 61 units K 2 O → 61 units K 2 O 54.3 bu soybeans: → 38 units P 2 O 5 → 60 units K 2 O → 60 units K 2 O

Agricultural Economics Budget Assumptions Base Scenario Fertilizer:$/ton$/unit Anhydrous (N)$850$.52 DAP (P 2 O 5 )$660$.51 Potash (K 2 O)$630$.53

Agricultural Economics Budget Assumptions Land Rent: Highly variable. Highly variable. Not included in budgets. Not included in budgets. → Subtract from net revenue.

Agricultural Economics Budget Assumptions Machinery and Labor: Fuel, Repairs, Deprecation, Labor. Fuel, Repairs, Deprecation, Labor. Based on Custom Machinery Rates. Based on Custom Machinery Rates. → Increased 25%. Adjusted to $3.50 fuel price. Adjusted to $3.50 fuel price. Trucking – 15 miles (one-way). Trucking – 15 miles (one-way).

Agricultural Economics Budget Assumptions Other: $2.50/gallon LP3 pts removed. $2.50/gallon LP3 pts removed. Direct Payment $20/acre. Direct Payment $20/acre.

Agricultural Economics Critical Budget Assumptions 11 1.Does not include land rent. 2.Includes “non-cash” costs. depreciation/overhead, unpaid labor. → depreciation/overhead, unpaid labor. 3.P and K application at removal rate. 4.Grain trucked directly to elevator.

Agricultural Economics Corn and Soybean Prices New Crop 2012 Price Scenario:CornSoybeans Low$4.25$9.50 Baseline$5.25$11.75 High$6.25$14.00

Projected 2012 Costs (per acre) Inputs: Corn (150 bu)Soybeans (48 bu) Seed$76$45 Nitrogen$83$0 P, K, and Lime$68$55 Pesticides$35$25 Total Inputs$263$125 Machinery and Labor$121$85 Other: Drying Grain$23$0 Crop Insurance$20 Misc.$20 Land RentVariable Operating Interest$7$4 Total Other$69$44 Total Costs$454+ Land Rent$254+ Land Rent

Agricultural Economics Summary Revenues/Costs (per acre) Yield and Price:CornSoybeans Expected Yield (rotation) Future's Price Fall 2011$5.25$11.75 Grain Revenue$788$564 Direct Gov’t Payment$20 Total Revenue$808$584 Total Costs (Less Land Rent)$454$254 Gross Return (Less Land Rent)$354$330

Agricultural Economics Baseline Scenario (per acre) $ Soybeans (elevator) $ 5.25 Corn (elevator) $.52-N; $.51-P; $.53-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $245$259$ bu corn $354$330$ bu corn $463$396$429 Note: Subtract land rent to get Net Return.

Agricultural Economics High Commodity Price Scenario $14.00 Soybeans (elevator) $ 6.25 Corn (elevator) $.52-N; $.51-P; $.53-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $370$352$ bu corn $504$438$ bu corn $638$519$578 Note: Subtract land rent to get Net Return.

Agricultural Economics Low Commodity Price Scenario $ 9.50 Soybeans (elevator) $ 4.25 Corn (elevator) $.52-N; $.51-P; $.53-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $120$166$ bu corn $204$222$ bu corn $288$274$281 Note: Subtract land rent to get Net Return.

Agricultural Economics Risk Management Options 1) Flexible Cash Leases 2) ACRE Program

Agricultural Economics ACRE Program FSA Program: Give up portion of direct payment. Give up portion of direct payment. Get downside revenue protection. Get downside revenue protection. Revenue guarantee can only go up/down 10% per year. Revenue guarantee can only go up/down 10% per year.

Agricultural Economics ACRE Price Guarantees Worst-Case Scenario ( Assumes Avg. State Yield) CornSoybeans $4.37 $ $3.93 $ $3.54 $8.46

Agricultural Economics 21 What is a Flex Lease? Lease rate will vary from year to year. Lease rate will vary from year to year. Based on price and/or yield. Based on price and/or yield. Usually has a base rate (floor). Usually has a base rate (floor). → Lease cannot go below this.

Agricultural Economics 22 Why Consider a Flex Lease? 1)Negotiating tool with landowners. 2)Potentially protect you if prices fall.

Agricultural Economics 23 More Specifically: Landowner shares price/yield risk. Landowner shares price/yield risk. Limits profit potential when revenue high. Limits profit potential when revenue high. Limits loses when revenue low. Limits loses when revenue low.

Agricultural Economics Example: Cash and Flex Lease Expected Price of $5.00/bu Final Corn Price Cash Lease Rate Flex Lease Rate $4.00$200$175 $5.00$200$225 $6.00$200$275

Agricultural Economics 25 Options for Flex Leases Important Point: These are only examples. These are only examples. Need to tailor Flex Leases. Need to tailor Flex Leases. → Both farmer and landowner. Infinite ways to write Flex Leases. Infinite ways to write Flex Leases. → Use your imagination.

Agricultural Economics 26 Options for Flex Leases 1)Price RatioPrice 2)Bushel EquivalentPrice 3)Revenue RatioPrice/Yield 4)Revenue PercentPrice/Yield 5)Revenue Base + %Price/Yield

Agricultural Economics 27 1) Price Ratio  Simplest Flex Lease.  Have a base rent and adjust for price increases.  If price increases by 25% than base rent increases by 25% (typical). Example: $200 base rent. $4.00 base corn price. If actual price is $5, then $5.00/$4.00 = 1.25 $200 x 1.25 = $250 rent for year $200 x 1.25 = $250 rent for year

Agricultural Economics 28 2) Bushel Equivalent  Price-based Flex Lease.  Landowner gets a set number of bushels as rent along with the final harvest-time price.  Thus final price determines the rent. Example: 50 bu base X $4.00 = $200 rent for year. 50 bu base X $5.00 = $250 rent for year 50 bu base X $5.00 = $250 rent for year

Agricultural Economics 29 3) Revenue Ratio  Just like the price ratio Flex Lease.  Have a base rent, a base revenue, and adjust for final revenue increase.  If revenue increases 20% from the base, then rent increases 20%. Example: $200 base rent. $700 revenue. If actual revenue is $840, then $840/$700 = 1.20 $200 x 1.20 = $240 rent for year $200 x 1.20 = $240 rent for year

Agricultural Economics 30 4) Revenue Percentage  Cash-lease version of a crop-share.  But usually with min. base rent.  No inputs contributed by landowner.  Can link yield to county average (or some % of the average) Example: Landowner gets 35% of revenue. 150 bushels X $4.50 X 35% = $236

Agricultural Economics 31 5) Revenue Base + Bonus  Base rent, base revenue, and % landowner gets above the base.  Sounds more complicated that it is. Example: $150 base rent; $600 base revenue; 40% of revenue above base. 150 bushels X $5.00 = $750 total revenue. $750-$600 = $150 revenue above base. $150 X 40% = $60 bonus. $60 bonus + $150 base = $210 total rent.

Base Plus Bonus Flex Lease Flex Lease Information: Cash Rent (for comparison)$200 Base Land Rent$150 Can final rent go below base rent?No CornSoybeans Total Costs (including base land rent)$600$400 Base Gross Revenue$600$400 Rent - % of Gross Revenue above base40% Bonus Land Rent$60$38 Flex Rent (Base + Bonus)$210$188 Flex Rent (rotation)$199 Increase from Cash Lease-1%

Example: Base + Bonus Flex Lease (#5) 40% Bonus Revenue Corn PriceFlex LeaseCash Lease $3.00 $150$200 $4.00 $150$200 $5.00 $199$200 $6.00 $249$200 $7.00 $299$200 Soybean Price 2.2 x Corn Price.

Example: Base + Bonus Flex Lease (#5) 40% Bonus Revenue Corn Price Net w/Flex Lease Net w/Cash Lease $3.00 -$107-$157 $4.00 $18-$32 $5.00 $94$93 $6.00 $168$217 $7.00 $243$342 Soybean Price 2.2 x Corn Price.

Revenue Percentage Flex Lease Flex Lease Information: Cash Rent$200 Minimum or Base Rent$150 Corn Soy- beans Land Rent - % of Gross Revenue35%40% Flex Rent$263$198 Flex Rent (rotation)$230 Increase from Cash Lease15%

Example: Revenue % Flex Lease (#4) 35%-Corn 40%-Soybeans Rev. Corn PriceFlex LeaseCash Lease $3.00 $154$200 $4.00 $184$200 $5.00 $230$200 $6.00 $276$200 $7.00 $322$200 Soybean Price 2.2 x Corn Price.

Example: Revenue % Flex Lease (#4) 35%-Corn 40%-Soybeans Rev. Corn Price Net w/Flex Lease Net w/Cash Lease $3.00 -$110-$157 $4.00 -$16-$32 $5.00 $62$93 $6.00 $141$217 $7.00 $219$342 Soybean Price 2.2 x Corn Price.

Agricultural Economics 38 Flex Lease Summary  Flex leases advantages/disadvantages.  Need to be understandable to landlords.  Need to understand risk-reward tradeoff.  Not for all landlords.  Crop-Share may be good option.

Agricultural Economics 39 Flex Lease Program  Farmers and landowners.  Henderson County 1/12/12 (Pilot).  Meetings scheduled Feb-March.

Agricultural Economics 40 Helpful Sites Iowa Flex Leases: Northcentral Farm Mgt Lease Site: