1. Profitability Outlook 2012 Flex Leases March 20, 2012 Greg Halich 859-257-8841Greg.Halich@uky.eduhttp://www.ca.uky.edu/agecon/index.php?p=169 Dept. Agricultural Economics University of Kentucky

2. 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.

3. Agricultural Economics Agronomic Assumptions Corn Yield Soybean Yield Corn/Soybean Yield Ratio 125 bu39.0 bu3.2 150 bu45.5 bu3.3 175 bu51.5 bu3.4

4. 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 45.5 bu soybeans: → 32 units P 2 O 5 → 50 units K 2 O → 50 units K 2 O

5. 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 51.5 bu soybeans: → 36 units P 2 O 5 → 57 units K 2 O → 57 units K 2 O

6. 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

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

8. 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).

9. Agricultural Economics Critical Budget Assumptions 9 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.

10. Agricultural Economics Corn and Soybean Prices New Crop 2012 Price Scenario:CornSoybeans Low$4.50$10.00 Baseline$5.50$12.25 High$6.50$14.50

11. Projected 2012 Costs (per acre) Inputs: Corn (150 bu)Soybeans (45.5 bu) Seed$76$45 Nitrogen$83$0 P, K, and Lime$68$53 Pesticides$35$25 Total Inputs$263$123 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$251+ Land Rent

12. Agricultural Economics Summary Revenues/Costs (per acre) Yield and Price:CornSoybeans Expected Yield (rotation)15045.5 Future's Price Fall 2011$5.50$12.25 Grain Revenue$825$557 Direct Gov’t Payment$20 Total Revenue$845$577 Total Costs (Less Land Rent)$454$251 Gross Return (Less Land Rent)$391$326

13. Agricultural Economics Baseline Scenario (per acre) $ 12.25 Soybeans (elevator) $ 5.50 Corn (elevator) $.52-N; $.51-P; $.53-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $277$254$265 150 bu corn $391$326$358 175 bu corn $506$392$449 Note: Subtract land rent to get Net Return.

14. Agricultural Economics High Commodity Price Scenario $14.50 Soybeans (elevator) $ 6.50 Corn (elevator) $.52-N; $.51-P; $.53-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $402$342$372 150 bu corn $541$428$485 175 bu corn $681$508$595 Note: Subtract land rent to get Net Return.

15. Agricultural Economics Low Commodity Price Scenario $ 10.00 Soybeans (elevator) $ 4.50 Corn (elevator) $.52-N; $.51-P; $.53-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $152$166$159 150 bu corn $241$223$232 175 bu corn $331$277$304 Note: Subtract land rent to get Net Return.

16. Agricultural Economics Nightmare Price Scenario $ 7.50 Soybeans (elevator) $ 3.50 Corn (elevator) $.30-N; $.35-P; $.35-K Gross Return Corn Gross Return Soybeans Gross Return Rotation 125 bu corn $90$86$88 150 bu corn $162$128$145 175 bu corn $234$169$201 Note: Subtract land rent to get Net Return.

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

18. 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.

19. Agricultural Economics 19 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.

20. Agricultural Economics 20 Why Consider a Flex Lease? 1)Negotiating tool with landowners. 2)Risk management.

21. 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

22. Agricultural Economics 22 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.

23. Agricultural Economics 23 Options for Flex Leases 1)Price RatioPrice 2)Bushel EquivalentPrice 3)Revenue RatioPrice/Yield 4)Revenue PercentPrice/Yield 5)Revenue Base + %Price/Yield

24. Agricultural Economics 24 1) Price Ratio  Simplest Flex Lease.  Have a base rent and adjust for price.  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

25. Agricultural Economics 25 2) Bushel Equivalent  Price-based Flex Lease.  Landowner gets a set number of bushels 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

26. Agricultural Economics 26 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

27. Agricultural Economics 27 4) Revenue Percentage  Cash-lease version of a crop-share.  But usually with min. base rent.  No inputs contributed by landowner. Example: Landowner gets 35% of revenue. 150 bushels X $4.50 X 35% = $236

28. Agricultural Economics 28 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.

29. 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%

30. 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.

31. 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.

32. 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%

33. 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.

34. 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.

35. Agricultural Economics 35 Let’s Work Through Other Scenarios

36. Agricultural Economics 36 4) Revenue Percentage Landowner gets 25% of corn revenue. Minimum rent of $150 100 bushels X $4.00 X 25% = $100 → $150 125 bushels X $4.80 X 25% = $150 150 bushels X $5.33 X 25% = $200 200 bushels X $5.00 X 25% = $250 200 bushels X $6.00 X 25% = $300

37. Agricultural Economics 37 4) Revenue Percentage Landowner gets 30% of corn revenue. Minimum rent of $150 100 bushels X $4.00 X 30% = $120 → $150 125 bushels X $4.80 X 30% = $180 150 bushels X $5.33 X 30% = $240 200 bushels X $5.00 X 30% = $300 200 bushels X $6.00 X 30% = $360

38. Agricultural Economics 38 4) Revenue Percentage Landowner gets 35% of corn revenue. Minimum rent of $150 100 bushels X $4.00 X 35% = $140 → $150 125 bushels X $4.80 X 35% = $210 150 bushels X $5.33 X 35% = $280 200 bushels X $5.00 X 35% = $350 200 bushels X $6.00 X 35% = $420

39. Example: Revenue % Flex Lease (#4) $150 Minimum Flex Rent Total Revenue25% Corn30% Corn35% Corn $400$150 $600$150$180$210 $800$200$240$280 $1,000$250$300$350 $1,200$300$360$420 Note: $800 revenue = 150 bushel x $5.33 per bu

40. Agricultural Economics 40 5) Revenue Base + Bonus $150 base rent; $600 base revenue; 30% of revenue above base. 100 bushels X $4.00 = $400 $400-$600 = - $200 revenue above base. → No Bonus

41. Agricultural Economics 41 5) Revenue Base + Bonus $150 base rent; $600 base revenue; 30% of revenue above base. 150 bushels X $5.33 = $800 $800-$600 = $200 revenue above base. $200 X 30% = $60 bonus. $60 bonus + $150 base = $210 total rent.

42. Agricultural Economics 42 5) Revenue Base + Bonus $150 base rent; $600 base revenue; 30% of revenue above base. 200 bushels X $5.00 = $1000 $1000-$600 = $400 revenue above base. $400 X 30% = $120 bonus. $120 bonus + $150 base = $270 total rent.

43. Example: Base + Bonus Flex Lease $600 Base Revenue and $150 Base Rent Total Revenue30% Corn35% Corn40% Corn $400$150 $600$150 $800$210$220$230 $1,000$270$290$310 $1,200$330$360$390 Note: $800 revenue = 150 bushel x $5.33 per bu

44. Example: Base + Bonus Flex Lease $800 Base Revenue and $150 Base Rent Total Revenue30% Corn35% Corn40% Corn $400 $150 $600 $150 $800 $150 $1,000 $210$220$230 $1,200 $270$290$310 Note: $800 revenue = 150 bushel x $5.33 per bu

45. 45 Base + Bonus Flex Lease $600 Base Rev. $150 Base Rent 30% Revenue Above Base

46. 46 Base + Bonus Flex Lease $600 Base Rev. $150 Base Rent 35% Revenue Above Base

47. 47 Base + Bonus Flex Lease $600 Base Rev. $150 Base Rent 40% Revenue Above Base

48. 48 Base + Bonus Flex Lease $400 Base Rev. $150 Base Rent 40% Revenue Above Base

49. 49 Base + Bonus Flex Lease $600 Base Rev. $150 Base Rent 45% Revenue Above Base

50. Agricultural Economics 50 Flex Lease Summary  Won’t work in all situations.  Need to be understandable to landlords.  Need to understand risk-reward tradeoff.  Not for all landlords.  Crop-Share may be good option.

51. Agricultural Economics 51 Helpful Sites Iowa Flex Leases: http://www.extension.iastate.edu/agdm/wholefarm/pdf/c2-21.pdf http://www.extension.iastate.edu/agdm/wholefarm/pdf/c2-22.pdf Northcentral Farm Mgt Lease Site: http://www.ncfmc.org/publications.aspx http://aglease101.org/