farmgate: Is a Production Contract Part of Your Operation?
What induces you to try something new? Compensation? Everyone else is doing it? Both those choice are prevalent in USDA’s latest survey on the growth in agricultural production contracts. Although the use of contracts in farming can be traced back a century, they have grown in popularity over the past 15 years, and are a substantial tool for both providing income for a farm operator and ensuring food for the US economy. Where do you fit into the equation?
Agricultural economists with USDA’s Economics Research Service say 39% of US agricultural production in 2003 was produced under terms of a contract. That compares to 28% in 1991 and 11% in 1969, indicating a substantial upward trend. In the ERS Agricultural Contracting Update, economists report the farms with both the largest volume of production and greatest increase in use of contract were those with sales exceeding $250,000 and operated by families or non-family business arrangements with a hired manager. Of those farms, “contract sales accounted for almost 47% of the total value of production on commercial farms in 2003, and commercial farms, in turn, handled almost 87% of the total US value of production under contract.” Out of curiosity, would your farm fit that definition, and does your involvement in contract production contribute to 47% of your gross revenue?
If your farm has a lesser level of sales, you may be in the category that ERS says does not have the greatest level of contract production involvement. “Nearly two-thirds of the largest farms (those with at least $1 million in sales) used contracts in 2003, while considerably fewer small farms used them. Contracts covered just one-fifth of production among small farms (those with less than $250,000 in sales) and over half of production on the largest farms. Moreover, contracting increased among the largest farms between 2001 and 2003, but held steady or declined among smaller farms.”
Type of commodity also dictates involvement in contract production. Livestock producers are more likely to engage in it than are crop farmers. In 2003, 47% of livestock production was under a production contract, a 14% jump in just 10 years. In that same year, 31% of crop production was under contract, compared to 25% in 1991-93. No surprise, but 90% of poultry and egg production is contract, in addition to over half of dairy and hog production.
Over half of southern crops, including rice, peanuts, tobacco, and cotton are produced under contract, but only 8% of wheat and 14% of corn and soybeans. However, 96% of sugar beets are under contract.
The purpose of a production contract is for the contracting company to manage its risk of acquiring the commodity. With the price structure part of the contract, it provides the producer the opportunity to manage that price risk. While statistics are not available for the supply and price gyrations of 2004 and 2005, the ERS study draws parallels with the 2001 and 2003 crop price variations. “Crop prices were relatively low in 2001, and the risk-reduction features of many marketing contracts may have insulated producers against some of the price decline, leaving contract producers with higher average prices than non-contract producers. Crop prices rose substantially by 2003; if contracts serve primarily to limit price swings for farmers, then contract prices should have fallen below USDA/NASS mean prices in 2003. Instead, mean contract prices matched average USDA/NASS prices for soybean and wheat producers and exceeded the average USDA/NASS marketing-year average prices for corn (3%), cotton (19%), and rice (62%). Indeed, contract cotton and rice producers with relatively low contract prices (25th percentile) still received prices above mean USDA/NASS prices.”
Apparently, one contract begats another, since the ERS survey found that if one operator has a contract, a neighbor probably has a contract as well. Frequent "yes" responses were received to the question "Is Another contractor for this commodity in area?" The percentage by commodity was: corn-90.3%, cotton-83.9%, rice-79.7% soybeans-90.6%, and wheat-85.9%.
What will the production contract look like in 2007, and beyond? The USDA study says contracts are evolving to address issues that arise, specifically environmental concerns, among others. “In the future, contracts may change to facilitate greater traceability of products and to allow new forms of risk-sharing and input provision. Designing future surveys to track such shifts would enable policymakers and stakeholders to better understand the determinants and effects of agricultural contracts.”
If you are a veteran or novice in contract production, ensure that you thoroughly evaluate the terms of any contract, not just the bottom line premium that you might receive. University of Illinois provides checklists in evaluating livestock, specialty grain, or vegetable production contracts. If the contract you are considering signing
contains any questions that you cannot answer, visit with the contractor for an explanation. If you are still unsatisfied, visit with your attorney. If you are still unsatisfied, it may not be the contract you want to sign.
Summary:
Production contracts are risk management tools for both the producer and the buyer of a commodity, and from the substantial increase in use of production contracts, their popularity indicates they have achieved their objectives. Although they may not be for every farmer, larger commercial farms have incorporated them into their operations for a wide variety of commodities. Whether you are considering a contract for a 2006 crop, or getting ready to renew, every operator should ensure the contract will have a positive effect on the operation.
Posted by Stu Ellis on January 24, 2006 2:57 PM to farmgate