If your landlord or farm manager hasn’t yet approached the subject of more cash rent for next year, it is only a matter of time. Crop share land owners already have a share of higher crop prices, and may or may not want a larger percentage. However, cash rent landowners also want a share, and will likely be able to get it, either from their current operator or from a competing operator. But what is your risk in agreeing to higher rent?

Most cash rent operators probably agreed to a higher rent for the current crop year because of climbing commodity prices last fall. And the jump upward probably won’t hold a candle to the next jump higher. But as rental agreements are negotiated, they always must be fair for both sides. That is hard to do when drooling neighbors are visiting with every landowner in the county. But along with today’s increased prices there are increased risks that could financially undermine your operation. And it is up to every farmer to identify those risks and manage them.

Farm Management Specialist Gary Schnitkey at the University of Illinois has completed a thorough study of how to quantify those market risks, to guide farmers and landowners toward the type of lease that will be fair to both owner and operator and allow both sides to share in the premium prices offered by the market. In his latest newsletter http://www.farmdoc.uiuc.edu/manage/newsletters/fefo07_12/fefo07_12.htmlSchnitkey says today’s high commodity prices will be offset by higher production costs and lower government support payments. As a result, farmers will have to find a way to retain a larger share of the revenue stream to protect against the risks of the marketplace and the higher cash rent agreements that will have to be paid out.

Revenue comparison
Schnitkey used the years of 2001 to 2005 as a base for comparison to the 2008 crop. (In 2006 prices began to change and 2007 prices aren’t fully known.) “Corn crop revenue is projected at $623 per acre in 2008, an increase of $236 over the 2001-2005 level of $387 per acre. Soybean revenue is projected at $442 per acre in 2008, a $142 increase over the 2001-2005 average.”

Expense comparison
Total non-land costs for corn are projected at $314 in 2008, an increase of $57 per acre from 2001-2005 level of $257 per acre. Total non-land costs for soybeans are projected at $199 in 2008, an increase of $28 per acre over the 2001-2005 level of $171 per acre.

Government payment comparison
In 2001-2005, loan deficiency payments (LDPs) averaged $29 per acre for corn and $14 per acre for soybeans. Projected 2008 commodity prices result in no LDPs. In 2001-2005, direct and counter-cyclical payments averaged $35 per acre. Counter-cyclical payments are not projected for 2008 projected prices. As a result government payments decline to $27 per acre.

Returns to operator and land
In 2001-2005, operator and farmland returns averaged $257 per acre for corn and $171 per acre for soybeans. Given a ½ corn – ½ soybeans rotation, operator and farmland return averaged $199 per acre, or $199 per acre to split between the landlord and the farmer. If cash rent averaged $150 per acre, farmers received an average return of $49 per acre. For 2008, operator and farmland returns are projected at $314 per acre for the ½ corn – ½ soybean rotation, an increase of $115 over the 2001-2005 average.

Future risk
Schnitkey says farmers will have three additional risks in coming years that will jeopardize their net revenue.
1) “Price variability likely will be higher over the next several years.” Using the volatility in the options market for fall delivery corn and beans, Schnitkey says the price risk for 2007 crops is twice of what the risk was for crops in the 2001 to 2005 period.
2) “Federal commodity programs will not provide as much downside price protection.” In the 2001 to 2005 period corn prices only had to drop below $2 to provide LDP income. Today, corn prices are $1.50 higher than such a threshold, given a continuation of the 2002 Farm Bill commodity program.
3) “Revenue for crop insurance must fall more in periods of high prices before insurance payments are received.” When commodity prices are high, they have to fall a lot farther before a crop revenue insurance policy make indemnity payments.

If an operator expected to make $50 per acre in the 2001-2005 period, and the same $50 per acre in 2008 after all expenses and rent is paid, Schnitkey calculated only an 11% chance of losing money in the 2001-2005 period, but a 35% chance of losing money in 2008. In other words, bidding up cash rent, and still trying to clear the same money as in the first half of the decade, an operator triples his chance of losing money. If the operator wants to retain the lesser chance of red ink, then the cash rent will have to be lower than what most landowners will want to accept.

Summary:
Higher commodity prices have created a major economic change for agriculture, but along with them come higher production costs and lower government payments. That scenario results in increased risk for operators who will find themselves either paying higher cash rents next year or being asked to do so. Although landowners want a share of the commodity prices, higher rents and the increased volatility in commodity markets create a greater chance for operators to be squeezed into a negative financial position.