Chances are you are farming because of the freedom it offers. But the independent nature of farmers has to be compromised with the wrenching and tugging of all of the dynamics within agriculture. Those involve both domestic and foreign issues, and while they can push prices up, they can also create other kinds of economic havoc in farm budgets.

An update on the latest dynamics has just been provided in testimony to the US House Agriculture Committee by Pat Westhoff, Program Director of the Food and Agriculture Policy Research Institute (FAPRI) at the University of Missouri. Westhoff said his assessment of the farm economy “in February 2007 looked a lot different than the one we issued a year earlier.” And he said his outlook continues to change, in part because of biofuels.

1) Projections of corn use for ethanol continue to climb upward, putting pressure on corn prices, encouraging acreage shifts, and resulting in reduced supplies of other crops.
2) Higher US prices are encouraging crop production expansion in South America and elsewhere, with an impact on livestock production and the price of meat.

But Westhoff says ethanol prices that were over $3 in the summer of 2006 have been trading at half that level, despite higher petroleum prices. And the lower ethanol prices have squeeze net returns over operating costs for ethanol plants from $1.56 in 2005/06 to $0.95 in 2006/07. “As a result, the future of the ethanol industry is now much less certain than it seemed just a few months ago. We expect plants under construction to be completed. However, it is less certain whether they will all operate at full capacity, and the pace of new investment seems sure to slow dramatically.”

Westhoff and FAPRI say profits are also declining sharply for biodiesel producers because of higher costs for soybean oil, which would “slow or even stop expansion of the industry.”

With the economic realities of the ethanol and biodiesel industries, what does that imply for the farm economy, which has been bolstered with higher commodities prices resulting from biofuel production?
1) the increased demand for corn and soybean oil has meant higher prices for those commodities and those closely related.
2) Energy and farm markets are becoming closely linked and corn demand will fluctuate with the price of oil.
3) Biofuel subsidies matter, and a reduction or loss will mean less production and lower commodity prices, such as a 30 cent drop in corn prices with an expiration of the ethanol subsidy.
4) Biofuel mandates matter, and those blending requirements will continue despite the price of corn.

In addition to biofuels, Westhoff and FAPRI say there are other dynamics that are impacting the farm economy and farm budgets:
1) Global economic growth has resulted in strong demand and prices for dairy products.
2) The weakness in the US Dollar has benefited agriculture by making US commodities less expensive for world buyers compared to similar commodities in other countries.
3) Overall population is growing but at a slower rate. However it is growing faster in lesser developed countries which are buyers of wheat and rice.
4) High commodities prices allow farmers to spend more money for crop inputs resulting in higher yields. However, the higher yields may reduce commodity prices despite increased demand.
5) Weather is the main driver of price since it determines supply, and wheat supplies are down, not because of slow demand, but because of adverse weather in wheat producing countries.
6) Producers demonstrated a strong response to market demands in 2007 with a 15% increase in corn acres, and that same response is expected to the changing demands for the 2008 crop.
7) High commodity prices have made Farm Bill supports less important in the US, and at the same time the EU has modified its policy to encourage more production, and China has modified its policy to ensure food has a priority over bio-fuels.
8) While land prices and cash rents are generally responsive to farm profitability, there are many other factors that impact prices such as the housing market and tax policies.
9) Livestock producers are paying more for feed, but for the livestock sector as a whole cash receipts are even more, and producers are expected to respond to the demand of various products.

Summary:
Current strong prices in commodities have resulted from the demand for bio-fuels, but profitability is challenged in the bio-fuels industry, and its future depends on petroleum prices, commodity prices, and government policy. Because commodities prices are now a function of the petroleum market, farmers need to beware of its dynamics. There are still many other dynamics that control prices and production, including global demand, overseas production, weather, land prices, and others.