Impact of fuel prices on machinery costs. Impact of fuel prices on farm-level costs. But, how well can prices be predicted?

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1 Managing High Input Costs in an Ever Changing Farm and World Economy Kevin C. Dhuyvetter Terry L. Kastens Department of Agricultural Economics Kansas State University Historical and forecasted oil and diesel fuel prices K-State Research and Extension Brown County Winter Farm Series 29 Farm Management Meeting February 12, 29. First United Methodist Church, Hiawatha 2 Monthly Crude Oil and Diesel Prices, Jan Dec 29 (Feb 29 - Dec 29 forecasted -- 1/3/29 futures prices) Historical and forecasted crude oil and farm diesel fuel average Mar-Oct prices 15 NYMEX crude oil SW KS diesel 4.8 Crude Oil and Off-road Diesel Fuel Prices Crude Year-to-year change Diesel Year-to-year change Year oil /1 $/barrel percent fuel /2 $/gal percent Crude oil price, $/barrel Diesel price, $/gallon 24 $41.84 $ % $1.37 $.32 3.% 25 $57.98 $ % $2.4 $ % 26 $68.7 $ % $2.41 $ % 27 $7.9 $2.2 3.% $2.52 $ % 28 $ $ % $3.68 $ % 24-8 avg /3 $7.44 $ % $2.4 $ % (F) $51.5 ($63.14) -55.3% $1.77 ($1.91) -51.8% 29 less 4-8 avg ($19.39) xxx -27.5% ($.63) xxx -26.3%. /1 Mar-Oct average of NYMEX futures /2 Mar-Oct average for Southw est Kansas Historical relationship suggests that NYMEX crude oil market can be used to forecast diesel prices. 3 /3 Year-to-year and percent changes are calculated from the previous 5-year average (i.e., ) F = forecast based on 1/3/29 futures prices 4

2 Impact of fuel prices on machinery costs Impact of fuel prices on farm-level costs Machinery Costs Per Acre, Kansas 28 vs. 29* Source: 182 KFMA Members (Beaton) Repairs Depreciation Fuel Interest % 3.3% 17.5% 22.9% 15.1% 27.4% Labor Ins. & shelter 3.8% 26.7% Annual Fuel Costs vs. Mar-Oct Diesel Price (Correlation from 2 to 27 =.992) Fuel costs, $/farm 3, 25, 2, 15, 1, Gas-Fuel-Oil (actual) Gas-Fuel-Oil (forecast) Diesel Price $8,311 $9,383 $8,82 $8,98 $11,369 $15,312 $18,26 $2,49 $27,899 $13, Diesel price, $/gallon 11.6% 5, % Total: $ % 13.6% Total: $ (F) (F) *Values calculated based on fuel price changes and inflation adjustments for other categories from 21 base Source: Fuel costs from average NE KFMA farm and diesel price for SW KS 5 6 But, how well can prices be predicted? Do we need to lock in current price forecasts? Price, $/gallon Monthly Diesel Price, Southwest Kansas Actual price avg = $2.28 Model-predicted price avg = $2.32 Predictions based on crude oil futures price on 1/3/9 (average for year = $1.75) Probability, % JUN '9 CL Futures Price Distribution Implied by Options Market, February 6, Price = $5.39 Historical volatility = 28 Current volatility = On average, actual diesel prices follow actual crude oil prices relatively well, how accurate are futures market forecasts? < >72 Price Range, $/barrel 7 8

3 Purchasing fuel based on seasonal patterns? 1.15 Seasonal Indices for Non-Taxable Diesel in US Seasonal pattern is not particularly predictable Seasonal Indices for Non-Taxable Diesel in US Seasonal Price Index Seasonal Price Index Avg Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec.7 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 9 1 Seasonal pattern used for analysis Seasonal Price Index Percent of Annual Fuel Needs Seasonal Indices for Non-Taxable Diesel in US, Distribution of When Fuel is Needed -- Example Kansas Farm 2% 15% 1% 5% % Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Advantage to seasonal purchases, $/gal Purchasing Diesel Fuel Seasonally versus Every Month, U.S. With cost of tank Without cost of tank.96 When fuel is needed throughout the year Avg.94 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 11 IF the only storage costs that existed were interest, then a strategy of buying in the months of Jan, Feb, Mar, Jun and Jul (based on 27-year seasonal pattern) would have resulted in a $.5/gallon advantage compared to buying as needed (i.e., every month). Purchasing fuel tanks turns gain into loss. 12

4 Pre-purchasing / locking in fuel prices Buy now and take delivery (need to have storage) Forward contract for later delivery Availability of this option? Quantity requirements? Hedge fuel in NYMEX crude oil (or heating oil) futures market Quantity one crude oil contract (1, barrels) effectively hedges 3,+ gallons of diesel Hedge using Exchange Traded Funds (ETF) Relationship between Crude Oil Futures and ETF DBO Daily Prices (1-5-7 to 2-6-9) Fertilizer prices (should you be cutting back on fertilizer rates?) DBO, $/share Crude oil, $/barrel Relationship suggest you could reasonably hedge crude oil price (hence diesel fuel price) via buying DBO stock. One share of DBO stock would effectively hedge approximately gallons of diesel (basis risk?)

5 N prices have fallen recently, but are still significantly above historical averages Nitrogen Prices, $/T (SP and WCB average) Retail Price, $/lb Monthly Nitrogen Fertilizer Prices, Corn Belt NH3 (82%) avg = $.197 UAN (32%) avg = $.278 Urea (46%) avg = $.254 $.81 $ NH3 UAN32 Urea /27/28 11/3/28 11/1/28 11/17/28 11/24/28 12/1/28 12/8/28 12/15/28 12/22/28 12/29/28 1/5/29 1/12/29 1/19/29 1/26/29 2/2/29 17 Prices fell off their highs, especially NH3 (big drops in a short time span) /27/28 11/3/28 Nitrogen Prices, $/lb (SP and WCB average) 11/1/28 11/17/28 NH3 UAN32 Urea 11/24/28 12/1/28 12/8/28 12/15/28 12/22/28 12/29/28 1/5/29 1/12/29 1/19/29 1/26/29 2/2/29 P and K prices have fallen recently, but are still significantly above historical averages Big differences in prices of N products urea adjusting to more what we expect? 19 * Price of phosphate is based on blend price less value of N (average of NH3, UAN 32, and Urea prices) 2 Retail Price, $/lb Monthly Phosphate and Potash Fertilizer Prices * avg = $ avg = $.18 Potash avg = $.161 $.94

6 Phosphate Prices, $/T (SP and WCB average) Phosphate Prices, $/lb (SP and WCB average) /27/28 11/3/28 11/1/28 11/17/28 11/24/28 12/1/28 12/8/28 12/15/28 12/22/28 12/29/28 1/5/29 1/12/29 1/19/29 1/26/29 2/2/29 1/27/28 11/3/28 11/1/28 11/17/28 11/24/28 12/1/28 12/8/28 12/15/28 12/22/28 12/29/28 1/5/29 1/12/29 1/19/29 1/26/29 2/2/29 Big price drops in a short time span now leveling off? 21 Big differences in prices of P products how fast will the adjustment be? 22 Like fertilizer prices, crop prices have fallen recently, but they are still significantly above historical averages What do these high prices imply for fertilizer rates?... perhaps not a great deal if expected crop prices also are really high... sort of what we ve been preaching the last year and a half Price, $/bu Northeast Kansas Monthly Grain Prices Source: Kansas Agricultural Statistics Wheat ( avg = $3.2) Corn ( avg = $2.6) Milo ( avg = $1.96) Soybeans ( avg = $5.42)

7 So, should we adjust fertilizer rates when fertilizer or crop prices change? KSU nitrogen recommendations no prices Corn and grain sorghum N rec = (Yield Goal x 1.6) (%SOM x 2) Profile N Manure N Other N Adjustments + Previous Crop Adjustments Wheat N rec = (Yield Goal x 2.4) (%SOM x 1) Profile N Manure N Other N Adjustments + Previous Crop Adjustments + Tillage Adjustments + Grazing Adjustments Sunflowers N rec = (Yield Goal x.75) (%SOM x 2) Profile N Manure N Other N Adjustments + Previous Crop Adjustments 25 Kastens, Dhuyvetter, Schlegel, & Dumler started working on this in late KSU nitrogen recommendations vs. N price Recommendations do not explicitly include prices Mathematical relationship between expected yield and nitrogen (i.e., production function) is needed in order to adjust recommendations for prices Similar issues pertain to P & K recommendations (i.e., no way to adjust them for prices) We assume KSU had in mind these prices: Wheat $3.22/bu Corn $2.35/bu fertn $.21/lb N (fertp, used later, $.24/lb P2O5) Nitrogen production function In a limiting factor framework, it is generally believed that relationship between N and yield is linear for any given year and location (implies linear plateau production function) Linear plateau production function implies that optimal N will either be or level where yield plateaus Average of multiple linear plateau production functions can be non-linear and this represents expectations of future N:yield relationship

8 Nitrogen production function Nice property of non-linear production function is that it implies diminishing marginal returns and thus prices matter Assumed functional form is quadratic plateau which allows diminishing returns consistent with linear plateau in any given year Estimate model parameters such that KSU Nrec is economic optimum at historical average prices Yield plateau is equal to yield goal Intercept goes through origin (i.e., N equates to yield) Defined points that allowed quadratic-plateau function to be defined Yield, bu/acre Wheat yield response function (2) Yield plateaus at yield goal (3) Yield at KSU rec (fertn) is economic optimal (i.e., slope of function = average price ratio) (1) No nitrogen implies zero yield TUN (fertn+stn+1*om, lbs/acre 3 Same optimal N (slope there =.21/3.22) but yields about 1% lower than plateau Yield, bu/acre Wheat yield consistent with KSU Nrec (YG: 4,5,6,7,8) quadratic plateaus; opt TUN: 96,12,144,168, Slope at diamonds is.4/3.22 versus slope at circles is.21/3.22 Yield, bu/acre Wheat yield consistent with KSU Nrec (YG: 4,5,6,7,8) opt $.4 fertn: 87.8,19.8,131.7,153.7, TUN (fertn+stn+1*om), lb/acre TUN (fertn+stn+1*om), lb/acre 31 With more expensive N, you make more money by applying less 32

9 Operationalizing production function Everything was embedded in an Excel spreadsheet so that users could determine optimal fertilizer N rates based on fertilizer N prices and crop prices We could use the spreadsheet to recommend some typical percentage cutbacks on fertilizer dealers had been requesting such info throughout 25 Late summer early Fall 28 Very high fertilizer prices and not just N Falling crop prices Producers asking about price-based adjustments again, especially related to high P prices ($1.2/lb P2O5??) And so we adjust the decision spreadsheet again this time incorporating P Use MF-2586 sufficiency P recs 34 KSU-NPI_CropBudgets.xls available at (click on Decision Tools under Projected Budgets ) 35 36

10 Scenarios considered Dry versus liquid N & P fertilizer prices Dry: N = $.365 and P = $.495 Liquid: N = $.535 and P = $.896 User enters yield goal, crop and fertilizer prices, and soil properties optimal N and P rates are calculated. Fertilizer rates Economic optimal 75% of economic optimal (under fertilize) 125% of economic optimal (over fertilize) Expected crop prices Wheat = $5.58; Corn = $3.85; Milo = $3.3; Soybean = $8.47 Varying crop prices impacts optimal rates and overall returns, but does not change overall conclusions Crop yield at expected 29 crop prices and various fertilizer scenarios Model-Estimated Yield vs Fertilizer Price and Rate (% of economic optimal) Wheat Corn Milo Soybean DC Beans Total Average Acres Dry N & P Prices (N=$.365 and P=$.495) A. Economic optimal rates xxx xxx B. 75% of economic optimal rates (under fertilize) xxx xxx priced fertilizer (dry). C. 125% of economic optimal rates (over fertilize) xxx xxx Liquid N & P Prices (N=$.535 and P=$.896) D. Economic optimal rates xxx xxx E. 75% of economic optimal rates (under fertilize) yields about 5% lower xxx xxx F. 125% of economic optimal rates (over fertilize) xxx xxx 1) Economic optimal yields are 1-4% higher at lower 2) Over-fertilizing results in yields about 1% higher than optimal rate yields. 3) Under-fertilizing results in than optimal rate yields. Return over costs at expected 29 crop prices and various fertilizer scenarios Return Over Costs vs Fertilizer Price and Rate (% of economic optimal) Wheat Corn Milo Soybean DC Beans Total Average Acres Dry N & P Prices (N=$.365 and P=$.495) A. Economic optimal rates KSU rates $36.75 $17.62 $79.46 $11.99 $54.8 $14.15 $3,842 $38.42 B. 75% of economic optimal rates (under fertilize) $12.53 $71.3 $8.73 $52.7 $14.15 $3,461 $34.61 C. 125% of economic optimal rates (over fertilize) $13.4 $71.36 $7.23 $51.32 $14.15 $3,448 $34.48 Liquid N & P Prices (N=$.535 and P=$.896) KSU rates D. Economic optimal rates $1.66 $ $3.76 $43.34 $5.8 $2,35 $17.3 $23.5 E. 75% of economic optimal rates (under fertilize) -$3.53 $ $6.65 $42.3 $5.8 $2,2 $2.2 F. 125% of economic optimal rates (over fertilize) -$3.53 $ $9.13 $41.21 $5.8 $1,915 $

11 Return over costs at expected 29 crop prices and various fertilizer scenarios Return Over Costs vs Fertilizer Price and Rate (% of economic optimal) Wheat Corn Milo Soybean DC Beans Total Average Acres Dry N & P Prices (N=$.365 and P=$.495) A. Economic optimal rates KSU rates $36.75 $17.62 $79.46 $11.99 $54.8 $14.15 $3,842 $38.42 B. 75% of economic optimal rates (under fertilize) $12.53 $71.3 $8.73 $52.7 $14.15 $3,461 $34.61 C. 125% of economic optimal rates (over fertilize) $13.4 $71.36 $7.23 $51.32 $14.15 $3,448 $34.48 Liquid N & P Prices (N=$.535 and P=$.896) KSU rates D. Economic optimal rates 1) Economic impact of over- or under-fertilizing is $17.3 $1.66 $ $3.76 $43.34 about the same at lower priced fertilizer (dry). $5.8 $2,35 $23.5 E. 75% of economic optimal rates (under fertilize) 2) At higher -$3.53 fertilizer $46.85 prices (liquid), -$6.65 over-fertilizing $42.3 $5.8 $2,2 $2.2 starts becoming worse than under-fertilizing. F. 125% of economic optimal rates (over fertilize) -$3.53 $ $9.13 $41.21 $5.8 $1,915 $ ) Fertilizer price (dry vs. liquid) has bigger impact on returns than deviations from the optimal rate. 41 Side issues with P Following MF-2586 N and Precs, depending upon crop and rotation, will end up over time at ppm STP At crop prices and high fertilizer prices shown (esp P), would end up at much lower STP, perhaps 5-1 ppm Seems weird to end up that low but is it wrong? Haven t seen such prices before 42 Critical issues to think about Are MF-2586 rates really predicated on other factors not limiting? Can we fully compensate for low soil fertility with fertilizer? Might application methods and timing modify our results? What about using fertilizer P to compensate for low soil ph? So, what should one do? Use the spreadsheet! If your intuition causes you to question the results: Average the results with some other method Use the adjustment factors in the spreadsheet Question your intuition Likely, no one would ignore prices forever, i.e., regardless of their levels 43 44

12 There may be bigger issues to consider We re seeing local fertilizer prices vary as much as 2x to 3x from location to location Liquid vs. dry hire custom applicator? We expect continued drops in prices but perhaps a spike again next spring since little fertilizer got placed in the fall of 28 What about availability? Do I trust my provider s finances? 45 Questions? 46