Free markets provide consumers quality products at the lowest price and provide producers a competitive rate of return on investment. It is not the responsibility of a market to assure that all producers make a profit. One responsibility of the market is to set prices so that inefficient producers do not make a profit.
Another responsibility of the market is to provide a profit to efficient producers. Without a competitive return to investment, commodities will not be produced. The scarcity of the commodity then results in users bidding up prices to make production profitable.
There is no question that 2009 wheat production costs will be higher than 2008 wheat production costs that were higher than 2007 wheat production costs. There is also no question that the market is currently offering most producers an expected profit for 2009 wheat.
I have heard producers quoting their wheat cost-of-production estimates ranging from about $5.25 to nearly $8 per bushel. These cost estimates are probably right for those calculating the cost. Costs are different between producers and even between fields. The point is that low-cost producers will make more profit than high-cost producers.
At this writing, the Kansas City Board of Trade July 2009 wheat contract price is $9.60. The June 2009 forward contract average basis in Oklahoma and the Texas Panhandle is a minus $1.10 and the range is from a minus $0.95 to a minus $1.35. The average June 2009 forward contract price being offered in Oklahoma and the Texas Panhandle is about $8.50 ($9.60 - $1.10).
Using $8.25 for the June 2009 wheat price and 35 bushels per acre implies a per acre gross return of about $290.
If 65 pounds of anhydrous ammonia ($1,000/tn), 55 pounds of diammonium phosphate ($1,125/tn), and 30 pounds of UAN (28%; $470/tn) are used per acre, fertilizer costs would be about $70. Sixty pounds of seed costs about $12. Fuel, oil, and lube costs are about $50. Other costs (interest, pesticides, and crop insurance) would be about $65 including $36 per acre harvesting cost. Total variable cost per acre would be about $195.
Using the above gross return and cost, the expected net return before paying land, labor, and management is $95 ($290 - $195) per acre.
If a producer has a cash rental agreement, the cash rent would be subtracted. If a producer rents using a sharecrop agreement of two-thirds production and two-thirds of the costs excluding the “other” costs above, the gross return would be about $194 ($290 x 0.67). Costs would be about $147 ($195 – (0.33 x $145)). Per acre return above variable cost would be about $47.
With the sharecrop agreement, the landlord’s expected gross return is about $96 ($290 x .33). The landlord’s share of the costs is expected to be about $44, and the expected net return is $52.
The above analysis is “guess work.” Per acre costs ($195 per acre) can be predicted relatively closely. Actual 2009 yield will not be the expected 35 bushels and yield has more downside risk than upside potential. Prices could be anywhere from $6.50 to $12 per bushel.
One point to remember is that if yields decline, prices tend to increase. Higher prices will partially offset the reduction in yield and keep expected gross returns relatively close to the estimate.
Per acre cost of production has more than doubled. This implies that risk of loss has more than doubled. It also implies that the market, over time, has to compensate producers for the increased risk, and that the long-run return to investment will be higher.
Producers also must decide if the most profitable use of the resources (land, labor, capital and management) is to produce wheat. My philosophy is that if it is worth doing, it is worth doing right. This means that you do not scrimp on fertilizer and other inputs.
The old adage “If you can’t make money with a pencil on paper in the office, you're sure not going to make it in the field” is applicable.