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Business & Economics

'Black swan' factors of war, inflation, and supply chain disruptions upends ag market stability

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Erich Westendarp
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Pixabay

This interview attached above is from SDPB's daily public-affairs show, In the Moment, hosted by Lori Walsh.

Russia's invasion of Ukraine in February has upended global ag markets. That's not the only factor impacting South Dakota farmers and producers this year.

Farmers Business Network has released its 2022 State of Agriculture Report. Kevin McNew is chief economist for Farmers Business Network. He authored the report.

Interview transcript

The following transcript is auto-generated and has not been thoroughly edited.

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Kevin McNew

Lori Walsh:

So, before we talk about the war in Europe, there are other things that are not over, like this long tail of supply chain disruption from COVID times. Tell us a little bit about how we're seeing the supply chain still impact farmers and producers.

Kevin McNew:

Yeah, you're exactly right. What we've seen really over the last, call it nine months or so is just a backlog of availability, especially on the farm inputs, chemicals, in particular, has been a challenge. A lot of the chemical active ingredients are sourced out of China or internationally. And so those prices for those farm chemicals have been going up, the ability to get them timely delivered has been challenging across much of the farm supply chain. And so farmers, as they get closer to spring and are ready to gear up and do some planting, are facing some challenges. The other big ingredient from a farm side is the fertilizer situation. That also has been up sharply in terms of prices starting back last fall. And then of course the war in Eastern Europe has added more fuel to that fire.

Lori Walsh:

Yeah. The historic inflation all Americans are seeing also impacts farmers. The price of bread is the same for them as it is for somebody living in a city. How are we seeing inflation change the game?

Kevin McNew:

Yeah, I mean, inflation's been something that US consumers have been feeling and the world has been feeling really over the last six months. And there are a lot of headlines saying 'highest inflation in the last 40 years.' And a lot of that is food-related. And unfortunately, with what's going on today, I don't see any reprieve as we look ahead for the balance of '22. I think consumers will continue to see prices at least as high, if not higher in the coming months. We are likely going to have farm cost going up as well, which will cause some constraints on farmers. But I think on the other side of things, commodity prices that farmers are able to sell at, the grain and oilseed prices that they are able to achieve will also continue to inflate as well. So we're really in this really elevated level of inflation, that's not only driven by Eastern Europe, but just overall demand, strength, and energy markets moving up. So it's just the right recipe for inflation to just keep running.

Lori Walsh:

Let's unpack some of these things so that people understand why a conflict in Europe can create this sort of immeasurable uncertainty in ag markets, but then also cause prices to rise here at home. Give me an example, like South Korea needs a place to buy and they don't anymore because of the war, because of Russia's invasion of Ukraine. Spin that out a little bit for us.

Kevin McNew:

Yeah, I mean, let's put it in context here, Russia and Ukraine combined account for one out of every three bushels of wheat that is exported in the world market. I mean, that's a huge, huge factor. And so we have Ukraine on the one hand, that's obviously in this major crisis trying to survive this massive conflict. And so their ability to ship and do business as usual is greatly impacted. And then, of course, you have Russia, who's really been banished from world markets in meaningful ways. And so that loss of wheat is impactful because it raises all wheat prices around the world. But where it's most strategically impactful is into countries like Egypt and Turkey that are relatively close in proximity to Russia and Ukraine, around that Black Sea region. And so their prices are going to have to go up even further because they're going to have to get wheat from US, or Canada, or Australia.

They're not going to be able to get it from normal places where they have, which is Russia and Ukraine. So not only is the global price of wheat going to go up, but the cost of hauling it, or putting it on a barge of vessels is going to go raise the cost of those countries as well. So I'm kind of concerned that we may see some geopolitical risk filter off into these North African countries. Because we have seen, historically, for example, 10 years ago, the Arab Spring was sort of started as a result of escalating wheat prices, a massive drought in Russia, that's kind of spawned that revolution.

Lori Walsh:

So there are countries that are incredibly food insecure and we don't know the full impact of these ripples yet at all. Do I understand it correctly?

Kevin McNew:

Yeah, you're exactly right. And I don't think today's markets and where they're valuing prices are the end of the story. We had this first run-up and we as a commodity and a traded commodity has almost been a barometer in lockstep with the issues in Russia and Ukraine over the last three weeks. And so as things escalate, wheat prices go up. As things look like they might be not escalating or maybe some resolutions through talks, prices will fall. But I think as we go further, I think we're getting more and more reality that this is not going to resolve anytime soon. That not only are we talking about disruption of trade in the near term, but we're talking about loss of production from Ukraine, a sizable player, not only in wheat but also in corn. They account for about 15% of global corn exports. So South Dakota farmers obviously, grow wheat, they grow corn, those commodities I think are clearly going to be in the epicenter of price inflation as we get into the growing season.

Lori Walsh:

Alright, let's talk about corn. Because there are other factors weighing in on that, the size of the ethanol sector. Are farmers in the Midwest going to plant less corn? What kinds of factors are impacting those decisions?

Kevin McNew:

Yeah, great question. And at FBN, we're actually surveying our farmers right now across the US trying to get a feel for that. USDA will release their official report one week from today and get the market clarity. But the underlying view is that yeah, farmers will likely plant less corn this year in the US. And the main factor is that high cost of fertilizer. Corn as a crop is very, very dependent on nitrogen in particular. And so as the price of fertilizer has gone up, it's becoming much costlier to grow corn versus some other crops. And then in the Northern Plains, beans, soybeans have become a pretty powerful crop tool or crop commodity that they will grow. And so we're seeing some early indications that farmers are probably going to be switching out of corn into beans because of this high price of fertilizer.

Lori Walsh:

Okay. So let's talk about soybeans and I'm really curious to have you help us understand biodiesel, renewable diesel and the impact of that, and increased regulatory benefits for those kinds of fuels.

Kevin McNew:

Yeah. So that's I think another exceptionally strong demand story, is the new paradigm around biodiesel or specifically renewable diesel. Renewable diesel is a little bit different than biodiesel. And I won't get into the science of it, but the important point about renewable diesel is that it's actually able to substitute pretty much directly for regular fossil-based fuel diesel. And that's important from a distribution standpoint because it can be used in pipelines. That was not the case with ethanol. And that was one of the core hiccups, if you will, of big oil, not really wanting to use ethanol in the energy space because they couldn't put it in a pipeline. So the fact that renewable diesel, which can be made from soybean oil and that will probably be the primary feedstock used to make renewable diesel. That's a really big benefit.

And so we are seeing big oil and big ag actually come together in meaningful joint ventures to build out renewable diesel plants and soybean crushing facilities to feed the soybean oil into renewable diesel manufacturing. So a big plant is going in, in North Dakota. That is a joint venture between ADM and Marathon. We see Bunge and Chevron, again, two stalwarts of big ag and big oil coming together in joint ventures. So I have a lot of optimism that renewable diesel is going to be a big market and is going to drive more demand for soybeans. And farmers are going to be enticed from market signals to grow more soybeans in the future.

Lori Walsh:

How about in South Dakota, do we have a growth in soy processing here?

Kevin McNew:

Yeah, I mean all across the board, we see soybean processing growing and your margins, what processing plants can make. We call that a margin kind of the bean oil and meal that they produce versus the bean cost. That margin is exceptionally strong. It's actually the highest it's been for a prolonged time period. And so the market is clearly signaling for more expansion in crushing facilities. And like I said, we see a sizable amount of new facilities that are going to be built over the next two to three years to fill that demand.

Lori Walsh:

Alright. So, let's talk a little bit about, you know, we mentioned inflation and just how difficult it can be to pay for inputs. Are farmers investing in them right now, because in some ways the prices are good, but yet it's the profit margin, is that shrinking? What kind of decisions are they making about equipment and land purchases or sales?

Kevin McNew:

Yeah, you're exactly right. And it kind of depends on the farm situation. But we have done some polling with our farmers around some of these things. And we certainly see land values going up. And as ag land values go up, it's kind of a double-edged sword. There are clearly farmers who own farmland, but there are a lot of farmers, nearly half of all farmland in the country is rented. And so there are clearly farmers who rely on rented ground and that rented ground is getting more expensive by a fairly fast margin as a result of higher commodity prices. But what we also see is some hesitancy around making big investments. And so we did do a poll around large equipment purchases over the next 12 months. And what we found was not much appetite for farmers to make a lot of large equipment purchases. Over half of them said they were not going to be buying large equipment over the next 12 months. And only about 13% said they would buy new farm equipment. And about a third of them said, they'd buy used.

Now, what's interesting about that is if you divide the results based on the size of the farm, we actually see that large farms are much more willing to invest in large equipment in the coming year, where small to medium-sized farms are pretty much going to sit on the sidelines. And so that is in some ways kind of a signal, I think that we will continue to see what we've seen over the last hundred years of agriculture in the US. In good times or in rising price times of commodity prices, big farmers are going to continue to get bigger. They're going to continue to invest by buying new equipment. They're going to invest by expanding acreage. And it's the small to medium farmers that have tight margins already that it's hard for them to kind of keep up the pace if you will.

Lori Walsh:

Any weather events, drought, La Niña, things like that, that are impacting that farmers are going to feel the crunch of?

Kevin McNew:

Yeah. I mean, normally this time of year, we're all talking about weather. But with everything that's going on in Eastern Europe, that's kind of taken a backseat. But we're firmly still in a La Niña. The La Niña has peaked and it is supposed to subside. But what's interesting is what meteorologists thought in January about the La Niña fading has kind of changed. It's actually going to hang around longer than what they thought. In January, they thought, "Oh, the La Niña will likely fade away by spring, probably April." And that would've set the stage for pretty decent weather in the US, especially the Western half and the Southwest Plains where things are really dry now. But as we've gotten closer to March or in March, now they're saying well, it's probably going to stick around till late spring and even into early summer, which does more drought risk in these already drought-prone areas, especially the Southwest Plains where we have so much emphasis on hard weather on our wheat.

Lori Walsh:

A lot to sort through. You can find the Farmers Business Network, 2022 State of Agriculture Report by Googling it. But we'll also put a link up on our website, sdpb.org/news. We've been talking with a frequent guest, Chief Economist, Kevin McNew from Farmers Business Network. Kevin, thank you so much. Always so great at explaining these really complicated things for all our listeners. We appreciate your time.

Kevin McNew:

Thanks, Lori.