Find your red flags

Find your red flags

Part IV in a series on the changing corn environment.

The original renewable fuels standard (RFS) triggered the current expansion in ethanol production and added substantially to the current demand for corn — about 3 billion bu. Current U.S. ethanol production is about 9 billion gals., well above the original goal of 7.5 billion gals. by 2012 — and additional production capacity is in the pipeline.

The new 2007 U.S. Energy Independence and Security Act set a new annual goal of 36 billion gals. of ethanol by 2022. Of this, 15 billion gals. is projected to come from corn, with the remainder from other input sources. Estimates are we could see up to 5 billion bu. of corn used annually in ethanol production by 2015 (Figure 1).

Figure 1. Projected corn consumption for ethanol production [3]
Figure 1. Projected corn consumption for ethanol production
Select image to enlarge

Clearly, the government-mandated demand for corn will keep corn prices at or near record highs for several years. As of June 26, Omaha cash corn was $7.17/bu.

Record-high gain costs

Record-high corn prices imply record high costs of gain (COG) in the feedlot sector. Kansas State University's (KSU) May “Feedlot Survey” calculated feedlot COG in June at $102/cwt. Figure 2 summarizes my calculated impact of corn prices on feedlot COG.

Not only is COG increasing beyond the ranch gate, but ranch-level costs of production have increased substantially the last couple of years. KSU studies suggest breakeven, full-economic costs could be $750/cow in 2008, and they're projecting economic breakeven calf prices of $119 in 2007, and $132 in 2008.

General guidelines for corn and feedlot cost of gain [4]
Figure 2. General guidelines for corn and feedlot cost of gain
Select image to enlarge

My Integrated Resource Management cost-and-return studies for western Nebraska and eastern Wyoming also show a dramatic run-up in ranch-level production costs. My calculated breakeven calf price with 2008 calves is $112/cwt.; that excludes operator labor costs, a management charge and a charge for equity capital.

As feeder-cattle and feeder-calf prices adjust to a new and uncertain supply/demand equilibrium price for corn, ranchers won't be able to do much about COG beyond the ranch gate. What ranchers should do, however, is implement an “optimal long-term business analysis,” which is designed to focus on the cost structure of their ranch business — one thing over which they have considerable control.

As the economics of the ranching sector change, ranchers can receive some early-warning business signals, if they do the proper business accounting and/or business planning.

  • Typically, the first business-oriented red flag is a projected negative economic return from the beef cow profit center (with farm-raised feeds valued at local market prices).

  • The second red flag typically relates to negative net cash flow from the beef cow profit center (with farm-raised feeds charged in at cash costs of production).

  • The third red flag occurs when net financial returns go negative and the ranch starts consuming equity capital (with farm-raised feeds charged in at actual costs of production).

I'm currently projecting a $68 positive earned net income for Nebraska/Wyoming beef cow herds producing 2008 calves. This is down slightly from the $81 I calculated for the production of 2007 calves, and down substantially from the calculated earned net income of $219/cow for 2005.

The Livestock Marketing Information Center is currently projecting a negative net cash flow for average beef cow herds in 2008. The take-home message is that some business red flags may well start appearing in 2008. These potential red flags are early warning signs.

It will be critical that ranchers focus their management energies on the business side of the ranch for the next few years. It's not just production, production, production; economic efficiency also must occur at the ranch level to make a profit from beef cows. Long-term business planning strategies will be absolutely necessary for meeting the cash flow needs of the ranch business during the next few years of this emerging biofuels era.

A rancher's unit cost of producing a hundredweight of calf (UCOP) — the breakeven price for calves — is going to become all the more important. Ranchers with low UCOP will weather the emerging biofuels era in reasonably good shape.

High-cost ranchers will experience financial stress (i.e., receive multiple business red flags). The sooner a rancher responds to a red flag, the less financial stress he'll likely experience. The key is to be proactive by preparing a long-term business plan (LTBP) designed to generate an economic evaluation of proposed production adjustments.

The four steps needed in a ranch LTBP are:

  1. Assess your herd's production parameters and the herd's economic performance for the last calf crop.

    • Compare your herd's production parameters and economic performance to published benchmarks.

    • Determine your herd's strengths and weaknesses.

  2. Construct a set of 3- to 5-year planning prices for the emerging biofuels era.

  3. Project your beef cow herd's economic performance over the next 3-5 years with current production parameters.

  4. Identify and implement the business adjustments needed to make your 3- to 5-year LTBP more profitable.

Harlan Hughes is a North Dakota State University professor emeritus. He lives in Laramie, WY. Reach him at 701-238-9607 or [email protected] [5].