Since much of what we’re reading these days is about the drought of 2012 and its impact on commodity prices and ultimately its effect on food prices, I’m reminded of the risk-reward tradeoff I learned about back in my college days. It makes me wonder why no one pays much attention to the “risk” side of the equation.
According to the risk-return tradeoff, you must spend money to make money. Or more correctly, it says “invested money can render higher profits only if it is subject to the possibility of being lost.”
Or, said another way, “potential return rises with an increase in risk.”
So, I can’t help but wonder how much a farmer actually loses when a crop fails.
While most industry observers seem to be comparing this year’s drought and its potential impact to that of the drought of 1988, at least one analyst says this year’s weather is a closer match with 2002. You can read more about his analysis of the situation this year starting on page 38.
So I did a little digging to compare the cost of crop production to the prices received for corn and soybeans in 1988 and 2011. I’m using 2011 because we don’t yet know where commodity prices will come in for this year.
According to Mike Duffy, extension economist at Iowa State Univ., the average cost to produce a bushel of soybeans in Iowa in 1988 was $5.53. This grew to $9.45 per bushel last year, for an increase of about 42%.
During this same comparison period, the average price farmers received for soybeans in 1988 was $7.21 vs. $12.52 in 2011, for a difference of 42%.
Using the same scenario for corn, Duffy estimated the average cost for producing a bushel of Iowa corn in 1988 to be $2.12 vs. $3.99 in 2011, an increase of about 48%.
According to USDA, the average price a farmer received for a bushel of corn in 1988 was $2.27 compared with $6.01 in 2011, an increase of 62%.
We need to add a footnote here, as the per-bushel price of corn in 2011 ($6.01) was 57% higher than a year earlier ($3.83). So if you were to compare 2010 to 1988, the per-bushel price that farmer received rose by 41% vs. the 48% rise in production costs during that same comparison period.
The bottom line is this: according to Duffy, it cost a grower nearly $473 to plant and harvest an acre of soybeans in 2011 vs. $210 in 1988.
For corn, per-acre production costs rose to $774 last year compared to $265 in 1988.Keep in mind this doesn’t include the cost of crop insurance, which according to various sources can range from $35–45 an acre. About 85% of farmers utilized crop insurance in 2011, according to USDA, vs. an estimated 25% in 1988.
So, the next time you hear anyone complaining about the inequity of subsidized crop insurance for those “rich farmers,” take the complainer to one of your customer’s fields and ask him, “Do you know how much this farmer is risking if his crop fails?”
If they’re unable to comprehend the fact that it actually costs a lot of money for that grower to put seeds in the ground and then do everything he possibly can to ensure that it grows and produces a good yield, do the math for him.
Then explain the risk-reward concept. Unfortunately, if your conversation partner didn’t grasp the first discussion, I have a feeling he won’t comprehend this basic principle of
economics either.
