Volatility Of Markets and Cost of Production Implications

Unprecedented volatility in the supply of global commodities has caused the dramatic increase in the cost of many agricultural inputs. As all growers would be aware, products particularly fertiliser, chemicals, finance, labour, plant and equipment costs have all increased significantly during 2022. The cost of these inputs has in part been offset by the corresponding lift in prices for agricultural commodities, particularly grain.  

The timing of these changes coincided with when Rural Management Strategies were completing Budget Reports for clients. This has led to budgets completed in summer utilising assumptions based on average figures seen at the time. However, those completed in late Autumn reflect the inflated costs clients were experiencing. Therefore, benchmarking a client’s performance against other budget clients in 2022 will not be possible. 

The increase in input costs may have a negative impact on clients’ Cost of Production margin depending on fluctuations in prices and yields. Many large scale cropping clients have seen their variable costs increase by 35-45% year on year, plus a modest increase in fixed costs. Clients with significant debt will also see a further erosion in their margin on Break Even Prices, due to interest rate rises. Since March, interest rates have increased by between 150-200%, with further increases expected. 

With higher costs already incurred, it will be necessary for growers to achieve robust yields at above average prices to break even. Due to the significant rain, the 2022/23 season will provide a wide variety of results, from those who haven’t even had an opportunity to sow the crop, to those with potentially record breaking crops. 

 Crops with high yield potential should still be managed to achieve a high yield; however, every additional cost incurred will increase the risk to the business if returns are affected through environmental impacts or price reductions. It is also necessary to remember that the law of diminishing returns applies as maximum yields are approached. Therefore, the efficiency of additional inputs will not be as high as previous applications, as the incremental yield response from the crop will be less. 

Prices while historically still very good, have also been very volatile during 2022. Currently prices have dropped from recent peaks due to the supply pressure from the northern hemisphere harvest. Some of the day to day volatility is due to significant fluctuations in the $AUD/$USD exchange rate. Consideration of forward selling some grain may be prudent to reduce price risk, particularly when high production costs have already been incurred. However grade spreads need to be understood prior to taking out a contract, as the forecast La Nina indicates that weather damage and quality downgrades at harvest may be likely. 

High costs are guaranteed this season, but the price and return per hectare are still unknown and could be highly variable. This has forced growers into a very high-risk situation, with significantly greater expenditure than budgeted. Growers should monitor expenditure and only allocate inputs to paddocks which have a high likelihood of providing a good return on that investment.