Comparative Costs of Production
-Monday, February 7, 2000
This analysis featured in the February 7, 2000 issue of the HGCA's MI Prospect, Volume 2, Number 16
This article explains why international comparisons of costs of production are of more than academic interest. It makes comparisons of cost of feed grain production for the UK, the US and Canada, and draws conclusion as to long term prospects.
Key Points
- Lower price support means more competition with world producers.
- Crop costs lowest in Canada, highest in UK
- Haulage to port makes big difference to farm prices
- Competition on world markets on a FOB basis
- Rent costs reflect area payments
Cost of Production and Market Support Programs
As market support programs, including the European Common Agricultural Policy (CAP), continue to be wound down as a result of international trade agreements, cost of production will increasingly become an important factor in the market place.
When the CAP for cereals was set up thirty years ago, market price support mechanisms were set at levels which were designed to provide an acceptable income for cereal growers in all members states. That these prices were well above international levels was not a major concern, as the EU, or the EEC as it then was, was deficit in cereal production. It was expected that any costs of disposing of occasional cereal surpluses would be offset by the revenue from tariffs on cereal imports.
The deficit situation was very quickly corrected as cereal growers in the more competitive production areas responded to higher and stable cereal prices by increasing output. The budgetary burden of the CAP accelerated. This together with pressure for reform in international trade forums, resulted in the MacSharry reforms in 1992-93, which began the shift from market support to acreage payments. Market support levels were cut by a third.
The original, July 1997, Agenda 2000 proposals called for a further 20 percent cut in market support with an increase in acreage payments. The proposal noted:
"The cuts proposed in intervention price are not fully covered by the rises proposed in direct income aid. But the Commission believes that market prices are likely to stay above intervention prices for the foreseeable future."
By the time Agenda 2000 proposals were approved in March 1999, cereals markets had collapsed, the Commission's expectations were doubted and the cut in support was negotiated politically to 15 percent with a smaller offsetting increase in acreage payments. Already there is an expectation
Whether this is the case will depend on whether other major exporters will maintain and expand output at these prices. In turn this will depend on their costs of production.
In the longer term, prices do not have to fall to the very low level where farmers will stop producing, but rather to a level that will discourage investment in increased output. Global demand is increasing steadily and will soon overtake supply, if output does not increase.
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Although quite precise cost of production information is available from the major production regions of the world, comparisons require some standardization of this data. Quality factors, costs beyond the farm gate, and per tonne adjustment of costs together with treatment of overheads are items requiring particular attention.
As there are generally wider variances in the value of wheat of different types than of feed grains, feed grain costs are used. US maize and Canadian barley are compared with UK barley.
Price competition in the international market place tends to occurs on a free-on-board basis. Thus, it is necessary to consider the costs of getting grain to tide water and loading it. The distance component of ocean freight rates, however, is relatively modest.
As costs of production are incurred by the acre or hectare, data is generally collected and published on an area basis. In making the per tonne conversion average, budgeting or expected, yields are used.
As expected UK costs appear quite a bit higher than North American costs (see table). This is mainly due to higher machinery and labour costs resulting from both the UK being a high cost economy and the difficulty of achieving new world economies of scale. US data may understate overheads as costs estimates are generally made on contractors rates rather than ownership and operating costs of machinery.
continueSummary of Benchmark Feed Grain Production Costs ------------------------------------------------- ------------------------------------------------------------- £ per tonne US maize Canadian barley UK Barley ------------------------------------------------------------- Crop costs 22.30 15.00 21.30 Overheads 12.20 16.20 42.50 Tidewater basis 9.60 19.90 6.00 Cash rent equivalent 24.80 9.00 20.60 Total 68.90 60.10 90.40 Total net of rent 44.10 51.10 69.80 Exchange Rate 1.64 2.40 1.00 Yield, tonnes/hectare 9.1 4.6 9.0 ------------------------------------------------------------- US - Iowa State University; Canada - Alberta Agriculture; UK - Sac & Nix. Crop costs include seed, fertilizers, chemicals, etc. Overheads are mainly labour and machinery. Tidewater basis includes cost from the farm gate to the ocean vessel. Costs may vary according to situation but are indicative in a general context.
continued
Crop costs are higher in the UK than the US, and much higher than for more extensive Canadian production. Canadian transportation costs are higher because of its geography. This offsets much of Canadian crop cost advantage.
Land or rent is the most difficult cost item to handle. In theory, rents should reflect profitability. In practice, there is much more involved. That government support is increasingly area rather than market dependent means that rents will reflect this. That UK and US are higher than Canadian rents probably reflects the direct payments received by farmers.
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With the bellwether US Gulf maize market having traded at the equivalent of the low £50's per tonne for many months, nobody is making much money out of the market. Barley is, exceptionally, trading at a premium at the moment but this is not expected to last beyond the end of the crop year. US and EU programs are surely supporting rents. With the Agenda 2000 plans expected to cut about £10 per tonne off European intervention support and the status of US programs uncertain much beyond this presidential election year, medium term prospects are unlikely to be encouraging any increase in supply.
The issue that is critical for Agenda 2000 prospects is whether international market prices will be high enough for long enough to allow European intervention stores to be emptied with limited budgets and within existing or any new international trade agreement restraints.
As in Europe, US farm income support programs have yet to be completely decoupled from the market. US maize growers appear to receive most of their farm income assistance through the acreage related Production Flexibility Contract program. Hence, rents are high. The US Loan Deficiency Program, however, still provides farmers with some market related assistance, the equivalent of about £6 per tonne with fob Gulf port US maize at about £55 per tonne. As prices rise, this payment falls.
In Canada farm income support is provided through income assurance programs funded jointly by growers and governments. These programs are largely but not totally decoupled from the market. Due to the structure of the grain industry, Canadian feed grain supply response is more muted than that of the US.
Market support programs continue to obscure the economic evidence. The gap between the European and international cereal prices has, however, narrowed. This greatly increases the probability that the next upturn in international prices will enable European intervention grain stores to be cleared as they were in the mid 1990's.
David Walker 01603 705153
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