A commentary by W. Michael Slattery, Grain Commodity Committee Board Member, Wisconsin Farmers Union.
The Grain Committee of the Wisconsin Farmers Union investigated the costs and profits of manufacturing inputs (primarily fertilizer and seed) for grain farming.
The comparatively low cost of goods sold and the high gross margin that these manufacturers are accruing mean that grain farmers are effectively subsidizing the manufacturers who are earning more than handsome returns compared to farmers' low profitability.
Farmers need to ask their cooperatives why they are acceding to excessive profit taking of their suppliers.
In order to understand the costs of production and profits earned from producing and marketing these products, we can analyze the major manufacturers of nitrogen (N), phosphorus (P), potassium (K) and seed, exclusive of research and development, marketing, general and administrative costs
This study was able to have a good grasp of these input costs for fertilizer production, but was less successful in analyzing the costs of seed producers in manufacturing their product, exclusive of overall corporate research and development costs.
Transport and brokerage costs for local coops or distributors of fertilizers are minor in terms of overall cost to the coop or distributor, but for the farmer these add significantly to his/her purchase.
Brokerage fees roughly cost $5 per ton when the coop is contracting the purchase of fertilizer.
Transport costs, for a coop in northeast Wisconsin from the Gulf of Mexico (Louisiana) up the Mississippi this year amounted to $60 per ton and trucking or rail costs to Northeast Wisconsin incurred another $18 per ton.
Oceanic transport costs depend on the port of export to the US and could not be analyzed. In aggregate, supplemental and incidental cost amounted to $83 per ton.
Nitrogen is generally the biggest and most expensive fertilizer input for a grain farmer. What is the cost of producing nitrogen (ammonia, urea, ammonia urea nitrate (AUN), ammonia nitrate (AN), and other nitrogen products)?
CF Industries, the world's second largest and North America's largest nitrogen producer, is an Illinois company, influences market prices tremendously and has nitrogen production plants in Louisiana, Mississippi, Oklahoma, Iowa, Alberta, and Ontario.
Similar to CHS, a cooperatives' cooperative, CF Industries was previously formed by a federation of Midwest cooperatives, inclusive of CHS.
In 2005, the present CF Industries converted to a stock company, with CHS continuing as its largest customer buying 10 percent of CF Industries' product today. For all of the aforenoted types of nitrogen fertilizer, CF Industries has captured a handsome profit.
Its gross margin, that is the sale proceeds of nitrogen sold minus the cost of raw materials and its production, since 2008 has averaged $154 per ton, or a 42 percent gross margin ((net sales minus cost of goods sold) divided by net sales) based on a five-year average of $358 per ton sales price.
Its costs of goods sold, namely, its purchase of raw materials and production costs have averaged $204 per ton.
Potash Corporation of Saskatchewan realized similar profitability from nitrogen production in 2012 with a 43 percent gross margin ratio. This profitability ratio may be considered the industry standard.
Given that 40 percent of the cost of nitrogen production is attributed to the cost of natural gas and given that natural gas prices are projected to remain low because of development of new natural gas fields and expanded use of fracturing technology in the eastern seaboard states and in the western Northern Plains, manufacturer costs should remain low and stable in the near and mid-range future.
Whether CF Industries and other fertilizer manufacturers pass these benefits along to the farmer and to what extent remains to be seen.
More than 80 percent of CF Industries' net sales come from the sale of nitrogen; the remainder is largely from phosphate sales.
The company has been able to keep its operating (i.e., non-production costs) relatively low because CF Industries does not engage in general retail sales, and to keep its depreciation expense also surprisingly low.
The company's profit margins, in terms of return on equity and return on operating earnings, are exceptionally high.
Between 2009-12, CF Industries has garnered a return on operating earnings that averaged 40.7 percent, with a high of 57 percent and a low of 20 percent; its return on equity has averaged 22.4 percent, with a high of 31 percent and a low of 8 percent.
This rivals the best performing blue chip companies on the New York Stock Exchange and is one reason that CF Industries is one of the S&P 500.
While going concerns are expected to earn a profit, the question becomes at whose expense and to what extent. Farmers generally have a return on equity of between two and six percent, at best.
Thus, farmers as the consumers of nitrogen, as seen in case of CF Industries, are effectively transferring their income to pad the bottom line of CF Industries and allowing CF Industries to earn exorbitant profits.
CF Industries has North America's largest phosphate mines, located in Florida, and is the US' largest phosphate producer, but is slightly smaller and a little more profitable in phosphate production compared to Potash Corporation of Saskatchewan, another major producer of phosphate.
The cost of production of phosphate for CF Industries between 2008-12 averaged $386 per ton on average net sales of $519 per ton. Its average gross margin for phosphate sales was $133 per ton.
Although not as profitable as nitrogen production, CF Industries is earning significant profits in phosphate production with an average gross margin ratio of 26 percent; Potash Corporation in 2012 generated a 22 percent ratio.
Again, this appears to be the industry standard for profitability.
Forty-six percent of the world's potash reserves are concentrated in Saskatchewan, with 43 percent of the remainder in Russia and Eastern Europe (Belarus), mined and traded by OAO Uralkali and Belaruskali.
Saskatchewan is the second largest world producer of potash and reportedly provides 90 percent of North America's potash supply through a trading consortium (cartel) named Campotex, comprised of Potash Corporation of Saskatchewan (also the world's third largest producer of nitrogen and phosphate), Mosaic, and Agrium.
Potash Corporation of Saskatchewan is the largest producer of potash in the world with 20 percent of global capacity that garnered a 64 percent gross margin ratio in 2012 - far higher than the tremendous profitability of CF Industries' nitrogen production.
It is followed closely by Uralkali, Mosaic and Agrium, both Canadian companies, and Belaruskali. Sales prices are essentially driven now by demand from India and China.
Potash Corporation's profitability is largely derived by the mining, manufacture and sales of potash. It has averaged $260 per ton gross margin since 2010.
Potash accounts for 57 percent of the company's operating income and net income. Its average cost of production of potash since 2010 amounts to $124 per ton on net sales at $384 per ton.
Similar to CF Industries, Potash Corporation is able to maintain low expenditure for marketing, general and administrative costs of about $200 million per year and low depreciation costs of about $500 MM per year (double that of CF Industries).
Since 2008, Potash Corporation has attained an average 16.6 percent return on assets, more than eight times what major US banks earn, and a 32 percent return on shareholders equity.
Russia's OAO Uralkali this summer notified Belaruskali that it was terminating its participation in the European marketing cartel.
Because Uralkali's potash reserves more than double those of Belaruskali, Russia will attempt to force its political leadership and business dictates on Belaruskali.
This dissolution of the cartel is projected to lower world production prices for potash possibly by as much as 25 percent.
BHP Billiton, an Australian mining company had already invested Canadian $14 BB in a new Greenfield potash reserve that it seeks to develop. After being jilted by Potash Corporation and the Saskatchewan government in an attempted acquisition of Potash Corporation, the price of Saskatchewan potash should hold steady at worst, if not drop because of over-capacity and dissolution of the European cartel.
Monsanto indisputably monopolizes the seed industry through its development of seed genetics. It is reputed to dominate about 90 percent of the seed market.
The company has a history of creative technological development, but not always for society's benefit (e.g., Agent Orange, PCBs, Saccharin, etc.).
Since the mid-1990s it has rapidly taken over the seed patent market, although its sale of seed reportedly only constitutes about 30-40 percent of the market. Monsanto does not break out its profits and costs for seed and genomics (seed technology), much of which is leased to competitors.
Unfortunately, we are unable to determine the cost of its seed and the cost of its patents leased or sold. But, the ratio of its gross margin to net sales is 58 percent.
Proponents of Monsanto contend that its high profit margin is needed because of costs incurred for research and development.
Over the past five years, though, the company has annually averaged $1.3 billion in R&D expense. As a percentage of net sales, R&D constitutes only 11 percent. Thus, despite that the fact that Monsanto incurs high operating expenses because of its retail operations, it still has garnered significant net income (averaging $1.8 billion) and a reasonable return on equity, averaging 17 percent since 2008.
Its income and net returns would be even higher were it not for outstanding and settled lawsuits on past undesirable products.
Finally, Monsanto is really a seed company, not a chemical company as it was until the end of last century. Only 14 percent or less of its profits arise from chemical sales, compared to its seed and genomic sales.
Although the cost of seed production could not be determined for Monsanto, nor for its major US competitors Dow and DuPont, we are able to calculate the cost of seed sold by Agrium, a major Canadian company that reportedly has a 19 percent share of the North American market for winter wheat and corn seed and markets its product under the name DynaGro.
The gross margin ratio for Agrium seed sales then averages 20 percent since 2009, which pales to Monsanto's 58 percent.
There are two probable conclusions.
Either Agrium is not as profitable a seed operation as Monsanto; or, if Agrium's gross margin ratio for seed is representative of the industry, Monsanto is obtaining the lion's share of its profits from patent leasing and sales.
Although seed sales comprise only 20 percent of Agrium's sales (with the remainder in the sale of nitrogen, phosphate and potash), its fertilizer sales are far more profitable than its seed business.
We will assume then that seed sales are not pulling off comparatively as much income from farmers as fertilizer and that seed genomics is the most profitable part of seed sales.
DuPont Pioneer reports that it holds a 39 percent share of the global agriculture industry. Clearly DuPont's acquisition of Pioneer has benefited the company greatly because more than 37 percent of DuPont's revenue accrues from agriculture sales.
The company is committed to expanding their seed business by investing more than $6 billion in a South African genomics operation.
Following Monsanto's model, DuPont would not be shifting its business model so heavily into conversion to an agricultural and seed company if it did not foresee high profitability in sales to farmers.
In conclusion, how can we as grain farmers who are purchasing these inputs for our grain production address this situation of transferring our wealth and income off our farms and subsidizing fertilizer and seed manufacturers?
We are not opposed to and, in fact, support these companies' right to make a profit, but, when their exorbitant profit levels arise in the face of our meager returns, we stiffen our backs at our subsidizing their profitability at our expense.
The massive profit-taking by the manufacturers accelerates the demise of small and medium-scale farmers.
While the previous three or four years were comfortably profitable for grain farmers, years prior to 2008 and this crop year present a totally different and difficult picture. We need to address our local cooperative management and direct them as members to pressure respective manufacturers to desist from extracting exorbitant profits from the sale of fertilizer and seed to farmers. Cooperatives by and large are not generating profits at even half the level as the manufacturers.
When we I thought meet representatives of the manufacturers or hold their stock, it behooves us as consumers of their products to this issue of excessive maldistribution of income.
If we fail to change this system, we will become increasingly marginalized and find farming as we know it unsustainable.