Technology: Is innovation important?

This article appears in the California/Arizona edition of the June 2009 issue of Western DairyBusiness

Dr. Thomas Elam answers the question, “is innovation important?” And peers into his crystal ball for dairy industry analysis.

By Ron Goble

VISALIA, Calif – Dr. Thomas Elam, of FarmEcon LLC, a well-respected authority on agricultural technology, innovation and analysis, told a group of dairy producers attending a meeting sponsored by Elanco here recently that technology and innovation hold the key to providing adequate food and fibre to feed and clothe the world.

The world population continues to grow while acres per person shrinks. Demand for food, however, is growing faster than population. We have an “intensive vs. extensive” food production battle on our hands. Intensive is more land-efficient, but extensive substitutes land for yield-enhancing technology. Harvested acres per person around the world has dropped significantly from 1.00 acre to 0.40.

“The good news,” said Elam, “was that the birth rates are declining and farm yields continue to increase along with technology and animal efficiency.”

The bad news is: agricultural land base not increasing as fast as food demand. Incomes will continue to grow; farming is using 1 billion of 2.96 billion U.S. acres; efficiency increases based on innovation challenged by a vocal minority; increasing niche market for organic/natural foods is land intensive; demand for animal products outgrowing population; and biofuel demand competes for food and land.

The United Nations says by 2050 there will be 9 billion people in the world, up from the current 6.6 billion today, almost a 50% hike.

“As we reduce technology use we lower yields and higher costs, and those two usually offset each other. You get about the same returns,” Elam said. “In Europe, 10 years ago when they had full access to modern technology in poultry, they were a net exporter. They are now a net importer of poultry meat. The same is true for beef – net exporter to net importer. They can’t compete with those countries in the world that use modern technology.”

On the subject of organic production and land use, Elam pointed to the following facts: 

• Organic milk and meat production systems produce at about 1960 productivity levels.

• Organic land productivity is 33-50% of modern levels.

• For many, production organics cost 2-3 times as much to produce.

• And 10% of U.S. milk and meat supplied by organic farms would need more than another Ohio’s crop acreage to produce their feed.

According to USDA figures, organic beef and dairy operations account for 0.21% of beef production and 0.96% of dairy animals.

“There is a squeeze on the amount of land available. So we need to look for ways to produce more food off each increasingly scarce acre,” Elam said. “Animal efficiencies do conserve land, ultimately. But we need tools, incentives, and freedoms to farm productively.

“Interest groups opposing innovation do not see the big picture,” he declared. 

On 2009-2010 milk and feed outlook, Elam sees:

• Higher costs driving the milk/meat system.

• Record high production reductions are coming. “We are going to cut meat production this year by 2 to 3 billion pounds in the US. The biggest reduction on record,” he said. 

•  No let-up in sight.

  ~ 2009 corn acreage is going to be down a little bit. 

  ~ Reduction in total planted acres, about 7 million acres.

  ~ Ethanol economics will help keep feed costs up, as ethanol producers used about 30% of the corn crop. The renewal fuel standard for 2009 is 10.5 billion gallons.

  ~ Economic recovery = higher oil/feed prices; again?

Elam outlined how feed costs are related to energy prices and energy policy:

• Higher energy prices, plus biofuel subsidies, equals higher corn demand.

• Higher corn demand, equals higher corn prices.

• Higher corn prices, equal less acreage, and higher prices for other crops.

• Higher corn prices, equal higher costs for all feed ingredients.

“Basically, according to Elam, two things are driving us right now. The underlying demand structure hasn’t changed, but what has changed are the drivers. 

1) “Global recession has taken a lot of purchasing power out of not only the US, but Europe, Asia, Latin America and result in less spending on food. Spending in the US in the fourth quarter 2008, in real terms (corrected for inflation), declined by more than 4% – the biggest decline since the Depression. People have less income and they are saving more. Savings went from zero to 3% in 1 year. They are cutting back on discretionary purchases: eating out at restaurants, buying cars, and buying houses,” he said.

2) “Higher costs coming out, corn going from $2 a bushel in the Midwest, to $4 a bushel since 2005, driving our costs up, which means producers that use the product, have to raise our prices to offset that…everyone is feeling the pain – dairy, beef, chicken, pork, turkeys, General Mills, Kraft Foods. We are all feeling the pain.,” Elam said.

He outlined the costs of California dairy feed ingredients comparing the 2004 average price with April 2009 prices. Corn/cwt up 50%; corn/bushel up 50%; soybean meal/ton, up 27%; canola meal/ton, up 21%; whole cottonseed/ton, up 22%; almond hulls/ton, up 3%; alfalfa, Modesto, good quality, down 7%; DDGS, 10%/ton, up 20%.  

The Southern California Class 2 milk price/cwt. was down 24% from $13.37/2004 average to $10.20 in April 2009.

The 2009-2010 Corn Outlook, according to Elam, should show corn acres down slightly. In 2009, ethanol production capacity far exceeds demand and corn prices bid up to variable cost breakeven for ethanol plants. These high-cost ethanol plants are losing money as seen by 27 closures on 1/29/09 and 38 closed by 5/05/09. He expects farm level Midwest corn price around $4.

Concerning his feed cost summary, Elam said, “We are likely to see small increases in protein and fat prices; somewhat higher grain prices are likely, but not a disaster; and about a 10% increase in overall feed costs. But, the oil market can drive this thing. If oil goes above $75/barrel we’ll start seeing some significant increases in feed prices. And if oil goes back to $150/barrel, we’ll have $7 corn in the Midwest and $9 corn in Stockton. I’m not painting a disaster, and I think we’ll be alright for 2009-2010.”

The dairy outlook for ‘09-2010, according to Elam, shows the “current price/cost balance is clearly not sustainable. I’m hearing numbers like milk prices at $10/cwt and feed costs at $9. I hear of some large dairy operations going through a half million dollars a month in cash and equity trying to stay in business. This isn’t going to last.

“However, costs are unlikely to come down from where we are today. I just painted that picture. You’re not going to see feed costs drop significantly. Therefore prices will increase, the only question is, how long will it take?” he questioned. 

“The milk cow herd – including the CWT program – will likely shrink 2.5 to 3% from January to December and milk production is likely to drop 1 to 2%. Will that be enough? Probably, enough to get our prices up.

“The big problem we have is export demand,” Elam declared. 

The drivers for 2009/2010 look like this: “Export demand weakness is driving production declines. However, domestic use of milk products is up a bit this year, so far. Part of that is lower prices that encourage people to drink more milk and use more dairy products in spite of reduced income,” Elam said.  “Cheese and butter prices have started to come back a little bit, but nonfat dry milk is stuck at the support level and it appears it is going to be there for awhile. Futures markets are pointing to higher prices and the good news is that with today’s feed costs, a $15 all milk price will get us back someplace close to the 2008 margin over feed. It won’t take $20 milk to get us back to a reasonable margin over feed cost.”

Elam’s milk production forecast for 2009 shows the second quarter at more than 48 billion pounds, dropping to 46 billion pounds in the third quarter and down to nearly 45 billion pounds by the end of 2009.

Elam predicts “milk exports will remain weak. Although price forecast, we should see the lowest of the year in the first and second quarters, strengthening somewhat to $14/cwt in the fourth quarter. Not a prosperous forecast, but maybe something that is a little more survivable than what we have today.”

The 2010 outlook, we are likely to see significant improvement in the overall economy, Elam said. “Given all the stimulus that the federal government has put in…export prospects are likely to be improved as economies recover around the world. We should start to see some significant price recovery next year. Some of the numbers I’ve seen are in the $15-$16 range.  But, there are major risks on feed costs, especially late 2010, depending on what happens in the oil markets we could be seeing corn back in the $5 to $6 range.

Beyond 2010, we are likely to see inflation and interest rates start to head a bit higher. Interest rates in today’s terms are at record low levels.

Finally, when the marketplace tells you to produce more milk, what is the most cost effective way to increase milk production? Elam asked. 

“I know that sounds a little farfetched at the moment, but think about the fact that we are cutting production at a time when domestic use is fairly stable, and in 2010 we are likely to see some increase in export and domestic demand while production has fallen. 

“More cows, or more milk per cow?

Elam said studies show that cow productivity increases have been sliding for the last 20 years in percentage terms. “We’ve been producing more milk by adding more cows, which adds costs for cows, land, facilities and labor,” he explained. 

“Let’s say that we wanted to increase milk production in the US by 1% in 2010. If we did it just by adding more cows, no change in milk per cow, it would cost the following: $29 million facilities investment, $31 million cow/heifer investment, $250 million in annual feed costs, $35 million in annual labor costs, $28 million in other variable costs, $60 million increase in fixed costs, $313 million increase in variable costs with $16.70 per/cwt, plus $60 million opportunity cost investment.

“That’s the high-cost approach the dairy industry has taken,” he said.

However, that same 1% increase in production using rBST, with no change in cow herd numbers, produces the following cost-effective scenario: $0 million facilities/animal investment, $97 million in annual feed costs, $2 million in annual labor costs, and $89 million in rBST cost. There is no increase in fixed costs, but a $188 million increase in variable costs with $10.05 per/cwt.

Elam concluded his remarks with a five-year planning horizon that expects feed costs to likely remain volatile, but milk price recovery expected to be complete by 2010. He sees the export market trending higher with inflation more of a threat, but a return to historical profitability averages and higher range of returns to the producers. During those years he expects milk production to grow 1 to 2% a year.

FYI

  To contact Dr. Thomas Elam of FarmEcon LLC, e-mail thomaselam@farmecon.com or call 317-414-7026.

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