The spot price of fertilizer has collapsed, but the price offered to farmers has remained high. A commonly offered rationale is that the suppliers can’t sell at the new prices without incurring enormous losses. My response: So what? Not covering your costs and incurring a large loss happens way too often for it to be a compelling reason why suppliers won’t have to lower their prices.
The question is, of course, when will suppliers need to start lowering prices? The answer: when they think that someone can steal their market share by bringing in lower priced fertilizer. In those markets, with more transportation options and competitive suppliers, this will be much sooner than closed markets with single suppliers and limited transportation options.
Another question farmers need to consider: How expensive is this fertilizer anyway? On a historical dollar basis it remains very high priced. On a relative basis to the value of corn, fertilizer prices have become relatively cheap. The second way of looking at inputs helps more than the first. Farmers need to understand that they will get some relatively constant portion of the crop yield for their contributions to the process. The more inputs they contribute, the bigger the share of the yield that should end up on their side of the table.
Typically, fertilizer has ended up with 16% of the corn yield. This represents fertilizer’s average revenue product contribution to improving yields. The whole idea of optimal economic rates of application relates the expected gain in yield to the expected increase in cost. It is an explicit implementation of the marginal revenue product being equal to the marginal factor cost from the microeconomic principles of the firm. Instead of babbling on about calculus, you can simply ask the question: If I put on another dollar’s worth of fertilizer, do I expect to get more than a dollar’s worth of additional corn to sell?
To answer the question, you’ll need to know the price of corn and the “expected” yield response rate to the dollar’s worth of fertilizer. This involves prices and yields that vary, but you need form some expectation from suppliers’ offers and the CBOT futures. If the current spot prices in the Gulf of Mexico and CBOT futures were to translate into cash prices, fertilizer costs would be their lowest since 2000 in terms of corn’s value. In order for farmers to lock up this “cheap fertilizer,” they’ll need to find a cash price that more closely relates to today’s spot prices and sell about 16% of their expected yield at today’s corn prices.
To read more and see graphs and charts, go to: https://www.wellsfargo.com/com/research/economics/agriculture/.