The FINPACK Flyover series provides digestible briefs from a 30,000 foot perspective on broader, macroeconomic issues or events and examines the potential threats / opportunities they may pose to the clients you work with. In this edition of the FINPACK Flyover, we look at potential impacts of the current uncertainty in global energy markets.
Importance of Energy Markets to Society Today
It’s easy to take for granted the crucial foundation petroleum creates for modern life presently. We all know oil provides us with the fuel to get to work, to transport goods, and to farm our fields. Natural gas allows us to heat our homes and to have our cookouts. Also remember, petroleum impacts our daily lives in less visible ways; it is used in the creation of various pharmaceuticals and the rubber in our tires. Renewable energy production may be growing, but we still presently have an integral need for oil and gas. Due to this integral need, when a major geopolitical event involves a major supplier of petroleum products, such as the Russian invasion of Ukraine, the fallout reaches every corner of the world.
In the United States, drivers have felt their budgets tighten with substantially higher gas prices. Farmers have been experiencing significant increases in the cost of key inputs such as diesel fuel and fertilizers. Some countries have experienced civilian protests over unaffordable energy prices. Europe could be facing a worrying winter where they may not have enough natural gas to heat their homes. Whether it’s due to financial challenges, political unrest, or worries about the future, energy markets are top of everyone’s minds today.
Potential Fallout for American Agriculture
Threat – Higher Fertilizer Costs
While high gas prices tend to be the front-page headline, agricultural input markets are just as full of uncertainty and challenges. Fertilizers are a crucial agricultural input and comprise a significant share of a farm’s operating expenses. Since fertilizers are derived from petroleum, when oil prices increase, the price of fertilizers increase as well. If fertilizer prices increase, then the operating expenses for farmers increase. Farmers have already seen steep increases in fertilizer prices and this climb could very well continue to get steeper.
Opportunity – Decreased Agricultural Production In Other Regions
Fertilizers are important for American farmers, but they are even more crucial to other countries that have, at best, marginal farmland. Many countries have terrains or climates which make agricultural production incredibly difficult without fertilizers. If fertilizer prices become unaffordable for the farmers in these countries, they will need to import more food. One would expect this enhanced demand to provide some sort of support to commodity prices. Farmers in the U.S. may be able to help satisfy the enhanced global food demand while capturing a higher price.
Why Does This Matter?
What does all of this mean for you? The uncertainty in energy markets that we’ve touched on above will likely impact your ag clients’ financial positions in some manner, if it has not already. You can expect to see the impacts in a couple of different areas of their financial measures. To what degree will they be affected? Well, it’s everyone’s favorite answer – it depends.
High diesel fuel and fertilizer prices will increase operating expenses and reduce net income. You would see this show up with (assuming all else remains the same):
- Increased operating expense to gross revenue ratio
- Decreased debt coverage capabilities
- Decreased rates of returns on assets and equity
- Decreased working capital to operating expenses ratio
- Decreased net farm income to gross revenue ratio
If it becomes a situation where US farmers face higher input costs, but there is an increase in demand for US agricultural commodities, then it is really a mixed bag. An increase in demand should provide some support to commodity prices to work against the effects of the higher input costs. But determining whether it would be a net positive or net negative is rather difficult since you’re dealing with concurrent effects on both sides of the profit equation. If prices increase enough to offset the higher input prices, then it is a net benefit. If prices do not increase much, it could be a neutral or negative net impact. Time tells all on this scenario.
