With the COVID-19 pandemic weighing heavily on the world economy and agriculture markets, David Kohl, professor emeritus of agricultural economics at Virginia Tech, recently shared how pandemic economics are impacting the U.S. dairy industry.
During his presentation at the Pennsylvania Dairy Summit, held virtually in early February, Kohl described the global environment, economic risks for dairy and strategies dairy producers can implement over the next year to mitigate their risk.
How black swan events affect agriculture
From Kohl’s perspective, the COVID-19 pandemic is a black swan event – an unusual event that typically occurs once every decade. He shared a few examples of previous black swans, each impacting agriculture more than others. In the 1980s, interest rates were raised significantly and Russia stopped buying U.S. goods. In the 1990s, oil prices skyrocketed, leading the U.S. into a recession which severely hurt agriculture. In the 2000s, it was the events of Sept. 11 and the meltdown of the high-tech market.
What do all these black swan events have in common? They have accelerated change for consumers, society and businesses. In some cases, Kohl said these events have also opened the door to opportunity.
“While black swans are disrupters and challengers, they also create opportunity. [With the COVID-19 pandemic], one of the things we’ve seen is the buy-local type of movement. That is really picking up,” he shared.
Along with heightened opportunity, black swans also accelerate financial and economic divide. Kohl described three areas he believes the dairy industry will need to focus on as it emerges from the current pandemic:
1. Economic volatility and extremes. “When I talk dairy, I talk about the big three: milk prices, feed costs and interest rates,” Kohl explained. “You’re probably not going to see too much change in interest rates, but your feed costs and milk prices will have the volatility and extremes. This is where a good marketing and risk management program is going to be very critical.”
2. Controllable versus uncontrollable factors. “In managing this type of environment, you have to separate the controllables and the uncontrollable,” he said. “There are certain things in our dairy businesses that we can control on our bottom line – all the way from nutrition to production to finance to management.”
3. Effective management. “Managers are going to have to be flexible, innovative and adaptive,” Kohl said. “But you’re also going to have to follow a process, and you’re going to have to focus.”
Super cycles and the importance of strategizing
In addition to being prepared for economic and financial divide, Kohl shared his insight on “super cycles” and how they affect the dairy industry. He described the “Great Commodity Super Cycle,” which occurred approximately 10 years ago when commodity prices increased immensely. According to Kohl, until now, there have only been three other super cycles since 1910.
“Right now, we’re in another super cycle, and it’s really impacting the dairy industry. I call it the government and central bank super cycle,” he explained. In this super cycle, dairy producers are experiencing a government payment stimulus boom. We are also witnessing the “China effect,” with China rebuilding their protein sector, including hog and poultry, and driving up prices on the grain side.
Kohl also explained that the current devaluation of the U.S. dollar, combined with the China effect, have enhanced export markets. Along the way, there have been extreme weather changes, particularly in South America, and we have experienced low and stable interest rates that have moved investors out on the risk curve.
All these elements combined make it imperative for dairy producers to have a strategy in place for once the cycle is over.
“All of these elements have shot our grain prices up, but I don’t see this super cycle lasting,” Kohl said. “I see this abating as we go into 2021 and 2022. We’re going to need a strategy for when we are post-government stimulus checks.”
Five global macro-economic risks
Along with lasting effects from the current super cycle, Kohl shared five global macro-economic risks he believes will impact the dairy industry this year – and the steps producers can take to prepare.
He described a tug of war between globalization and deglobalization. As government, business and consumer agendas continue to move away from globalization, it could be at the detriment of U.S. agriculture. “If you look at your dairy exports, they have become a bigger and bigger share. So if this deglobalization continues, it impacts agriculture in the U.S. We’re an exporting nation. That’s something to keep on your radar,” he said.
Kohl also predicts a disjointed recovery from the pandemic. On one hand, the hotel and airline industries, school systems and sporting complexes are operating at 50% to 75%, and each of these economies are linked to the dairy industry. On the other hand, businesses like Target and Amazon are operating at 125%. They hold a lot of power around the world, and this uneven balance in power could make for a bumpy economic recovery.
Trade agreement uncertainty and China’s aggressive pursuit for global power are other risk factors for the dairy industry. “Trade agreement uncertainty is going to be with us for a few years, so managing volatility is going to be very critical,” Kohl advised.
He also predicts an increase in state, federal and local taxes, with the government needing to recover from the payouts in the past 12 months. Perception and competitiveness will be key. He encouraged dairy producers to work closely with an accountant or advisory group to prepare for when this risk becomes a reality.
“As we see future stimulus checks, it’s going to be interesting how other segments of society perceive agriculture getting that support. They’re going to look at who is getting the support. Is it big agriculture or small agriculture?” Kohl said. “The other question is: Which country is going to give up their support first? This impacts our competitiveness globally. Over the next few years, one of your best advisory groups could be a good accountant and tax accountant who understands agriculture. You need to have a plan in place for post-government support.”
Focus on business, finance management
One part of developing a plan is focusing on how you manage both your business and your finances.
“Your business management and financial mindset is going to be really critical. It’s going to be one of the dividers of success in the decade of the 2020s,” Kohl added.
Kohl explained how the top 20% of dairy businesses have a strong “business IQ,” meaning they have a strong productional and operational efficiency and know how to drive their key performance indicators to hit a margin. The low 20% have weaker business IQs that often lead them to refinancing or facing liquidity issues.
To help improve business IQ, Kohl shared a template with attendees that included a checklist of 15 critical elements dairy producers should focus on within their management. Some of the elements include: knowing your cost of production, doing a projected cash flow, executing a risk management plan, having a proactive attitude, completing a financial sensitivity analysis and implementing a record-keeping system.
He encouraged attendees to complete the business IQ exercise to identify three areas in their business they will continue and three areas they can improve upon.
“Sometimes your business IQ has to come internally. You have to have the initiative. If you don’t have initiative, you better have a lot of equity out there,” Kohl said.
Moving forward with an action plan
As the dairy industry continues to recover from the COVID-19 pandemic and brace for impacts from the current economy, Kohl concluded by motivating attendees to start an action plan. With economic risk factors in mind, he encouraged dairy producers to take these steps to prepare:
- Develop a written farm budget and compare actual to budget.
- Think big picture and evaluate your budgets as economic conditions change in the U.S. and globally.
- Establish a personal family living budget and compare actual to budget. “A personal family living budget is just as important as a farm budget. Particularly on dairy farms, too many families are trying to live out of the business. What happens is: The business is not big enough to accommodate them,” Kohl explained.
- Re-establish your goals and objectives.
- Communicate with your advisory team (lenders, crop/livestock consultants and accountants).
- Develop a risk management plan.
- Surround yourself with the right people and follow your plan.
“You not only have to have the right people on the bus – you have to have the right bus driver, you have to know the directions (your business plan), and you have to have a plan for detours,” Kohl added.
