Episode 3: Price takers vs. Price makers - The arable perspective
Norfolk-based wheat, barley, rape seed and potato farmer extraordinaire Kit Papworth explains how arable prices are formed, why there might be a slight drop in yield this year and concludes that the drive toward environmentally-based subsidies may deliver much-needed investment in UK Agriculture and define its future.
Contributors in this episode
Kit Papworth
LF Papworth Ltd
Florian Ritzmann
FutureFarm
“There are people prepared to invest because they think that actually whilst food production is important, reversing climate change, or at least stabilising climate change by the use of land might be equally important and might be equally profitable or more so. So that is driving land and land sales and land consolidation as much as food production is right now.”
Florian Ritzmann: Welcome to the FutureFarm Podcast. I'm Florian Ritzmann and in this series we speak to farmers about the big topics in agriculture. Today we'll be talking economics with Kit Papworth, a Norfolk based arable farmer. I'll be tapping into Kit’s experience to discuss something that I still cannot understand.
- And it is this:
According to official UK Government stats, arable farmers in the UK made just 4% of their income from selling that crop in the 2021 growing season, while 66% came from subsidies. So that's about 14 times more in subsidies than from selling crop. That's odd, isn't it?
So to get to the bottom of that, I'll be asking Kit how prices are formed in his space. Is he a price maker with the tools to influence what he gets from his crop? Or are arable farmers price takers who have to accept the price they are given, regardless of what it costs to grow a crop.
Before we get into this Kit, perhaps it might be a good idea if you could introduce your farming operation to us and tell us what you grow?
Kit Papworth: Yeah, I’m Kit Papworth, I’m a contract farmer in northeast Norfolk, so just north of Norwich on the bit of England that sticks out if you're not English.
So we contract-farm for 26 different other people and we try and help them achieve what they're trying to do with their land. And we have some land owned by our families too. The business that we run is predominantly growing arable crops for other people. The main crops we grow are combinable crops so wheat and barley and oilseed rape, and then we grow sugar beets, potatoes, vining peas. And that's quite a consolidated list compared to a few years ago, when we were growing sort of 26 crops or so.
So we've narrowed it down to what we think we can have as a sustainable rotation. And that's constantly under review. So that's a bit of background about where our farming operation is. And then I work with my cousin to run this business, he specialises in potatoes, and I try and look after most of the other things. He specialises in fertiliser, I specialise in agronomy and spraying and then we work together to share our teams and our machinery and our resources. And then we both have jobs outside of our farming business as well, where we try to help other businesses and gain knowledge elsewhere as well.
Florian Ritzmann: Well that certainly gives me a hell of a lot to tap into here. So this might be a long call. Let's get started. So arable crops, lets just try to peel the curtain back on this a little bit. For the layman - ow are arable prices set when you grow your wheat and your barley? How and when do you know what you're going to get paid for it?
Kit Papworth: Okay, well, that would take up the whole podcast to explain that in full. But just in very brief terms, almost all of our major crops have a world market. And that is set on some of the major continents. So we have a UK wheat market, which follows global trends and sets them and there are various other markets around the world as well. And wheat can be traded like any other commodity, or almost anything else that you can possibly want to buy and sell.
And so we just trade it over a very broad window. So I can currently sell the wheat I haven't put in the ground yet - for a price - but I need to be very careful not to sell wheat that I don't think I have, because markets can be very volatile. And generally the markets are driven by factors outside of our control. So as we speak, the markets are on a slightly unusual high, because of the unrest in the Ukraine and Russia that would on the face of it appear to have nothing to do with wheat production in Norfolk, but it's having quite a big effect on the price of wheat before harvest this year, and a little bit of an effect on the price of wheat after harvest. So those markets are quite long. We can sell wheat over a big period of time, but they're influenced by a lot of different things. And I can sell at any point but lots of farmers choose not to do that.
Florin Ritzmann: So it sounds a bit like stock trading, selling things you don't own. That's a bit like short selling, isn't it?
Kit Papworth: That's the irony; so very, very rarely the farmers ever sell anything they don't own. So most farmers wait until they have they have their own grain before they sell anything at all.
Florian Ritzmann: Some fascinating insights from kit already - when we go back to the chat, it's still Kit, don't worry. It's only the audio that changes.
Kit Papworth: Most farmers will wait until after harvest before they sell what they've grown so they know what they've got. Rather than speculate what they might achieve because yields can be very variable as well as price.
Florian Ritzmann: It's a bit of a stock market out there. Most farmers do it the traditional way they grow it first before they sell it. Right now you're saying because of the situation in the world prices are high. But let's just assume prices are not high, prices were bad. And if you were to sell today, do you have any levers available to influence the price? Or are you always completely at the mercy of whatever that stock market tells you your wheat is worth?
Kit Papworth: So in the commodity market, so wheat, barley, oilseed rape, and sugar, so they are the major markets in which we trade, I have very, very little influence, I would say almost no influence on the market itself, farmers collectively have, but that is across the world. And farmers are very good at responding to the market. But it takes a very long time for them to do so. So I have very little influence on my base price. So if the price of wheat was say a 150 pounds a ton, I either take it, or I choose to wait and see if it will go up or down.
What I can do is potentially grow a premium crop. So I can get a premium over the base price. But that comes with additional costs, and probably additional complexity, which may not be worth it for my business. So the base price is pretty much set by the market and is determined by global markets. But I I can do other things which add on top of the global market.
“So I I think I have virtually no power within the market. Farmers have always been described as price takers in a marketplace that is set by others.”
Florian Ritzmann: So you would probably then agree with me that you don't consider yourself as having a lot of pricing power in the market that you operate in?
Kit Papworth: None at all. No. So I I think I have virtually no power within the market. Farmers have always been described as price takers in a marketplace that is set by others.
Florian Ritzmann: And so just go a little bit deeper on the sort of levers that are available - arable farmers perhaps have one lever, which is to store the grain and wait for markets to get better. Do you do that a lot?
Kit Papworth: Yes. So on our cereals side, we store almost all of our grain with some exceptions, which we might touch on later. And our oil seed rape, we store almost all of that as well, but in a different way. Because storing oil seed rape is a specialist job. We would aim to store and try - and this is partly about cashflow, it is partly about management of price because we don't want to necessarily sell the day we combine it or very soon after combining and also that money has been tied up for a very, very long time. So we need to be very careful that we don't just extend the amount of time that we're waiting to get the money back. You know, often the timescale of a crop can can be sort of 30-odd months, when we first start spending money on that crop right through to actually receive money back in our bank,
Florian Ritzmann: No real pricing power, but perhaps some some wiggle room when it comes to waiting out the market, which livestock farmers, well I know for a fact they don't have that as a tool. But let's stick with arable for the moment. It's a very specific question coming up now, which is that one thing that I find quite - being relatively new to the farming industry - quite striking is the role of big distributors in this market.
So there's maybe three or four distributors selling chemicals, fertiliser, but from what I understand they also act as grain traders. And I was wondering to what extent their role as grain traders - does it empower you? Does it help you with cash flow? If you buy your inputs from a distributor and then sell the same crop back to the distributor? Is it something that you do? Is it something that is good?
I find that rather strange, for me I imagine imagine Volkswagen buying a lot of steel and then selling the cars back to the steel company, instead of selling the cars themselves. It's just an odd thing for me to compute. So I'm waffling on, but what is the role of the big distributors in this whole price taking and setting market?
Kit Papworth: Okay, so the reason farmers are price takers is because we are very, very small players in the marketplace. And one of the other levers we could potentially pull is to work together, in in a cooperative sector or in in some sort of pooling system. The pooling systems and a lot of the purchases tend to occur through as you say, smaller and smaller numbers of merchants and then we purchase our seeds, fertiliser and agrochemicals through most of those same companies
There are models by which you buy those inputs and don't pay for them and then you sell your grain to that company and you get paid out for what's left at the end but that'd be quite an unusual model for most farmers in the UK, most farmers probably prefer to pay as they go along either through a Cooperative Purchasing Group or just direct through that supply company, and then they would sell their grain to whoever they feel has given them the best price.
But you're quite right in saying that in the wider world, that's quite an unusual model, because you are effectively running with the hare and hunting with the hounds. But farmers are so weak in this marketplace, unless they actually collaborate in both purchasing and sales that, you know, even a very big farm has very little power in the market.
“ ...you are effectively running with the hare and hunting with the hounds. But farmers are so weak in this marketplace, unless they actually collaborate in both purchasing and sales, you know, even a very big farm has very little power in the market.”
Florian Ritzmann: So I guess that particular model would be quite attractive, at least at first look, for a smaller farmer, right, with perhaps bigger cash flow issues? Say I'll take my seed from you, and then I'll sell my output to you. And I'll take the cut in margins - is this more of a problem for smaller farmers or do you generally not see this as a big issue?
Kit Papworth: The reason the model hasn't really developed is because fundamentally, up until the last couple of years, producing food and unless you are very much on top of your costs, and on making an exceptional job of sales, has not been that profitable. And so it's very transparent in that type of model how little money you're actually making, whereas most farmers tend to try and purchase through their purchasing group or through their supplier. And because the timescale is so long, it doesn't really compute how little is left at the end of it when you've added all of the costs in of your own work, and the cost of fuel, etc.
So you know there is very low margins on these, particularly if you're renting land to grow the crops, and we perhaps might come on to the economics of renting land, etc. But you know that there is very little margin left at the end of this for the guy who's actually paying for the seed at the start, and who receives the income at the end.
Florian Ritzmann: So scale seems to be the way out for farmers. But we know, I know, from experience that organising farmers as a group is not the easiest thing. But you touched the low profit margins. And I was listening to James Dyson in one of his interviews and one of the comments he made is that British farming is under-invested. Given the dynamic of high input costs, and being a price taker and not being able to charge a fair price for your product - is that the reason why James Dyson might be thinking that British farming is under-invested in - because the money is simply not there for arable farmers?
Kit Papworth: Absolutely. In very rough terms, as you highlighted in your very first question. UK farming PLC, in other words, all of the farming, all added together doesn't make as much money in a normal average year as is paid to us in subsidies, plus, the costs of effectively cleaning up after agriculture, British farming PLC doesn't make any money and therefore, very few people are investing in it.
Some people are trying to grow quickly, and sometimes with money from outside of the industry and trying to consolidate their land base into you know, a very profitable area, and others are working together with each other. And sometimes when that happens together, you can see very large farms coming together, and James Dyson would be a good example of that. He's one of the largest farmers in this country, he is investing very heavily in very good technology. And the industry will be the net net beneficiary of that, as I hope Mr. Dyson will be, too, because he is really pushing the boundary and the people who work for him.
But consolidation is very expensive and very difficult to do. And investment is, you know, very, very poor. You know, I know plenty of large businesses that won't invest in their business without significant return on capital. And you're very unlikely to see a return on capital on infrastructural spend in agriculture, you know, anything above sort of 2 or 3% - if that - whereas most people are looking at 10 or 20% return on capital. So it's quite difficult to get outside investors to invest in our industry,
“You’re very unlikely to see a return on capital on infrastructural spend in agriculture, you know, anything above sort of 2 or 3% - if that - whereas most people are looking at 10 or 20% return on capital. So it’s quite difficult to get outside investors to invest in our industry,”
Florian Ritzmann: Which I presume a lack of investment will feed a vicious circle or might be feeding a vicious circle - if a farmer can't innovate, because they don't have the money to invest in their own business. Their yields might drop, the quality of their food will have to suffer. And you get into a spiral really where. - well, it certainly can't get any better and and the subsidies might not be help. Is that fair?
Kit Papworth: That would be fair in what we would call our traditional food production. But over the last few years, there's been a sudden interest in agriculture and particularly in owning land. There are multiple reasons for that. But the current in vogue one is the thought of biodiversity, net gain and carbon trading, because farming is one of the only industries that could actually be part of the answer to our climate change problems. And because we're in control of so much land collectively, there are people prepared to invest because they think that actually whilst food production is important, reversing climate change, or at least stabilising climate change by the use of land might be equally important and might be equally profitable or more so. So that is driving land and land sales and land consolidation as much as food production is right now, despite the fact that actually there are parts of the world that are short of food and you know, our global population is still rising.
Florian Ritzmann: So that's interesting, because in our last podcast, we had Chris Hollingsworth, who's a regenerative farmer, and he is signed up with Agreena to earn carbon credits. And what came out of that conversation was that farmers will, you know, by adopting regenerative practices, which essentially sequesters carbon, which can then be turned into certificates that can be sold on the market. Well, you initially in the first two, three years, you will take a dip in yield, which means that you have to have deep pockets in order to get to the benefit at the other end of the two, three years.
So we are left with the problem that if you're not making any money to begin with from your crop, or you depend on to some extent, your distributor, perhaps and you certainly depend on subsidies, how much leeway does the average farmer really have to make those changes to go into carbon, into regenerative farming or whatever it takes to earn these carbon credits? A bit of an open question, but perhaps you have a comment?
“You’ll either farm for improvement in soil and carbon or you will farm for the marketplace. And personally, I don’t see a lot of crossover in there.”
Kit Papworth: Yeah, absolutely. So farmers have been extremely adept over the last few years at, you know, cutting costs and reducing, working together, etc. And the consolidation has happened gradually, over many, many years of the number of active farmers, the number of people who own the land is relatively stable, but more and more people are coming to people like ourselves and saying: Would you help us to farm our farm or part of it. And so that consolidation is occurring, but not as far as as it occurs in the merchant sector, where as you rightly said, at the start, we've got four or five people and who sell the majority of the inputs and purchase majority of the grains. However, we have been propped up over the last few years by subsidy. And that's virtually held the industry together.
Now, in the UK, that subsidy system is about to change very, very significantly, and we're not going to receive an area-based payments where we were being paid per hectare. So the people who own the land got paid an area-based payment by the government, formally by the EU, via the government.
And now we're going to receive what's called public money for public good, in other words, for improving the environment, improving our soils, etc. And that will be a huge driver in the dynamic of land use, particularly in eastern counties, where people will look at regenerative agriculture and one of the benefits of that could be more carbon being sequestered. And we might then think about it. But this won't be a choice. And between doing a bit or not, you'll either farm for improvement in soil and carbon or you will farm for the marketplace. And personally, I don't see a lot of crossover in there.
Florian Ritzmann: It's interesting that even on this call, in this conversation, we came back to regenerative farming. There seems to be something to it.
Kit Papworth: There's something to it, because because the government are fully on board with this. It started with Michael Gove after we left the EU when he was agriculture minister, you know, it has continued on and we now start to know some of the details - we're a long way from knowing all the details - so some of the details of what our future support systems look like, most agriculture can't manage without a support system. So it is left with very little choice unless you go in with very high value crops. But to follow that - that money is directing us towards, you know, regenerative farming type systems, albeit probably not a you know, fully embracing of a no till agriculture across the piece. But yeah, definitely down that road.
Florian Ritzmann: To round off this conversation, which has been extremely insightful - we touched on this at the beginning, we're talking about the distributors, the merchants, and the high, the very high cost of input prices right now. And just like to ask you, when we put fertiliser on the shelves yesterday at 732 pounds and just a year ago, that would have seemed like outlandish, right. And it still feels weird today to be touting that as a good deal, which clearly it isn't. But…
Kit Papworth: …it probably is a good deal today. But a year ago, those prices would have been unheard of. And if you'd asked any farmer that I know, they would have said I'd never paid that much. But they frankly don't have a choice.
Florian Ritzmann: They don’t have a choice. We spoken to farmers back in November, who were saying yeah, we'll just wait and it'll come down and it hasn't. And so I was just wondering, what do you think the scenario is? If you are that cash strapped farmer, that stereotype that I'm kind of stressing here? Are you going to be buying much less and using it smarter and growing less and accept that? What does this mean for our food security, and for the profitability of farming in the next six months? Does anyone know? Do you have an idea?
Kit Papworth: So the profitability is driven by number of factors and nitrogen is our most efficient input. So once we drilled the crop, once the crop is in the ground, once the seed is growing, nitrogen is our most efficient input. And so we need to use use that efficiently. And because we don't know what our sale price is, we are effectively taking a gamble on what we think our margin might be. But at the moment this could change depending on what happens in Ukraine and lots of other places as well. At the moment, it looks like we will probably be reducing our nitrogen inputs by about 10%, this will probably reduce yield. But that's hugely dependent on weather, on climatic conditions around the world, and on the geopolitical situation. So at the moment, if the wheat price goes to 250, I might not even cut back on nitrogen, you know, because this is still is a very efficient input. And all of these things are up for review between now and the end of April. So yeah, at the moment, I think there will be less nitrogen and therefore there will be less, there will be a slightly lower yield, probably. But the big, the big impact on in this area is water. But once we put the nitrogen on the crop, drought is our biggest yield influence.
Florian Ritzmann: Okay, so in our crystal ball we see a slight drop in yield, and a reduced use of more expensive inputs. From a consumer point of view, we should be expecting food prices to rise strongly this year. Is that fair?
“Yield might be lower, I think it’s unlikely to really hit us hard in our weekly shop compared to other factors.”
Kit Papworth: Sadly, it doesn't work like that, because all of the things that I grow, with the exception of potatoes, require so much processing between leaving my farm gate and arriving with the consumer, that the raw ingredient that I'm growing is such a tiny factor in the thing that you buy as a consumer, that actually, that is the least of your worries, compared to all of the other factors, including labour, including fuel, etc, that go to make up the item.
So if we, for example, pick an individual loaf of bread, the actual value of the wheat might go up by five pounds, 10 pounds because of the drop of yield. But if we go to war, the price of wheat probably go up 50 quid. And therefore the value of the wheat in the loaf might go up three p perhaps two p or the price of malting barley and your beer or your whiskey is such a tiny factor compared to wage inflation, fuel inflation, etc. So whilst I think yield might be lower, I think it's unlikely to really hit us hard in our weekly shop compared to other factors.
Florian Ritzmann: I guess that's some good news that we, as consumers, won't complain about. So on balance, then rising input prices can be balanced by a rise - you said 250 pounds - for your wheat. If you achieve that - and it helps that you're used to gambling, you're a farmer, you gamble every day.
So you're not chucking it in yet. You're going to keep growing and feeding Britain?
Kit Papworth
I'm planning to be a farmer for a while yet. Yes, definitely.
Florian Ritzmann: That's great. Well, that's been really, really interesting. Thank you very much. And in summary, I guess what comes through quite clearly is that you you are in a way hostage to the market when it comes to making a profit. And I might be overstepping my boundaries here, but subsidies are here to stay; they might change in terms of shape and structure, but without them there is not going to be UK agriculture. Is that a fair assessment?
“We’ve gone from tonnage based payments to area based payments, we’re now going to environmental based payments, and farmers will respond to that. ”
Kit Papworth: I think the UK Government has guaranteed the same budget for for agriculture. And I think it's highly unlikely that we will see a change to that right now. Yet, as you say, they will change and farmers are extremely good at adapting to what that new new environment looks like with their subsidies. We've gone from tonnage based payments to area based payments, we're now going to environmental based payments, and farmers will respond to that.
But they also respond to very high prices. As we're seeing at the moment. If prices drop away. I think you'll see a great uptake in those schemes where if prices continue to rise with rape at 600 pounds. I think farmers are very, very good at reacting to that market, but it's a very slow process.
“Farming profits will continue to depend on subsidies but by moving to an environmentally based scheme we may trigger investments that otherwise might not be available. And I want to be an optimist like Kit and hope that this money, if it materialises, will contribute to making the business of farming itself more profitable. ”
Florian Ritzmann: So here are my takeaways:
The first one is that Kit Papworth’s optimism is infectious.
Next, we can decisively conclude that arable farmers are 100% price takers. Kit can to some extent try to wait out the world market for a better price, but cashflow considerations limit his room for manoeuvre.
And that leaves me with the final point – farming profits will continue to depend on subsidies but by moving to an environmentally based scheme we may trigger investments that otherwise might not be available. And I want to be an optimist like Kit and hope that this money, if it materialises, will contribute to making the business of farming itself more profitable.
