No. 102 - Greenhouse Gas Control: Implications for Agriculture (Part 3)

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Farmers are being lured into endorsing greenhouse gas reduction programs by the promise of being paid to store more carbon in their soil, but this carrot has strings attached. Rewards for carbon sequestration would be part of a comprehensive greenhouse gas control program likely to include higher energy prices, registration and verification of emissions, emissions caps and permits, and new regulations on farming practices. The costs of such rules and regulations are likely to outweigh whatever benefits farmers and foresters receive for sequestering more carbon.

Regulatory Threats to Farmers

According to EPA, agricultural activities were responsible for emitting 526 million metric tons of carbon dioxide equivalent in 2001, or 8 percent of total U.S. greenhouse gas emissions.<39> Methane (primarily from beef and dairy cattle production) and nitrous oxide (primarily from fertilizer application) are the principal greenhouse gases emitted by agricultural activities.

Agriculture’s emissions make it a target for environmental activists seeking, first, to reduce total greenhouse gas emissions in order to avoid or postpone the risk of global warming, and second, to force farmers to return to less intensive agricultural practices that produce fewer emissions (but also lower yields).<40> In 1996, the Clinton administration and liberal environmental groups circulated a list of nine types of regulations affecting agriculture and forestry the administration was said to be considering to reduce greenhouse gas emissions. They were:

• Stricter fuel economy requirements

• Reduction or phase out of the use of diesel fuel

• Limitations on production per acre for some crops

• Requirements for no-till soil preparation

• Mandatory fallowing of crop land

• Limits and restrictions on livestock production to reduce methane emissions

• Restrictions on the use of fertilizer

• Restrictions on timber harvesting

• Restrictions on processing, manufacturing, and transporting food products

Any one of these policies could impose a significant cost on individual farmers and ranchers. Aggressive pursuit of several items on this list would have serious negative economic consequences for the entire industry. If this list represents the agenda of groups that favor greenhouse gas control programs, then farmers should hesitate to join the “global warming coalition.” Their would-be allies are waving carrots at them, but hiding sticks.

This list deserves attention because voluntary programs often become mandatory programs, and programs that are narrowly focused (on sequestration, for example) often become more expansive over time. The list, then, could represent the price farmers would eventually have to pay for endorsing biological carbon sequestration schemes. It would be a high price indeed.

Higher Energy Costs

Agricultural production in the U.S. is an energy-intensive process, so higher energy costs have a direct and negative effect on the industry. Fuel and oil costs account for only about 30 percent of a typical farm’s total energy bill, while the remaining 70 percent lies hidden in the prices of manufactured inputs, fertilizer, and pesticides. For example, natural gas typically accounts for 75 percent of the cash cost of manufacturing anhydrous ammonia, a basic feedstock for all nitrogen fertilizer products. Energy accounts for half or more of the underlying cash production costs for nearly all of a farm’s manufactured inputs.

In 1995, DRI/McGraw-Hill estimated the equivalent of a 60 cents per gallon tax on gasoline would be required to reduce emissions to their 1990 levels by the year 2010.<41> WEFA’s more recent analysis puts the necessary tax at 68 cents per gallon.<42> The Clinton administration had claimed a tax hike equivalent to just 25 cents per gallon of gasoline would be sufficient to reduce energy consumption to 1990 levels.<43> The administration’s methodology assumed a highly efficient international emission trading regime and an economic boost from shifting taxes away from capital.<44> Both assumptions have been criticized and rejected by independent researchers,<45> but to avoid debate the Clinton administration’s estimate of 25 cents per gallon can be used as a low estimate and 50 cents per gallon as a more likely estimate of the higher energy prices required to reduce carbon emissions to 7 percent below 1990 levels.

Impact of Higher Energy Costs on Farmers

We have calculated the average expected cost increase per acre and the likely effect on the average farmer’s profits of a 25 cents-per-gallon and a 50 cents-per-gallon tax on gasoline.<46> We then estimated the likely effects of these energy taxes on agriculture as an industry.

Four representative field crops--wheat, soybeans, corn, and cotton--were chosen for the first analysis. Some commodity production is very energy intensive, while other commodities are less affected by changes in energy prices. For example, corn and cotton crops use a lot of nitrogen fertilizer and pesticides, products very sensitive to changes in energy prices. Wheat and soybean production, by contrast, is less energy intensive and thus less sensitive to changes in energy costs.

The impact of higher energy prices on agricultural inputs is calculated first. Since some inputs are more energy intensive than others, an increase in energy prices raises the price of some inputs more than others. Using farm production cost data from the Economic Research Service of the U.S. Department of Agriculture, we arrived at the estimates shown in Table 2.

Table 3, on the following page, shows the impact of higher-cost inputs on the per-acre cost of producing four major crops. The baseline year is 2003. In the case of corn, we see the average variable cash cost in 2003 was $163.04 per acre. A 25 cents-per-gallon tax on gasoline (or an equivalent energy price increase) raises the cost per acre to $185.76. A 50 cents-per-gallon tax raises the cost to $208.47.

Table 3 also shows the effects of higher energy prices on farmer net profits.<47> Looking once more at corn production, we see average profit after variable costs is estimated to be $154.84 per acre. Adoption of a 25 cents-per-gallon tax on gasoline would reduce net profit to $132.10 per acre, and a 50 cents-per-gallon tax would lower net profit to $109.41.

Although the percentage change in costs and profits for the six agricultural products is also reported in Table 3, we report those figures separately in Table 4 for easier interpretation by the reader.

The average farmer would see his or her operating expenses increase by between 10.9 percent (for soybeans) and 13.9 percent (for corn) if gasoline taxes are raised by 25 cents per gallon. A 50 cents-per-gallon price increase would increase expenses by between 21.8 percent (again for soybeans) and 27.9 percent (again for corn).

Although in percentage terms the change in operating expenses is nearly the same for the four field crops, when viewed in dollar terms there is a much greater difference. Under the 25 cents-per-gallon tax scenario, total variable cash expenses for wheat increase by only $7.84 per acre, whereas expenses for cotton increase almost $34 per acre. A similar increase occurs when gasoline taxes are hiked by 50 cents.

Turning to net profit, the 25 cents-per-gallon tax would reduce net profits by 7.5 percent (for soybeans) or as much as 23.7 percent (for cotton). A 50 cents-per-gallon tax reduces net profits on soybean production by 15.0 percent and net profits on cotton by 44.7 percent, or nearly by half.

It should be noted that in all cases the gross value of production or price received by farmers is based on the 2003 year. Commodity prices vary from year to year. For example, cotton prices were substantially lower in 2002, so that the higher variable cash expenses would have exacerbated the losses producers were already experiencing.

Looking at costs per acre produces a farmer’s eye view of what would happen if a national greenhouse gas control program were approved. The view is of great concern. The average farmer could see profits before fixed costs fall by about 15 percent if gasoline taxes were raised by 25 cents a gallon--the minimum amount of increase required to meet the requirements of the Kyoto Protocol. If taxes on gasoline were raised by 50 cents a gallon, as is more likely the case, the average farmer loses about 30 percent of his net profits.

Keep in mind these projections are for a national greenhouse gas control program. State programs, because they cannot exploit lowest-cost opportunities or make use of market-based regulatory approaches, would typically be 10 times as expensive. Obviously, this could cause much greater losses to farmers.

Impact on the Agricultural Sector

Table 5, on the next page, presents the results of a “macro” analysis of the effects of higher energy taxes on the agricultural sector. Whereas the previous analysis may be of most interest to individual farmers and ranchers, this “big picture” analysis should interest people in businesses that serve as suppliers to or buyers from farmers and ranchers. What would happen to the size of your market if your state adopted a greenhouse gas control program?

The cells in the bottom right corner of Table 5 show total U.S. farm production expenses would rise by $11.6 billion if gasoline taxes were raised 25 cents a gallon, and by $23.2 billion if taxes were raised 50 cents a gallon. Those figures represent 5.6 percent and 11.5 percent, respectively, of total 2002 production expenses of $199 billion. If you are in a business that sells production inputs to farmers, those figures mean the buying power of your customers would shrink by either $12 billion or $23 billion as a result of greenhouse gas control programs.

The loss of net income to the agricultural community that would result from higher energy taxes also can be calculated. Annual U.S. net farm income averaged $45.2 billion over the past 10 years. The increased expense of a 25 cents-per-gallon gasoline tax would equal 26 percent of net farm income, while a 50 cents-per-gallon tax would equal 51 percent of net farm income. Those figures are close to the estimates we obtained through the earlier micro analysis. If you are in a business that sells finished goods to farm families, your customers would have either one-fourths or one-half as much to spend on your products if greenhouse gas control programs are implemented.

These figures reveal higher energy taxes have the potential for causing a major economic downturn in the agricultural sector that could parallel the experience of the mid-1980s. Not only would net farm income fall in the short term, but a downturn in land prices would shrink asset values and, most likely, result in another mini-depression in the farm sector. Increased production costs would reduce farm profits and farm income, invariably slowing farm loan and mortgage repayments. This scenario bodes poorly for lenders who extend credit to farmers.

Another outcome of either scenario would be the increased consolidation of agricultural production. Many small farmers, who typically have a higher average cost of production, would be forced to sell to large farmers. Young farmers just starting or those who have recently taken on increased debt to expand their operations could find themselves in an unprofitable situation that might force them to abandon agriculture. Not only would this hurt lenders, but it also would have an adverse economic impact on small towns and rural America in general.

It should be noted that Table 5 shows two categories of expenses that are expected to fall if energy prices were to rise. First is the livestock and poultry purchase category under farm-origin inputs. When farmers who feed livestock bid on the animals--calves, piglets, or chicks--their bids are predicated on the potential profit of feeding that animal. When feed prices increase they compensate by lowering their bids for these young animals. While that reduces production expenses, it also is an overall negative to gross farm revenues. For the agricultural sector as a whole, it is a net loss.

The other expense expected to fall is net rent to non-operator landlords. This, too, has some rather ominous implications. Lower rents are a reflection of the higher cost of production, which means farmers renting land will reduce their bid or the rental rate. (It may be a rather heroic assumption that this occurs in year one, but it will happen over time if higher expenses reduce profits in successive years.) Associated with this reduction is the fact that land prices in general will also come under downward pressure. So this would also be viewed as a negative impact on assets and the farm sector financial balance sheet.

Conclusion

If biological carbon sequestration is to play more than a token role in a state or national greenhouse gas program, emitters must be taxed or forced by caps to buy emission credits from farmers or firms able to reduce their own emissions. Emissions caps could prove more damaging than direct taxes: While tax increases might be absorbed, at least in part, by prospering farmers in a growing economy, emission caps work to slow economic growth in the first place, by restricting the energy consumption needed to fuel a prospering economy.

This analysis suggests energy prices would have to increase by between 25 cents and 68 cents per gallon of gasoline in order to reduce greenhouse gas emissions to 7 percent below 1990 levels by 2010. Such higher energy costs would have a significant negative impact on the U.S. agricultural sector. Farmers stand to see their net income fall by as much as 51 percent if gasoline taxes are raised by 50 cents per gallon. Even a 25 cents-per-gallon tax would likely lower net income by 26 percent. Related industries would also be hurt by declining farm revenues and profits.

NOTES TO PART 3

1 Joseph Bast is president of The Heartland Institute in Chicago; Dennis T. Avery, an agricultural economist, directs the Center for Global Food Issues at the Hudson Institute in Indianapolis; Alex Avery, a biologist, is Director of Research and Education at the Center for Global Food Issues; James L. Johnston is a senior fellow in regulatory affairs for The Heartland Institute and retired senior economist for Amoco; John Skorburg and Terry Francl are economists at the American Farm Bureau Federation. The authors would like to thank Carlos Stagnaro and David E. Wojick for their comments on early drafts of the manuscript. Any errors that remain are strictly the responsibility of the authors.

39 U.S. Environmental Protection Agency, supra note 29, page ES7.

40 Paul Hawken, Amory Lovins, and L. Hunter Lovins, Natural Capitalism (Boston, MA: Little, Brown and Company, 1999), Chapter 10, pages 190-212.

41 Lawrence M. Horwitz, The Impact of Carbon Dioxide Emission Reductions on Living Standards and Lifestyles, DRI/McGraw-Hill, September 1995.

42 Mary Novak et al., supra note 14, page 20. WEFA, DRI/McGraw-Hill, and CONSAD Research Corporation all adopted the convention of expressing the cost of complying with the Kyoto Protocol in terms of a hypothetical tax per gallon of gasoline, even though the actual policies being modeled are much more complex. This methodology allows for an apples-to-apples comparison of different studies.

43 See John J. Fialka, "Clinton Economist Defends Curbing Global Warming," The Wall Street Journal, March 5, 1998.

44 "Economic Effects of Global Climate Change Policies: Results of the Research Efforts of the Interagency Analytical Team," various drafts in May and June 1997.

45 See Ian Parry, "Revenue Recycling and the Costs of Reducing Carbon Emissions," Climate Issues Brief No. 2, Resources for the Future, June 1997; James Johnston, "Whom the Gods Would Destroy," Regulation, Winter 1998, pages 7-8.

46 The following updates research that originally appeared in Terry Francl, Richard Nadler, and Joseph Bast, "The Kyoto Protocol and U.S. Agriculture," Heartland Policy Study #87, October 1998.

47 Net profit is defined as the value of production less cash expense. This calculation does not include adjustments for changes in land values, debt, or interest, which we assume in the short term are not affected by higher energy prices.

© 2003 The Heartland Institute. Permission is granted to quote from this Heartland Policy Study, provided appropriate credit is given. Nothing in this Heartland Policy Study should be construed as reflecting the views of The Heartland Institute, nor as an attempt to aid or hinder the passage of legislation. Questions? Contact The Heartland Institute, 19 South LaSalle Street #903, Chicago, IL 60603; phone 312/377-4000; fax 312/377-5000; email think@heartland.org; Web http://www.heartland.org.