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By Ben Johnston, COO of Kapitus
Iran Conflict:
The war with Iran has effectively closed the Strait of Hormuz and forced producers in the Gulf region to begin shutting down oil and gas production, actions that cannot be quickly reversed. Given that approximately 20% of the world’s oil production must travel through the Strait of Hormuz in order to reach farmers, as well as businesses and consumers, it is likely that this disruption will be significant, and last for weeks or months, depending on the duration of hostilities and the time it takes to reestablish production and a working supply chain once the war is over.
In addition to oil and gas, Gulf states also export a range of products critical to global agriculture and manufacturing such as fertilizer that is critical for maintaining crop yields around the world.
The agriculture industry is highly exposed given the diesel-powered heavy machinery used in production, the distribution costs required for products to reach consumers, and the fertilizer required to maintain crop yields.
Other Economic Factors (inflation, tariffs and consumer spending):
Rising oil prices are yet another shock to operating margins that farmers and other agriculture businesses need to contend with. Almost a year ago, these businesses were contemplating the impact of “Liberation Day” tariffs imposed on nearly all of our trading partners. Over the course of the year, many have learned how to navigate these tariffs, altering supply chains and production as much as possible in an effort to avoid the tariff’s most painful effects. It seems unlikely that farmers will see tariff relief any time soon, given the Trump Administration’s aggressive response to the Supreme Court’s decision, in which he promised to maintain or increase tariffs using other sections of the Trade Act of 1974. The President promised to immediately implement a 15% tariff on all countries using Section 122 of the Act and committed to use Section 301 of the Act to open investigations into the unfair trading practices of other nations, which could result in additional tariffs. The end result is continued volatility in U.S. trade policy without material relief from tariffs in the short term.
At the same time, farmers grappled with improving, yet stubbornly high, inflation and interest rates which combined to further reduce margins. Today, with oil climbing above $100 per barrel, small businesses are once again grappling with the impact of an unforeseen expense and agonizing over whether to pass these increased costs on to an already stretched customer base. We expect that farmers will likely delay raising prices as long as possible – similarly to when tariffs were first introduced – but that they will ultimately need to pass these expenses on to customers should prices remain elevated for several months.
The uncertainty caused by a sudden spike in oil prices and the lack of clarity as to the severity and duration of the spike will likely cause many farmers to retrench, holding off on starting new projects, taking on new hires, and investing in the growth of the business, until the picture becomes clearer. Given the importance of farming to the U.S. economy, this could have a significantly negative impact on the unemployment rate and overall GDP growth.
Farm/agriculture revenue is made up primarily of consumer spending. Rising oil prices hit consumers directly by increasing non-discretionary spending like the cost to drive to work and heat one’s home. As a result, consumers cut back on the discretionary spending that small businesses rely on, thereby reducing cashflow and financial health.
On the Positive Side:
The U.S. has a robust oil and gas industry which employs many small businesses involved in both upstream and downstream production. These businesses will benefit from higher prices which, if sustained for a long enough period of time, make additional oil and gas projects economically viable. It is also important to note that as the largest oil and gas producer in the world, the United States is less exposed to economic disruption than many other developed economies, especially those in Europe and Asia. As a result, it is likely that fuel costs will rise higher and faster in parts of the world where we are currently levying tariffs with the goal of driving production back to the United States. If U.S. oil prices become a relative advantage to U.S. businesses, it may serve to speed the repatriation of manufacturing back to the U.S. during this period of instability.
What Farmers Can Do To Navigate the Current Economy:
Over the past several years, farmers have become all too adept at managing through crises. Many have learned the hard way the importance of keeping a close eye on margins, managing supply chains and cost of goods sold, and developing products that appeal to cost conscious consumers. Successful businesses today maintain options in their supply chain, their headcount, and in their access to capital. Many farmers today are investing in automation as a way to reduce dependency on human capital.
Successful farming also maintain multiple financial relationships capable of providing working capital to fund growth. Many also finance equipment purchases and maintain revolving lines of credit to manage the volatility of cashflows month to month. It is important for farmers to maintain both bank and non-bank relationships to ensure access to a full suite of financial products.
However, uncertainty in the economy leads to higher lending prices. If higher oil prices lead to reduced business margins, the market will react by demanding higher rates to compensate for an increase in risk.
Editor’s Note: Kapitus is a small business lender and marketplace that provides business loans, lines of credit and SBA loans. Visit kapitus.com for more information.