Econ 337, Spring 2012 ECON 337: Agricultural Marketing Chad Hart Assistant Professor

Econ 337, Spring 2012 Today’s Topic Farm Programs

Econ 337, Spring 2012 Direct Payments Payments that provide income support to farmers “Fixed” – do not change with agricultural conditions “Decoupled” – do not change with individual decisions

Econ 337, Spring 2012 Direct Payment Base Payments are based on historical acreage and yields Payment rate is set by law Producers know the exact amount they will receive each year

Econ 337, Spring 2012 Direct Payment Rates CropUnit Corn$/bu.0.28 Soybeans$/bu.0.44 Barley$/bu.0.24 Wheat$/bu.0.52 Oats$/bu Cotton$/lb Sorghum$/bu.0.35

Econ 337, Spring 2012 Direct Payment Example Direct Payment = 83.3% * Payment Acreage * Direct Payment Yield * Direct Payment Rate $27.08 = 83.3% * bu/ac * $0.28/bu

Econ 337, Spring 2012 Price Countercyclical Payments Payments that provide income support to farmers “Price Countercyclical” – payment rate changes with season average commodity price

Econ 337, Spring 2012 Countercyclical Payment Base Payments are based on historical acreage and yields Payment rate changes with price Producers do not know the exact amount they will receive each year

Econ 337, Spring 2012 Target Prices CropUnit Corn$/bu.2.63 Soybeans$/bu Barley$/bu Wheat$/bu Oats$/bu Cotton$/lb Sorghum$/bu

Econ 337, Spring 2012 Loan Rates CropUnit Corn$/bu.1.95 Soybeans$/bu.5.00 Barley$/bu Wheat$/bu Oats$/bu Cotton$/lb.0.52 Sorghum$/bu.1.95

Econ 337, Spring 2012 Countercyclical Payment Rate Countercyclical Payment Rate = Max(0, Target Price – Direct Payment Rate – Max(National Loan Rate, National Season Average Price)) Target Price, Direct Payment Rate, and National Loan Rate are set by Congress

Econ 337, Spring 2012 Countercyclical Payment Rate Countercyclical Payment Rate = Max(0, Target Price – Direct Payment Rate – Max(National Loan Rate, National Season Average Price)) $0.29 = Max(0, $2.63 – $0.28 – Max($1.95, $2.06))

Econ 337, Spring 2012 Countercyclical Payment Example Countercyclical Payment = 83.3% * Payment Acreage * Countercyclical Payment Yield * Countercyclical Payment Rate $29.52 = 83.3% * bu/ac * $0.29/bu

Econ 337, Spring 2012 Countercyclical Payments

Econ 337, Spring 2012 Marketing Loan Program Government program meant to provide cash flow support during the marketing year Loans are nonrecourse, this means that the crop can be used as payment for the loan Available for over 20 commodities

Econ 337, Spring 2012 Loan Rates CropUnit Corn$/bu.1.95 Soybeans$/bu.5.00 Barley$/bu Wheat$/bu Oats$/bu Cotton$/lb.0.52 Sorghum$/bu.1.95

Econ 337, Spring 2012 Marketing Loans and LDPs The program sets rates at the county level by crop Eligible production may either be put under loan or have a loan deficiency payment (LDP) taken on it The amount of the loan or LDP depends on the quantity you wish to use in the program

Econ 337, Spring 2012 Marketing Loans and LDPs The program is based on the county in which you will store your crop, not the county in which you produce the crop There may be advantages to growing the crop in one county and storing in another

Econ 337, Spring 2012 Marketing Loans Loans are for 9 months, but can be redeemed at any time To pay back the loan, you may either forfeit the crop as payment or pay an amount set by the minimum of the posted county price (PCP) or the loan rate plus interest Possible to pay back the loan at less than face value

Econ 337, Spring 2012 Posted County Prices (PCP) Estimate of local market prices Usually based on 2 terminal markets, takes the higher price Terminal prices are adjusted for transportation costs and other factors

Econ 337, Spring 2012 PCP Calculation Example: Story County, Iowa, Corn 11/10/05 PCP = $1.40

Econ 337, Spring 2012 Loan Deficiency Payments (LDP) Alternative to taking the loan Works like taking the loan and paying it back the same day Can not take the loan and LDP on the same quantity If the PCP is greater than the loan rate, then you can only take the loan

Econ 337, Spring 2012 LDP Calculation Example: Story County, Iowa, Corn 11/10/05

Econ 337, Spring 2012 Loan vs. LDP The loan is like a free put option at the loan rate The loan protects you against downside price movements, but costs you interest if prices exceed the loan rate The LDP exposes you to downside price movements, but there are no interest charges

Econ 337, Spring 2012 Loan vs. LDP

Econ 337, Spring 2012 Average Crop Revenue Election (ACRE)  ACRE is a revenue-based counter-cyclical payment program  Based on state and farm-level yields per planted acre and national prices  Producers choose between the current price- based counter-cyclical payment (CCP) program and ACRE  Program has state and farm trigger levels, both must be met before payments are made

Econ 337, Spring 2012 Farmer Choice  Starting in 2009, producers were given the option of choosing ACRE or not  Could choose to start ACRE in 2009, 2010, or beyond  Once you’re in ACRE, you stay in ACRE until the next farm bill  If you sign up for ACRE, you must do so for all eligible crops  Producers choosing ACRE agree to 20% decline in direct payments and 30% decline in loan rates

Econ 337, Spring 2012 ACRE Settings  ACRE is based on planted acres  Total acres eligible for ACRE payments limited to total number of base acres on the farm  Farmers may choose which planted acres are enrolled in ACRE when total base area is exceeded

Econ 337, Spring 2012 ACRE Set-up for Iowa Corn in 2009 YearYield per Planted Acre (bu./acre) Olympic Average171 YearSeason-average Price ($/bu.) Average4.13 So the expected state yield would be 171 bushels per acre and the ACRE price guarantee would be $4.13 per bushel.

Econ 337, Spring 2012 ACRE Structure  ACRE revenue guarantee = 90% * ACRE price guarantee * Expected state yield  For Iowa corn in 2009, the ACRE revenue guarantee is 90% * $4.13/bu. * 171 bu./acre  $635.61/acre

Econ 337, Spring 2012 Beyond 2009  The ACRE revenue guarantee is updated each year using the same rules  5 year Olympic average for yields  2 year average for prices  But the ACRE revenue guarantee can not change by more than 10 percent (up or down) from year to year

Econ 337, Spring 2012 ACRE Guarantees YearPriceYieldInitial Guarantee Allowed RangeActual Guarantee LowHigh ($/bu)(bu/acre)($ per acre)

Econ 337, Spring 2012 ACRE Structure  ACRE Farm revenue trigger = Expected farm yield * ACRE price guarantee + Producer-paid crop insurance premium  Let’s assume farm yields equal to state yields and use the average producer-paid crop insurance premium for 2011  171 bu./acre * $5.69/bu. + $24.23/acre  $997.22/acre

Econ 337, Spring 2012 ACRE Payment Triggers  ACRE actual state/farm revenue = Max(Season-average price, ACRE Loan rate) * Actual state/farm yield per planted acre  Given our example, ACRE payments are triggered when ACRE actual revenue is below $709.50/acre and ACRE actual farm revenue is below $997.22/acre

Econ 337, Spring 2012 ACRE Payments  Payment rate = Min(ACRE revenue guarantee – ACRE actual revenue, 25% * ACRE revenue guarantee)  ACRE payment adjustment: Payment multiplied by ratio of Expected farm yield to Expected state yield  Payments made on 83.3% of planted acres in , 85% in 2012 (up to total base acres)

Econ 337, Spring 2012 ACRE Payment Timing  Payments can begin as soon as practicable possible after the end of the marketing year  So 2012 ACRE payments could start to be paid out in October 2013  There are no provisions for advance payments

Econ 337, Spring 2012 ACRE vs. CCP ACRE pays out No ACRE payments CCP pays No CCP payments If price = $6.00, yields below 118 bushels per acre will trigger a payment. If price = $4.00, yields below 177 bushels per acre will trigger a payment.

Econ 337, Spring 2012 An Example for 2012  To start, we need the expected state and farm yields and the ACRE price guarantee  Expected state yield 171 bu/acre  Expected farm yield 160 bu/acre  Olympic average of yields per planted acre  ACRE price guarantee$5.69/bu  Average of 2010 and 2011 season-average prices  ACRE Revenue Guarantee$  ACRE Farm Revenue Guarantee$  $5.69 * 160 bu/acre + $24.23/acre

Econ 337, Spring 2012 Example (continued)  For 2012, we need the actual state yield, the actual farm yield, and the season-average price  Actual state yield 140 bu/acre  Actual farm yield 155 bu/acre  Season-Average Price$5.00/bu  ACRE Actual Revenue$  $5.00/bu * 140 bu/acre  ACRE Farm Actual Revenue$  $5.00/bu * 155 bu/acre

Econ 337, Spring 2012 Example (continued)  State Trigger  ACRE Revenue Guarantee$  ACRE Actual Revenue$  So we’ve met the state trigger  Farm Trigger  ACRE Farm Revenue Guarantee$  ACRE Farm Actual Revenue$  So we’ve met the farm trigger

Econ 337, Spring 2012 Example (continued)  ACRE Payment$7.40  Min(25%*$709.50, $ – $700.00) * (160 bu/acre / 171 bu/acre) * 83.3%

Econ 337, Spring 2012 Farmer’s Choice  In deciding about ACRE, farmers must weigh:  The loss of 20% of their direct payments, a 30% drop in the marketing loan rate, and no access to CCP payments versus  The potential for payments under ACRE

Econ 337, Spring 2012 Comparing Program Parameters  For Iowa Corn  Under the current CCP program  CCP Yield Average = bushels per acre  CCP Effective Target Price = $2.35/bushel  In our example, for ACRE  ACRE Yield Guarantee = 171 bushels per acre  ACRE Price Guarantee = $5.69/bushel  20% of average Iowa corn direct payment = $6.50 per acre

Econ 337, Spring 2012 Factors to Consider  ACRE looks more attractive if:  You think prices will fall in the future, but stay above the current loan rates  Markets continue to show higher price volatilities  Current programs look more attractive if:  You think prices will rise in the future  Potentially no ACRE payments combined with cut in direct payments

Econ 337, Spring 2012 Quick Comparison (Your results may vary) Source: William Edwards, ISU Extension Analysis for 2009

Econ 337, Spring 2012 Summary of Programs  Direct payments – Crop-specific income support  Counter-cyclical payments – Crop-specific price support  Marketing loans – Crop-specific price support  ACRE – Crop-specific revenue support  SURE – Whole-farm revenue support

Econ 337, Spring Senate Proposal  Just came out last week  Eliminates direct payments, countercyclical payments, and the ACRE program  Keeps marketing loan program  Creates the Ag. Risk Coverage program

Econ 337, Spring 2012 ACR instead of ACRE  Revenue-based support program  Farmer chooses county or farm-based guarantee  Choice determines the % of land covered by the program

Econ 337, Spring 2012 ARC Guarantees  Based on 5-year Olympic averages of price and yield  Price is national season-average price  Yield is farm yield for farm-based coverage and county yield for county-based coverage  Yield is per planted acre  Guarantee = 89% * Ave. Price * Ave. Yield

Econ 337, Spring 2012 ARC Set-up for Corn in 2013 Yield per Planted Acre YearFarm (bu./acre) County (bu./acre) Season-Average Price ($/bu.) Olympic Average So the farm and county yields would be 164 bushels per acre and the ACR price would be $4.75 per bushel.

Econ 337, Spring 2012 ARC Guarantees  Benchmark Revenue = $779.00/acre 164 bu/acre * $4.75/bu.  In this case, the farm-based guarantee equals the county-based guarantee 89% * $779.00/acre = $693.31/acre  Payments are triggered when actual revenues fall below this level

Econ 337, Spring 2012 ARC Actual Revenues  Price is set at the higher of the crop loan rate or the mid-season price  Loan rate for corn is $1.95/bu.  Mid-season price is the average price over the 1 st 5 months of the marketing year

Econ 337, Spring 2012 ARC Actual Revenues  Yield is the actual yield per planted acre  Farm-based option uses actual farm yield  County-based option uses actual county yield  Actual Revenue = Price * Yield

Econ 337, Spring 2012 ARC Payment Rate  Payment Rate = Minimum of 10% of Benchmark Revenue or ARC Actual Revenue – ARC Guarantee  In my case, the maximum payment rate is $77.90/acre (10% of Benchmark Revenue)

Econ 337, Spring 2012 ARC Acreage  Program is based on planted and prevented planted acres, but doesn’t pay on all of them  Acreage limit = average of plantings (and prevented plantings)  Treats planted and prevented planted acres differently

Econ 337, Spring 2012 ARC Acreage  For farm-based option, you get paid on 60% of your planted acres and 45% of your prevented planting acres  For county-based option, you get paid on 75% of your planted acres and 45% of your prevented planting acres

Econ 337, Spring 2012 ARC Payout Graph ARC pays out No ARC payments

Econ 337, Spring 2012 Factors to Consider  Farm-based guarantee could be higher or lower than county-based guarantee  Farm-based option is generally more likely to pay out, but you get payments on 15% less acres  County-based option might not trigger when farm has a loss

Econ 337, Spring 2012 Not the Last Word on the 2012 Farm Bill  Senate proposal is just the start of the process  There will likely be several changes/modifications  ARC may or may not be in the final farm bill  But now we know the starting point for negotiations

Econ 337, Spring 2012 Class web site: Spring2012/ Have a great weekend!