Econ 338C, Spring 2009 ECON 338C: Topics in Grain Marketing Chad Hart Assistant Professor/Grain Markets Specialist

Econ 338C, Spring 2009 Today’s Topic Government Programs With a side trip through Tuesday’s USDA Reports

Econ 338C, Spring 2009

Government Intervention in Agriculture Supply Control Conservation Price Support Risk Management Trade Promotion Food Security

Econ 338C, Spring 2009 Farm Bill Titles I. CommoditiesIX. Energy II. ConservationX. Hort. & Organic Ag. III. TradeXI. Livestock IV. NutritionXII. Crop Insurance V. CreditXIII. Commodity Futures VI. Rural DevelopmentXIV. Miscellaneous VII. ResearchXV. Trade & Taxes VIII. Forestry

Econ 338C, Spring 2009 Farm Bill Projected Spending Projected Spending $297 Billion

Econ 338C, Spring 2009 The 2008 Farm Bill  Continues many of the same programs we have currently  Direct payments  Price countercyclical payments (CCPs)  Marketing loans  CRP, EQIP, and other conservation programs  Gives producers a choice on programs  Average Crop Revenue Election (ACRE)  Sets up new permanent disaster program  Supplemental Revenue Assistance Payments Program (SURE)

Econ 338C, Spring 2009 Direct Payments Payments that provide income support to farmers “Fixed” – do not change with agricultural conditions “Decoupled” – do not change with individual decisions

Econ 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 Price Countercyclical Payments Payments that provide income support to farmers “Price Countercyclical” – payment rate changes with season average commodity price

Econ 338C, Spring 2009 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 338C, Spring 2009 Target Price Changes CropUnit Corn$/bu.2.63 Soybeans$/bu Barley$/bu Wheat$/bu Oats$/bu Cotton$/lb Sorghum$/bu

Econ 338C, Spring 2009 Loan Rate Changes CropUnit Corn$/bu.1.95 Soybeans$/bu.5.00 Barley$/bu Wheat$/bu Oats$/bu Cotton$/lb.0.52 Sorghum$/bu.1.95

Econ 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 Countercyclical Payments

Econ 338C, Spring 2009 Risks in Agriculture At planting time, agricultural producers face two major risks: Yield uncertainty  Input application, crop insurance Price uncertainty  Marketing strategies and tools

Econ 338C, Spring 2009 Government Sponsored Risk Management Programs Marketing Loan Program  Marketing Loan vs. Loan Deficiency Payments Crop Insurance  Yield vs. Revenue Insurance

Econ 338C, Spring 2009 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 338C, Spring 2009 Loan Rate Changes CropUnit Corn$/bu.1.95 Soybeans$/bu.5.00 Barley$/bu Wheat$/bu Oats$/bu Cotton$/lb.0.52 Sorghum$/bu.1.95

Econ 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 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 338C, Spring 2009 PCP Calculation Example: Story County, Iowa, Corn 11/10/05 PCP = $1.40

Econ 338C, Spring 2009 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 338C, Spring 2009 LDP Calculation Example: Story County, Iowa, Corn 11/10/05

Econ 338C, Spring 2009 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 338C, Spring 2009 Loan vs. LDP

Econ 338C, Spring 2009 Example Farm A 100 acre corn farm in Story County, Iowa Harvested 180 bushels per acre of corn (18,000 bushels) Based on market information for 11/10/05 and an expected basis of $-0.30

Econ 338C, Spring 2009 LDP and Sell You could take the LDP today and sell on the cash market Return = Cash value of the crop + LDP amount today $34,920 = $26,820 + $8,100 = ($1.49/bu + $0.45/bu) * 18,000 bu

Econ 338C, Spring 2009 LDP and Store You take the LDP today, store the crop until July, and sell on the cash market Return = Cash value of the crop in July + LDP amount today - Storage charges Most risky strategy of the three since you take on all price risk The other strategies limit downside price risk, but at a given cost

Econ 338C, Spring 2009 Revenue Dist. of LDP and Store LDP and Sell

Econ 338C, Spring 2009 Loan and Store You take the marketing loan today and store the crop until July Your return depends on prices in July If prices are below the loan rate, forfeit the crop and keep the loan Return = Loan value

Econ 338C, Spring 2009 Loan and Store If prices are above the loan rate, repay the loan and sell the crop Return = Cash value of the crop - Interest charges - Storage charges Less risky since the loan provides a revenue floor

Econ 338C, Spring 2009 Revenue Dist. of Loan and Store LDP and Sell

Econ 338C, Spring 2009 LDP, Store, and Hedge You take the LDP today, store the crop until July, hedge the cash value of the crop with the July futures contract, and sell on the cash market The hedge is constructed by selling the July futures contract today and buying it in June

Econ 338C, Spring 2009 LDP, Store, and Hedge Return = Cash value of the crop in July + LDP amount today + Return from the hedge - Storage charges This is the least risky strategy since you are locking in a narrow range of values

Econ 338C, Spring 2009 Revenue Dist. with Hedge LDP and Sell

Econ 338C, Spring 2009 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  There are still some details to be worked out about ACRE (stay tuned)

Econ 338C, Spring 2009 Farmer Choice  Starting in 2009, producers will be given the option of choosing ACRE or not  Can 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  Deadline for sign-up, June 1 of each year (Aug. 14, this year)  Producers choosing ACRE agree to 20% decline in direct payments and 30% decline in loan rates

Econ 338C, Spring 2009 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 338C, Spring 2009 Loan Rates under ACRE Corn $1.365Soybeans $3.50 Current Loan Rates Corn $1.95Soybeans $5.00

Econ 338C, Spring 2009 Average Direct Payments Per Payment Acre for Iowa CropCurrent Program ACREDifference Corn Soybeans Please note the 83.3 or 85% rule has not been yet to these payments.

Econ 338C, Spring 2009 ACRE  Program has state and farm trigger levels, both must be met before payments are made  Expected state and farm yield based on 5 year Olympic average yields per planted acre  ACRE price guarantee is the 2 year average of the national season-average price

Econ 338C, Spring 2009 ACRE Set-up for Iowa Soybeans YearYield per Planted Acre (bu./acre) Olympic Average50.5 YearSeason-average Price ($/bu.) Average9.73 The 2008 yield and price are USDA’s March 2009 estimates. So the expected state yield would be 50.5 bushels per acre and the ACRE price guarantee would be $9.73 per bushel.

Econ 338C, Spring 2009 ACRE Structure  ACRE revenue guarantee = 90% * ACRE price guarantee * Expected state yield  For our example, the ACRE revenue guarantee is 90% * $9.73/bu. * 50.5 bu./acre  $442.23/acre  ACRE actual revenue = Max(Season- average price, Loan rate) * Actual state yield per planted acre

Econ 338C, Spring 2009 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 2008  50.5 bu./acre * $9.73/bu. + $17.58/acre  $508.95/acre

Econ 338C, Spring 2009 ACRE Payment Triggers  ACRE actual farm revenue = Max(Season- average price, Loan rate) * Actual farm yield per planted acre  Given our example, ACRE payments are triggered when ACRE actual revenue is below $442.23/acre and ACRE actual farm revenue is below $508.95/acre

Econ 338C, Spring 2009 ACRE Payments  Payment rate = Min(ACRE revenue guarantee – ACRE actual revenue, 25% * ACRE revenue guarantee)  Payments made on 83.3% of planted/base acres in , 85% in 2012  ACRE payment adjustment: Payment multiplied by ratio of Expected farm yield to Expected state yield

Econ 338C, Spring 2009 ACRE Payment Timing  Payments can begin as soon as practicable possible after the end of the marketing year  So 2009 ACRE payments could start to be paid out in October 2010  There are no provisions for advance payments

Econ 338C, Spring 2009 ACRE vs. CCP ACRE pays out No ACRE payments CCP pays out No CCP payments Both pay

Econ 338C, Spring 2009 Looking 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  So if the 2009 ACRE revenue guarantee is $442.23, then the 2010 ACRE revenue guarantee must be between $ and $486.45

Econ 338C, Spring 2009 An Example for 2009  To start, we need the expected state and farm yields and the ACRE price guarantee  Expected state yield 50.5 bu/acre  Expected farm yield 55.0 bu/acre  Olympic average of yields per planted acre  ACRE price guarantee$9.73/bu  Average of 2007 and 2008 season-average prices  ACRE Revenue Guarantee$  90% * $9.73/bu * 50.3 bu/acre  ACRE Farm Revenue Guarantee$  $9.73 * 55 bu/acre + $20/acre

Econ 338C, Spring 2009 Example (continued)  For 2009, we need the actual state yield, the actual farm yield, and the season-average price  Actual state yield 45 bu/acre  Actual farm yield 55 bu/acre  Season-Average Price$9.00/bu  ACRE Actual Revenue$  $9.00/bu * 45 bu/acre  ACRE Farm Actual Revenue$  $9.00/bu * 55 bu/acre

Econ 338C, Spring 2009 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 338C, Spring 2009 Example (continued)  ACRE Payment$33.78  Min(25%*$442.23, $ – $405.00) * (55 bu/acre / 50.5 bu/acre) * 83.3%

Econ 338C, Spring 2009 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 338C, Spring 2009 Comparing Program Parameters  For Iowa Soybeans  Under the current CCP program  CCP Yield Average = 38.5 bushels per acre  CCP Effective Target Price = $5.36/bushel  In our example, for ACRE  ACRE Yield Guarantee = 50.5 bushels per acre  ACRE Price Guarantee = $9.73/bushel  20% of average Iowa soybean direct payment = $3.14 per acre

Econ 338C, Spring 2009 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 338C, Spring 2009 Supplemental Revenue Assistance Payments Program (SURE)  Provides payments to producers in disaster counties for crop losses  Based on crop insurance program, non- insured crop assistance program, and disaster declarations  Whole-farm revenue protection, not commodity-specific

Econ 338C, Spring 2009 SURE Triggers  Declared “disaster county” by Secretary of Agriculture or contiguous to one  Farm with losses exceeding 50% of normal production in a calendar year

Econ 338C, Spring 2009 Iowa SURE Eligibility in 2008

Econ 338C, Spring 2009 SURE Settings  Participation and revenue guarantee tied to crop insurance  Farm revenue, including some government payments, used to determine payment  Payments set as 60% of the difference between guarantee and actual revenue  Limited to $100,000 per producer  Payments not known or paid until the end of the marketing year

Econ 338C, Spring 2009 SURE Guarantee  Farm guarantee is the sum of  (115 or 120)%*Crop insurance price election*Crop insurance coverage level*Planted acres* Max(APH or CCP yield), for insurable commodities  (120 or 125)%*NCAP price election*Planted acres* Max(NCAP or CCP yield), for non-insurable commodities  For an individual crop, the guarantee can not be greater than 90% of the crop’s expected revenue

Econ 338C, Spring 2009 SURE Expected Farm Revenues  Expected farm revenue is the sum of  Max(APH or CCP yield)*Planted acres*100% of the crop insurance price for insurable commodities  100% of NCAP yield*100% of NCAP price*Planted acres for non-insurable commodities

Econ 338C, Spring 2009 SURE Actual Farm Revenues  Actual farm revenue is the sum of  Harvested acres*Farm yield*National season- average price for all commodities  15% of direct payments  All CCP or ACRE payments  All marketing loan benefits  All crop insurance or NCAP payments  Any other disaster assistance payments

Econ 338C, Spring 2009 SURE Payments  Payments set as 60% of the difference between farm guarantee and actual farm revenue  Payments limited to $100,000 per producer  Payments not known until end of marketing year

Econ 338C, Spring 2009 Payment Limitations  Direct payments: $40,000 (w/o ACRE) $32,000 (w/ ACRE)  Counter-cyclical payments: $65,000  ACRE: $73,000 ($65,000 + $8,000)  Marketing loans: No limits  SURE: $100,000  Direct attribution of payments

Econ 338C, Spring 2009 Summary of Programs  Direct payments – Crop-specific income support  Counter-cyclical payments – Crop-specific price support  ACRE – Crop-specific revenue support  Marketing loans – Crop-specific price support  SURE – Whole-farm revenue support

Econ 338C, Spring 2009 Class web site: See you next week!