1. The 1-2-3 Scenarios: An Analysis of Safety Net Alternatives Prepared at the Request of Rep. Charles Stenholm January 18, 2001 Presentation to the All Commodity Group Lubbock, TX FAPRI www.fapri.missouri.edu www.afpc.tamu.edu

2. Why We Do It? Because of National Policy Objectives 1.Income – Maintain adequate net farm income for livestock and crop farmers. 2.Food – Maintain an adequate food supply at reasonable prices. 3.Exports – Maintain a competitive trade position. 4.Conservation & Environment – Enhance environmental and conservation quality. 5.Inputs – Maintain a viable input industry. 6.Reserves – Adequate reserves in the event of crop production problems. 7.Rural Areas – Development of rural areas. 8.Government Cost – Achieve objectives at the least cost. FAPRI

3. Direct Government Payments 11.8 16.7 14.5 13.4 12.2 20.6 23.3 12.4 9.5 0 5 10 15 20 25 197919831987199119951999 Billion Dollars Direct Payments1986-2000 Average = $12.0 Billion FAPRI Standard Deviation = $4.8 Billion

4. Direct Government Payments FAPRI

5. First, a word about the baseline... n Analysis, prepared at the request of Rep. Charles Stenholm, is compared to the FAPRI January, 2000 baseline. – The baseline assumes provisions of the FAIR Act with 2002 levels extended for the life of the baseline. n We need to remember a few things about the baseline because it does have a bearing on the outcome of the scenarios. FAPRI

6. US Cotton Prices n Prices remain under pressure throughout the early years of the baseline. n Longer term, prices struggle to reach 95-99 average. n LDPs remain a significant factor throughout the baseline. FAPRI

7. US Crop Prices n In general, baseline crop prices are weak in the near term before showing recovery in later years. n For soybeans and cotton, loan rates continue to play a large role through 2005. FAPRI

8. Scenario Assumptions n For the scenarios, all baseline policies remain in place, i.e. AMTA payments remain. n In addition, assume authority exists for additional spending above baseline levels for the 2001-05 crops. – Average $1 Billion/Crop Year ($5 Billion Total) – Average $2 Billion/Crop Year ($10 Billion Total) – Average $3 Billion/Crop Year ($15 Billion Total) FAPRI

9. More Assumptions n Spend the additional money in three ways – Modified Supplemental Income Payments (MSIP) - Payments based on 1995-99 reference period. – Higher Marketing Loan Rates (LR) - Increase all loan rates by the same percentage in order to achieve the additional spending. – Market Loss Assistance (MLA) Payments - Distributed in the same fashion as the previous MLA payments. Some money included for oilseeds. n Precise levels for loan rates and SIP triggers set so as to spend on average the same amount as the increase in MLA payments. FAPRI

10. Modified SIP for Cotton: Where the Baseline Is Important n Relative to the FAPRI baseline, MSIP will play a larger role in the early years as the value per acre falls well below the 1995-99 average. n Over time, stronger prices and increasing yields reduce the gap between the value and the reference period. FAPRI

11. MSIP Trigger Levels Corn -- $306.73 Cotton -- $402.14 Rice -- $516.11 Soybeans -- $232.36 Wheat -- $135.38 FAPRI

12. Loan Rate Formulas: Where the Baseline Is Important n In the FAPRI baseline, loan rates are held fixed through the 2001 crop and then allowed to adjust to minimum levels based on the formulas. n The scenarios maintain this convention with loan rates for all crops increased by the same percentage above baseline levels. FAPRI

13. Market Loss Assistance n Market Loss Assistance payments are allocated based on percentages from the previous assistance packages. n Feed grains receive 50% of the money under these rules. n Rice receives 8% of the money. FAPRI

14. $1 Billion$2 Billion$3 Billion MSIP (Trigger %) 89.80%93.86%96.75% LR Increase Above Base 3.50%6.67%9.60% MLA Payments $1 bil/crop yr$2 bil/crop yr$3 bil/crop yr Policies Analyzed in this Study n 3 ways to spend an additional money above baseline spending over the 2001-05 crops. Avg Annual Additional Spending FAPRI

15. Determining Sources of Variability n Shocks include the following: – US crop yields – Harvested/planted ratios – US crop exports – Costs of production – Animal slaughter weights – Adjustment factors on selected crop demand equations, livestock per-capita demand equations, and selected animal inventory equations. n Shocks are applied with correlations determined from historical observations – a good corn yield most often is accompanied with a good soybean yield FAPRI

16. Multiple Draws Must Be Done n Looking at one possible path doesn't provide enough information. n Program must be evaluated over a number of runs. We have done 500 simulations. n Graph shows 10 of the 500 cotton yield paths used in this analysis. n Remember - all other shocks are being introduced at the same time. FAPRI

17. Generating Results, Developing Probability Ranges n The results of the 500 draws will give variability around production, consumption and prices. n We can develop probabilities ranges or the likelihood that price will be in a certain range. FAPRI

18. Change in Per-Acre Returns, $2 Billion Scenario n Of the 3 options Cotton receives the most under SIP Rice payments are highest under MLA Corn receives largest payment under MLA Soybeans receive the most under LR Wheat payments are highest under MLA Rankings the same under alternative spending levels. FAPRI

19. Assessing Variability n Thus far, we have focused on the average outcome based on the 500 simulations. n However, to get some idea of the variability, we can look at: – The range of outcomes and probabilities associated with those outcomes. l Does the policy reduce the chance of an undesirable outcome? or increase the chance of a desirable one? – The "counter-cyclical" nature of the policies? FAPRI

20. n Average spending levels are similar under all 3 programs ($12.6 Bil) n With fixed payments, there is a higher minimum under MLA. n In all cases, much more upside spending potential than downside. Distribution of Gov't Outlays, $2 Billion Scenario Average FAPRI

21. Distribution of Gov't Outlays, $3 Billion Scenario Average of $13.6 bil FAPRI

22. Likelihood That Net CCC Outlays Exceed $15 Bil, $2 Billion Scenario n The infusion of additional money under all 3 scenarios greatly increase the likelihood that outlays exceed $15Bil. n In general, MSIP2 and LR2 have greater chances of exceeding $15 Bil, when compared to MLA2. – Upside spending potential when linked to prices and production. FAPRI

23. Likelihood That Net CCC Outlays Exceed $15 Bil, $3 Billion Scenario n The infusion of additional money under all 3 scenarios greatly increase the likelihood that outlays exceed $15Bil. n In general, MSIP3 and LR3 have greater chances of exceeding $15 Bil, when compared to MLA3. – Upside spending potential when linked to prices and production. FAPRI

24. n Average returns under LR2 and MLA2 are $165/ac. Average under MSIP2 is $169. n Note the different shape relative to corn returns – Skewed in the opposite direction. Distribution of Cotton Returns, $2 Billion Scenario Average Distribution of Cotton Per-Acre Net returns, 2004 $2 Billion Scenario 255075100125150175200225250275 Net Returns (Dollars per Acre) Frequency MSIP2 LR2MLA2 Averages FAPRI 165 165 169

25. Distribution of Corn Per-Acre Net Returns, 2002 $2 Billion Scenario 75100125150175200225250275300 Net Returns (Dollars per Acre) Frequency MSIP2 LR2 MLA2 n Returns average $155 under MSIP2 and MLA2. Average is $151 under LR2. n SIP reduces more of the downside risk in returns. Distribution of Corn Returns, $2 Billion Scenario Averages FAPRI 151 155 155

26. Distribution of Soybean Per-Acre Net returns, 2002 $2 Billion Scenario 75100125150175200 Dollars per Acre Frequency MSIP2LR2MLA2 n Returns average $132 under MSIP2 and $135 under LR2. Average is $128 under MLA2. n SIP reduces more of the downside risk in returns. Distribution of Soybean Returns, $2 Billion Scenario Averages FAPRI 128 132 135

27. Distribution of Wheat Per-Acre Net returns, 2002 $2 Billion Scenario 255075100125 Dollars per Acre Frequency MSIP2LR2 MLA2 n Returns average $72 under MSIP2 and $67 under LR2. Average is $73 under MLA2. n SIP reduces more of the downside risk in returns. Distribution of Wheat Returns, $2 Billion Scenario Averages FAPRI 67 72 73

28. Summary Points n The results of the analysis are not "universal" – They are influenced by baseline characteristics such as l Loan rates adjusting after 2001 l Relative price/loan rate relationships for different crops n With that in mind, the results of the $2 billion scenario generally hold for the other two as well, just at different magnitudes. n Acreage Impacts – Small in the aggregate. – MSIP shifts acreage from soybeans into other crops. – Soybeans, cotton, rice gain acreage under LR. FAPRI

29. Summary Points n Relative to MLA and LR, MSIP reduces the variability per-acre crop returns. – LR and MSIP increase the variability and upside spending potential of government outlays – Under LR and MSIP, there are higher probabilities that outlays exceed $15 bil. However, MLA gives a better chance of producing outlays above $10 billion. n At the national level, "countercyclical" nature of MSIP provides greater downside protection on net returns. – This may not hold for farm level results. A number of local factors come into play. FAPRI

30. MSIP Points n PROS n Based on high income period of time n Most downside protection n Based on harvested acres n CONS n Local yields vs. national yields n Regional weather FAPRI

31. Loan Rate Summary n PROS n Favors areas with high yields and low yield variability n Paid on actual bushels produced n CONS n Paid on actual bushels produced (No crop = No payment) FAPRI

32. Market Loss Assistance Summary n PROS n Best for grain, wheat, and rice n Greatest pass through of dollars from government to the farm sector n Frozen base and yields n CONS n Least protection in bad years n Frozen base and yields FAPRI

33. Consideration for Future Analysis n Of the 3 counter-cyclical options, which worked best (based on national average net returns) for Highest Average Down Side Risk n RiceMLAMSIP n CottonMSIPMSIP n WheatMLAMSIP n CornMLA & SIPMSIP n SoybeansLRMSIP n Total Farm???? FAPRI

34. Texas Net Farm Income, 1970-1999 FAPRI 197019721974197619781980198219841986198819901992199419961998 0 1 2 3 4 5 Billion Dollars Direct Government Payments Market Net Income

36. IAG2400598.2Corn1200 Soybeans1200 TXNP67001606.1Corn3350 Sorghum335 Wheat1675 KSSW3180331.1Wheat2258 Sorghum652 Corn56 Soybeans87 NDW4850678.8Wheat2585 Barley470 Soybeans705 Sunflowers940 TXSP36971066.9Cotton2665 Peanuts285 TX37501311.9Long Grain Rice1500 Farm Name Cash Receipts ’99 ($1,000) AcresCrops