1. Econ 339X, Spring 2010 ECON 339X: Agricultural Marketing Chad Hart Assistant Professor/Grain Markets Specialist chart@iastate.edu 515-294-9911

2. Econ 339X, Spring 2010 Today’s Topics Government Programs

3. Econ 339X, Spring 2010 Direct Payments Payments that provide income support to farmers “Fixed” – do not change with agricultural conditions “Decoupled” – do not change with individual decisions

4. Econ 339X, Spring 2010 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

5. Econ 339X, Spring 2010 Direct Payment Rates CropUnit2008-12 Corn$/bu.0.28 Soybeans$/bu.0.44 Barley$/bu.0.24 Wheat$/bu.0.52 Oats$/bu.0.024 Cotton$/lb.0.0667 Sorghum$/bu.0.35

6. Econ 339X, Spring 2010 Direct Payment Example Direct Payment = 83.3% * Payment Acreage * Direct Payment Yield * Direct Payment Rate $27.08 = 83.3% * 116.1 bu/ac * $0.28/bu

7. Econ 339X, Spring 2010 Price Countercyclical Payments Payments that provide income support to farmers “Price Countercyclical” – payment rate changes with season average commodity price

8. Econ 339X, Spring 2010 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

9. Econ 339X, Spring 2010 Target Prices CropUnit2008-092010-12 Corn$/bu.2.63 Soybeans$/bu.5.806.00 Barley$/bu.2.242.63 Wheat$/bu.3.924.17 Oats$/bu.1.441.79 Cotton$/lb.0.7240.7125 Sorghum$/bu.2.572.63

10. Econ 339X, Spring 2010 Loan Rates CropUnit2008-092010-12 Corn$/bu.1.95 Soybeans$/bu.5.00 Barley$/bu.1.851.95 Wheat$/bu.2.752.94 Oats$/bu.1.331.39 Cotton$/lb.0.52 Sorghum$/bu.1.95

11. Econ 339X, Spring 2010 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

12. Econ 339X, Spring 2010 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))

13. Econ 339X, Spring 2010 Countercyclical Payment Example Countercyclical Payment = 83.3% * Payment Acreage * Countercyclical Payment Yield * Countercyclical Payment Rate $29.52 = 83.3% * 122.1 bu/ac * $0.29/bu

14. Econ 339X, Spring 2010 Countercyclical Payments

15. Econ 339X, Spring 2010 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

16. Econ 339X, Spring 2010 Loan Rates CropUnit2008-092010-12 Corn$/bu.1.95 Soybeans$/bu.5.00 Barley$/bu.1.851.95 Wheat$/bu.2.752.94 Oats$/bu.1.331.39 Cotton$/lb.0.52 Sorghum$/bu.1.95

17. Econ 339X, Spring 2010 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

18. Econ 339X, Spring 2010 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

19. Econ 339X, Spring 2010 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

20. Econ 339X, Spring 2010 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

21. Econ 339X, Spring 2010 PCP Calculation Example: Story County, Iowa, Corn 11/10/05 PCP = $1.40

22. Econ 339X, Spring 2010 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

23. Econ 339X, Spring 2010 LDP Calculation Example: Story County, Iowa, Corn 11/10/05

24. Econ 339X, Spring 2010 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

25. Econ 339X, Spring 2010 Loan vs. LDP

26. Econ 339X, Spring 2010 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

27. Econ 339X, Spring 2010 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

28. Econ 339X, Spring 2010 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

29. Econ 339X, Spring 2010 Revenue Dist. of LDP and Store LDP and Sell

30. Econ 339X, Spring 2010 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

31. Econ 339X, Spring 2010 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

32. Econ 339X, Spring 2010 Revenue Dist. of Loan and Store LDP and Sell

33. Econ 339X, Spring 2010 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

34. Econ 339X, Spring 2010 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

35. Econ 339X, Spring 2010 Revenue Dist. with Hedge LDP and Sell

36. Econ 339X, Spring 2010 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

37. Econ 339X, Spring 2010 Class web site: http://www.econ.iastate.edu/classes/econ339/hart- lawrence/ http://www.econ.iastate.edu/classes/econ339/hart- lawrence/