As we begin to digest the details of the 2018 Farm Bill, I was given the opportunity to provide the webinar discussing the provisions of the bill. More details will come out over time. We will continue work to provide timely information as the bill is implemented.
http://extension.msstate.edu/agriculture/agricultural-economics
So we have a new Farm Bill if, as all signs suggest, the President signs the new legislation. The bill is estimated to cost $428 billion over the next 5 years and $867 over the next 10 years according to the Congressional Budget Office (CBO). Over 76% of the cost is estimated to be for the Nutrition title of the bill. CBO estimates the bill will spend about $1.5 billion more than continuing existing legislation. This is in contrast to the $23 billion cut in the last Farm Bill.
The largest cut occurred in the Rural Development title by tighten some Rural Utility Services programs. The Miscellaneous title has the greatest increase among the various titles, and contained funding for an animal disease vaccine bank, funding for feral hog eradication and Beginning farmer assistance.
Commodity Programs
Agricultural Risk Coverage (ARC)
Price Loss Coverage (PLC)
|
Commodity |
Units |
PLC Reference Price | Maximum Effective Reference Price |
| Corn | bu. | $3.70 | $4.26 |
| Grain Sorghum | bu. | $3.95 | $4.54 |
| Peanuts | ton | $535.00 | $615.25 |
| Rice | cwt. | $14.00 | $16.10 |
| Seed Cotton | lb. | $0.367 | $0.422 |
| Soybeans | bu. | $8.40 | $9.66 |
| Wheat | bu. | $5.50 | $6.33 |
Loan Programs
| Commodity | 2014 Farm Bill | 2018 Farm Bill |
| Corn | $1.95/bu | $2.20/bu |
| Cotton (ELS) | $0.7977/lb | $0.95/lb |
| Cotton (Upland) | $0.45 ‐ $0.52/lb | $0.45 ‐ $0.52/lb |
| Grain Sorghum | $1.95/bu | $2.20/bu |
| Peanuts | $0.1775/lb | $0.1775/lb |
| Rice | $6.50/cwt | $7.00/cwt |
| Soybeans | $5.00/bu | $6.20/bu |
| Wheat | $2.94/bu | $3.38/bu |
Conservation
Crop Insurance
I am really proud of our undergraduate research program at Mississippi State. This past year Alba Collart and I mentored Shea Gould an undergraduate researcher who has now joined our Department as a grad student. In her undergraduate research she asked a representative sample of 465 U.S. adults their preferences for allocating funds to the programs authorized in a farm bill. The survey focused on four broad categories of USDA spending – farm programs, conservation, nutrition, and a broad category subsuming all other USDA activities.
As Farm Bill conferees meet, the House of Representatives and Senate Bills are estimated to spend near current levels over the next ten years — essentially a zero-sum game of shifting priorities. Consistent with the zero-sum game being played in Congress right now, we asked respondents to reallocate the USDA pie rather than shrinking or adding to USDA spending.
We find the average U.S. adult. U.S adults desire to spend about the same as currently spend supporting farmers – in fact they support a slightly increased shared of the total USDA budget – from 18 to 19%. Though slight in percentage terms, this increase corresponds to an annual increase of $1.4 billion.
American adults desire to see USDA spending a smaller share of its budget on nutrition assistance programs. Reductions in nutrition spending were reallocated to the other three categories. Even when a subset of survey respondents were shown current levels of spending on nutrition programs they still wanted to spend less, but chose to cut less. Interestingly, spending on nutrition program have dropped significantly without a legislative change due in large part to an improving economy.
The biggest percentage change desired by American adults is that they would increase conservation programs from 7% to 22% of the total USDA budget. That is a three-fold increase. Our results show that survey respondents primarily wanted to take funding from nutrition programs.
Finally, the survey findings indicate a desire for increased spending on “other programs” which were summarized as encompassing research, marketing and regulatory activities, rural development, and food safety. Because the survey addressed such a broad set of areas, it did not dig deeper into desired spending in subcategories. We hope to do follow up research on what was in the ‘other program’ category that led to a desire for increased funding?
Barry Goodwin, Ardian Harri, Rod Rejesus and I just published a paper in the American Journal of Agricultural Economics examining the use of the Black-Scholes implied volatilities in rating crop revenue insurance. For those not familiar with futures option implied volatility, it is derived from observed option premiums and known parameters of the option contract. Under certain assumptions it is the price volatility implied by the price of the option contract.
To rate a revenue contract one needs both an expected price and a volatility associated with that expected price. Needing an expected price is rather obvious, but many forget that the price volatility estimate profoundly affects premium rates. In 2017 the premium associated with these revenue insurance policies was approximately $7.68 billion dollars. Just a few years ago both expected corn and soybean prices and volatilities were much higher than today. For example, in 2010 the price volatility used by the USDA Risk Management Agency (RMA) for Midwest corn was 0.28 while in 2017 it was 0.19. This decline in volatility has reduced premium rates and the amount of subsidy in the program.
Current USDA RMA methods are based upon a pre-signup average of futures closings and Black–Scholes (BS) implied volatilities calculated from “near–to–the–money” options for the harvest time contracts. We focus on options and futures markets during the period of time used by RMA for price discovery (i.e., planting and harvest time pricing).
We find that the Black-Scholes model works well when there is robust trading during the pricing period. We also conclude there is strong support for using a forward looking implied volatility rather than a backward looking historical based volatility. We also determine there is merit in using a third party source of volatility rather than some less transparent model. However, the contracts for which significant violations of the assumptions inherent in the BS model tend to be for thinly traded crops.
This leads to a really interesting question. Does crop revenue insurance which protects against low prices, as well as, low yields reduce the number of natural pre-season hedgers in the futures and options market? If so we have something of a catch-22.
I know that up-side price protection makes revenue insurance more conducive to pre-harvest hedging than straight revenue insurance. But is does also have a substitution effect (Coble, Heifner, Zuniga JARE 2000). In the end I think the prima facie evidence is that corn and soybeans have had robust preseason price data and these two crops have among the highest levels of crop revenue protection insurance participation. Conversely, rice arguably has had the most severe price data problems and yet has relatively low crop insurance participation. Finally, note also that crop insurance does not affect the natural longs in the market. However, we are left with the question of how to utilize the data from a thin market such as rice.
Lastly, there is another closely related question we did not address. Are historical models good enough to rate crop revenue insurance when there is no futures and options market? This deserves more research given the demand for revenue insurance in those markets is obvious since a functioning price risk market often does not exist.
Risk remains one of the salient features of commodity agriculture. We usually discuss weather or market price risk, but we also need to be mindful of policy risk. Macro-economic policy in the 1980s and more recently the Renewable Fuel Policy of 2007 are examples of policy decisions that shocked commodity prices. When I teach risk management, I tell students that risk = probability of a bad event x the severity of the event. Much of what challenges us in risk management is how to deal with the low probability but severe negative event.
Current discussion regarding NAFTA, recent withdrawal from the Trans-Pacific Partnership, and other looming threats make trade disruption increasingly probable events. However, if there is a sudden trade disruption in our crop sector, what happens to U.S. producers? Most economist suggest the price of our agricultural commodities could fall, perhaps dramatically. Trade disruptions may occur for a variety of reasons such as disease outbreaks, a trading partner’s economic turmoil, or war.
So here is the question. To what extent would our current farm safety net mitigate a sudden shock to crop prices due to a trade disruption?
Crop Insurance – Based on planted acres, crop insurance would protect against a price shock only if it occurred during the growing season. Since price guarantees are reset with the futures markets every year, a new lower equilibrium futures price in the following year would be used to value insurance losses. Thus, the economic adjustments to lower price levels would be unprotected by this program.
Agricultural Risk Coverage – To the extent base acres match planted acres, ARC would mitigate the decline in price, but would only cover a 10% band of crop value. ARC would provide some protection over the next few years, but the Olympic average used in ARC would gradually adjust over a 5 year period.
Price Loss Coverage – uses base acres as does ARC and protects against prices below a legislatively set reference price. If a medium term price shift occurred (3-5 years), these programs would provide a significant protection but at a high budgetary cost.
Ultimately, our farm safety net is not designed for such a shock. Maintaining trade flows and reducing barriers to trade has a strong economic justification. There are clear benefits to consumers and agricultural producers.
The 2008 Farm bill provided for an alternative level of crop insurance subsidies for Enterprise Units relative to Basic and Optional Units. As you can see in Table 1 the subsidy for enterprise units are sometimes as much as 20% higher than for the same coverage with basic and optional unit structures.
| Coverage Level | Basic & Optional
Subsidy % |
Enterprise Unit Subsidy % |
| 50% | 67% | 80% |
| 55% | 64% | 80% |
| 60% | 64% | 80% |
| 65% | 59% | 80% |
| 70% | 59% | 80% |
| 75% | 55% | 77% |
| 80% | 48% | 68% |
| 85% | 38% | 53% |
A brief review of unit structures is as follows:
Importantly, because enterprise units are aggregated from basic units the base rates for enterprise units are generally lower than for the basic units from which they are aggregated. Thus, higher subsidies and lower rates lead to significantly lower producer paid premiums for enterprise units.
A review of RMA participation data from 2009-2016 reveals the choices farmers have made. The results are reported by crop. For the six major row crops enterprise units have covered at least 27% of acres since 2009. However, it appears enterprise units are far more popular for corn and soybeans than the other four crops. More than ½ of corn and soybean acres have been insured with enterprise units. In contrast, ½ of wheat acres have been insured at the optional unit level.
| Percent of 2009-2016 Acres Insured with Basic, Enterprise, or Optional Units | ||||
| Crop | Optional Unit | Basic Unit | Enterprise Unit | |
| Corn | 28% | 18% | 53% | |
| Cotton | 42% | 25% | 33% | |
| Rice | 12% | 54% | 33% | |
| Sorghum | 34% | 38% | 29% | |
| Soybeans | 28% | 20% | 52% | |
| Wheat | 50% | 23% | 27% | |
Source: USDA RMA County Summary Data
With a looming farm bill debate, crop insurance stands as the largest single component of the crop farm safety net. The program provides risk protection from low yield or revenue in return for a premium that producers pay. These premiums were subsidized by the USDA on average about 63% across all programs in 2016. The total cost of the subsidy in 2016 was approximately $5.85 Billion. Figure 1 provides a bit of historical perspective on acres insured and total crop insurance subsidy. Beginning in the early 1990s a series of legislative changes increased subsidy levels and acreage insured has trended up as well. We note that recent declines in subsidy primarily result from reduced crop value as prices decline from historic highs.
Figure 1
In the next farm bill debate the amount of subsidy for crop insurance is likely to be a topic of discussion. A frequent question posed to economist sounds something like this, “If we change the subsidy structure what will happen to crop insurance participation.” This question has been asked and answered numerous times. In most, but not all studies, the conclusion has been that crop insurance demand is inelastic. That is, the percent change in participation will be less than a percentage change in subsidy. However, many of those studies are older and may reflect a different era of crop insurance.
In this report, we examine some key data associated with RMA corn and soybean program participation. We do not estimate an elasticity, but rather show evidence of a consistent pattern in in how much farmers are willing to pay for crop insurance. We use the dramatic changes in crop value between 2011 and 2016 and variation in riskiness across regions to show a remarkable constant in crop insurance demand. We find that across periods of high and low crop value and across regions of low and high risk – corn and soybean farmers are willing to pay out-of-pocket no more than four percent of the expected value of the crop. If this is true, it has implications for the demand for crop insurance when subsidy is changed. We do not provide a theoretical explanation for this finding but believe it may be tied to the degree of risk aversion and farmer budget constraints.
We begin by examining variation across region in the base county premium rate. The maps in figure 2 and 3 show wide variation the level of yield risk across growing regions. While most producers purchase revenue insurance, regional variation in premium rates are largely driven by yield risk.
Figure 2
Figure 3
Next we examine the amount of insurance chosen by corn and soybean producers. Figures 4 and 5 reflect the acre-weighted average coverage level chosen in each county. We use coverage level to represent the amount of insurance chosen by those who participate in the program. When figures 4 and 5 are compared to figures 2 and 3, a pattern begins to emerge. Areas of the country with lower per-acre base premium rates also tend to purchase higher coverage levels than areas with higher base premium rates.
Figure 4
Figure 5
Figures 6 and 7 show the 2016 average producer paid premium per acre for corn and soybeans by county. Note that producer premium is a function of the coverage level, rate, and value of the crops. In general, low risk-high yield regions pay similar premiums per acre as higher risk-lower yielding regions. Having said that the lower coverage levels chosen in many higher risk regions results in lower producer paid premium per acre. Finally, the maps show that producer paid premium for soybeans are generally lower than for corn. This is in part due to lower per acre expected crop value.
Figure 6
Figure 7
Figures 8 and 9 divides the average producer paid premium by the insured value of the crop to compute the percentage of expected crop value farmers opt to pay in producer paid premium. This reveals our primary finding. As can be seen in both figures, the majority of counties are shown to pay between one and four percent of the value the crop in 2016. Thus, we find that farmers appear to be willing to pay a premium of about four percent of crop value and no more.
Figure 8
Figure 9
To test the robustness of our results in 2016 we also conduct the same analysis using data from 2011. These results are shown in figures 10 and 11. Note that higher crop price in 2011 resulted in expected crop revenue more than 30% higher in that year than in 2016. However the premium paid as a percent of crop value maps look quite similar to that of 2016.
Conclusions
While we find quite robust results, it is not clear why producers seem to spend such a constant percent of crop value on crop insurance. Most likely it is related to the out of pocket cost associated with this program and the perceived benefits. We suggest that models of insurance demand consider the possibility of a budget constraint on crop insurance demand. Ultimately, the consistency of these results suggests that if crop insurance costs rose past four percent of expected crop value, the producers would reduce insurance expenditure – most likely by reducing coverage levels.
Figure 10
Figure 11
As the cotton industry asks for a new Title I program in the next Farm Bill, the question of what becomes of generic base becomes a central issue. In this report, we summarize a USDA/FSA report summarizing the program crops to which generic base has been applied in 2015. Note that an acre of generic base applied to a program crop then receives the payments associated with that crop. Nationally 10.6 million acres of generic base were applied to program crops in 2015. Of that total 33% were applied to soybean acres. However, the Mid-south pulled up the national average where over 60% of generic acres were applied to soybean acres.
| 2015 Crops Planted on Generic Acres | Percent of Planted Generic Acres | ||||||
| Total Acres | WHEAT | RICE-LONG GRAIN | CORN | GRAIN SORGHUM | PEANUTS | SOYBEANS | |
| Grand Total | 10,675,012 | 22.9% | 0.2% | 19.0% | 14.0% | 8.7% | 33.2% |
| TEXAS | 3,281,424 | 39.2% | 0.0% | 18.4% | 34.9% | 3.7% | 0.7% |
| MISSISSIPPI | 1,316,641 | 3.9% | 0.3% | 21.1% | 3.6% | 2.0% | 68.9% |
| ARKANSAS | 1,020,523 | 5.4% | 1.3% | 14.7% | 10.0% | 0.7% | 67.7% |
| GEORGIA | 871,613 | 7.3% | . | 16.5% | 1.7% | 59.0% | 13.6% |
| LOUISIANA | 830,276 | 4.8% | 0.1% | 30.3% | 2.7% | 0.0% | 61.9% |
| NORTH CAROLINA | 643,072 | 13.3% | . | 18.2% | 1.7% | 7.2% | 58.9% |
| TENNESSEE | 609,802 | 10.7% | . | 20.6% | 7.8% | 0.0% | 60.8% |
| OKLAHOMA | 455,071 | 89.8% | . | 1.5% | 4.6% | 0.6% | 1.2% |
| ALABAMA | 407,582 | 15.7% | . | 19.6% | 1.8% | 24.7% | 36.5% |
| MISSOURI | 351,708 | 8.0% | 0.6% | 16.2% | 7.1% | 0.3% | 67.7% |
| CALIFORNIA | 276,897 | 51.9% | . | 27.8% | 8.4% | . | . |
| SOUTH CAROLINA | 251,367 | 11.2% | . | 29.9% | 1.9% | 19.3% | 36.8%[1] |
In Texas, the state with the most generic acres, wheat and grain sorghum captured the highest percentage of generic acres. Nationally wheat was the second highest percentage of generic acres pulled up by states like Oklahoma and California where almost 90% and 52% of generic acres went to wheat, respectively.
Many have suggested generic base was moving to peanuts. Nationally, only 8.7% of generic base has moved to peanuts. However, that shift is more common in Southeastern states where peanuts are a larger player such as Alabama, South Carolina and especially Georgia where 59% on generic base went to cotton.
Final thoughts
[1] Source: https://www.fsa.usda.gov/Assets/USDA-FSA-Public/usdafiles/arc-plc/pdf/2015%20and%202014%20Crops%20Planted%20on%20Generic%20Base%20Acres%20%20Oct%2024%202016.pdf
Today, one of the biggest buzz phrases in agriculture is ‘big ag data.’ While precision agriculture has been around for some time, it’s important to recognize that the data produced by agricultural equipment, field sensors, and various other technologies may pose a variety of opportunities but may also disrupt some long-standing relationships as well. I have had the opportunity to engage this topic in recent years by writing a soon to be released white paper as well as being a Board member of the Ag Data Coalition, which is bringing together industry, farm groups, and Universities, to develop producer controlled data storage.
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