1. The 1-2-3 Scenarios: An Analysis of Safety Net Alternatives December 05, 2000 Presentation to the Texas Corn Growers Association Amarillo, Texas 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 Payments1979-98 Average = $8.5 Billion FAPRI

4. 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 Payments1983-2000 Average = $11.4 Billion FAPRI Standard Deviation = $4.6 Billion

5. 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

6. Net CCC Outlays n Increased LDPs due to the low prices, together the 1998 and '99 assistance packages push net outlays to near- record levels. n Longer term, outlays decline as prices increase and AMTA payments fall. 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. US Livestock Prices FAPRI

9. US Farm Income n In the absence of additional assistance packages, farm income remains around $40 billion through 2006. n Modest recovery in the later years as the cattle cycle turns. FAPRI

10. 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

11. 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

12. Modified SIP for Corn: 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

13. Modified SIP for Sorghum: 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

14. Loan Rate Formulas for Corn: 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. – Rice loan rate remains at $6.50 in the baseline. n The scenarios maintain this convention with loan rates for all crops increased by the same percentage above baseline levels. FAPRI

15. Loan Rate Formulas for Sorghum: 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. – Rice loan rate remains at $6.50 in the baseline. n The scenarios maintain this convention with loan rates for all crops increased by the same percentage above baseline levels. FAPRI

16. 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 Wheat receives 24% of the money. FAPRI

17. $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

18. Methodology n The FAPRI baseline represents a deterministic view of the future conditioned on specific assumptions such as – trend yields – stable growth in macroeconomic indicators. n However, this view does not provide an indication of the range of outcomes and the potential variability. n To capture this range, shocks were introduced into the FAPRI US modeling system for the major sources of variability. FAPRI

19. 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

20. 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 corn yield paths used in this analysis. n Remember - all other shocks are being introduced at the same time. FAPRI Multiple Draws Must Be Done, Example for Corn Yields U.S. Corn Yield

21. Multiple Draws Must Be Done, Example for Sorghum Yields 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 sorghum yield paths used in this analysis. n Remember - all other shocks are being introduced at the same time. FAPRI

22. 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

23. 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

24. Change in Net CCC Outlays, $2 Billion Scenario n Scenarios designed to achieve the same average increase in CCC outlays for the 2001-05 crops. n Given FAPRI price projections, spending under SIP and LR scenarios increase more in early years and less in later years. n Similar patterns under the other spending levels. FAPRI

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

26. 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

27. 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

28. Likelihood That Net CCC Outlays Exceed $10 Bil, $2 Billion Scenario n Rising prices and declining AMTA payments reduce chance that net outlays exceed $10B. n Fixed payments under MLA2 give greatest chance of net outlays exceeding $10 billion. n From 1986-99, net outlays surpassed $10 billion in 10 of 14 years. FAPRI

29. 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

30. 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

31. Distribution of Sorghum Per-Acre Net returns, 2001 $2 Billion Scenario 5075100125150175 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 Sorghum Returns, $2 Billion Scenario Averages FAPRI

32. 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

33. 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

34. 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

35. 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

36. 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

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

38. Loan Rate Summary n PROS n Favors areas with high yields and low yield variability n CONS n No crop, no payment FAPRI

39. 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 CONS n Least protection in bad years FAPRI

40. Consideration for Future Analysis n Objectives n Many different groups sitting at the Farm Bill table n For the given objectives, what should the farm program costs? n Look at history n Need to reach $14-$16 billion in bad years n In extreme cases, need to reach $18-$20 billion FAPRI

41. Consideration for Future Analysis n What is the projected average cost over time? n Need a new baseline – March 2001 n Current estimates have spending declining from $13 billion to $7 billion with an average of $8 billion per year n Which income enhancement is likely to work best? FAPRI

42. Consideration for Future Analysis n Of the 3 counter-cyclical options, which worked best for n Rice? n Cotton? n Wheat? n Feed Grains? n Soybeans? n Total Farm? FAPRI

43. Consideration for Future Analysis n PROS and CONS of each option n Has to be examined regionally n Large yield differences n Regional analysis will require risk assessment n With crop insurance n Are the options WTO compatible? FAPRI

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

46. Multiple Draws Must Be Done, Example for Wheat Yields 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 wheat yield paths used in this analysis. n Remember - all other shocks are being introduced at the same time. FAPRI

47. Distribution of Rice Per-Acre Net returns, 2003 $2 Billion Scenario 50100150200250300350400450 Dollars per Acre Frequency MSIP2 LR2MLA2 n Returns average $242 under MSIP2 and $258 under MLA2. Average is $228 under LR2. n SIP reduces more of the downside risk in returns, especially relative to LR2. Distribution of Rice Returns, $2 Billion Scenario Averages FAPRI

48. Likelihood of Rice Net Returns Less than $200, $2 Billion Scenario FAPRI

49. Rice Gross Returns in 2003, $2 Billion Scenario MSIP2 MLA2 LR2 FAPRI

50. Corn Gross Returns in 2002, $2 Billion Scenario MSIP2 MLA2 LR2 FAPRI

51. Cotton Gross Returns in 2004, $2 Billion Scenario MSIP2 MLA2 LR2 FAPRI

52. 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. n Soybean example given in the chart. FAPRI

53. 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

54. 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

55. 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

56. Likelihood of Net Returns Less than $150, $2 Billion Scenario CornCotton FAPRI

57. Likelihood of Net Returns Less than $150, $2 Billion Scenario CornCotton FAPRI

58. 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

59. Modified SIP Formulas n For each crop, the following calculations are made: – US Value of Production = max(US Farm Price, US Loan Rate)*US Production – US Value/Acre = US Value of Production/Harvested Acres – Fixed Reference Period = 1995-99 Average of Value/Acre – Current Per-Acre Payment = max(0, Trigger %*Reference Period Value/Acre - Current Year Value/Acre) Everybody gets same per-acre payment – Total Payments = Per-Acre Payment * Harvested Acres FAPRI

60. Analyzing Alternative Policies n The 500 sets of exogenous shocks are evaluated under baseline policies. This generates a range of outcomes for prices, production, exports, gov't costs and farm income. n Each of the scenarios has been analyzed using the same 500 sets of exogenous shocks. n The only changes are the policy adjustments defined in each scenario. n Impacts of the scenarios are evaluated at the mean (i.e. the average outcome),as well as over the range of possible outcomes. FAPRI

61. Change in Planted Area, $2 Billion Scenario n MSIP - acreage shifts from soybeans into other crops. n Under LR, soybeans, cotton and rice gain acres at expense of grains. n No crop shifting under MLA payments due to decoupled nature. Less than 1% of total FAPRI

62. Change in Crop Prices, $2 Billion Scenario n Price changes reflect planted are shifts. n In general, price changes are relatively modest. FAPRI

63. Probability Density Function, Think About Rolling a Pair of Dice n The range and likelihood of outcomes can be shown with a probability density function (PDF). n As you would suspect, if you roll the dice enough times, outcomes are going to be symmetrical and some more likely to occur than others. FAPRI

64. US Rice Prices n Projected prices are similar to those observed in the early 1990s – Much below the levels of the mid-90s. n For rice, LDPs remain a significant factor throughout the baseline. FAPRI

65. 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