The 1-2-3 Scenarios:An Analysis of Safety Net AlternativesDecember 05, 2000

Presentation to the Texas Corn Growers AssociationAmarillo, Texas

FAPRIwww.fapri.missouri.edu

www.afpc.tamu.edu

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

Direct Government Payments

11.8

16.7

14.513.4

12.2

20.6

23.3

12.4

9.5

0

5

10

15

20

25

1979 1983 1987 1991 1995 1999

Bil

lion

Dol

lars

Direct Payments 1979-98 Average = $8.5 Billion

FAPRI

Direct Government Payments

11.8

16.7

14.513.4

12.2

20.6

23.3

12.4

9.5

0

5

10

15

20

25

1979 1983 1987 1991 1995 1999

Bil

lion

Dol

lars

Direct Payments 1983-2000 Average = $11.4 Billion

FAPRI

Standard Deviation = $4.6 Billion

Direct Government Payments

11.8

16.7

14.513.4

12.2

20.6

23.3

12.4

9.5

0

5

10

15

20

25

1979 1983 1987 1991 1995 1999

Bil

lion

Dol

lars

Direct Payments 1986-2000 Average = $12.0 Billion

FAPRI

Standard Deviation = $4.8 Billion

-5

0

5

10

15

20

25

30

1987 1990 1993 1996 1999 2002 2005 2008

Bil

lion

Dol

lars

Def/AMTA Payments LDP's CRP Other

Net CCC Outlays

Increased LDPs due to the low prices, together the 1998 and '99 assistance packages push net outlays to near-record levels.

Longer term, outlays decline as prices increase and AMTA payments fall.

FAPRI

1

2

3

4

5

6

7

8

91 93 95 97 99 01 03 05 07 09

Do

lla

rs p

er B

ush

el

Corn Soybeans Wheat

US Crop Prices

In general, baseline crop prices are weak in the near term before showing recovery in later years.

For soybeans and cotton, loan rates continue to play a large role through 2005.

FAPRI

US Livestock Prices

50

60

70

80

90

100

110

1991 1995 1999 2003 2007

Do

llars

per

Cw

t.

NE Direct Steers, 11-1300#OK City Feeder Steers, 600-650#

FAPRI

35

40

45

50

55

60

1987 1990 1993 1996 1999 2002 2005 2008

Bil

lion

Dol

lars

Net Cash Net Farm Income Real NFI (1997$)

US Farm Income

In the absence of additional assistance packages, farm income remains around $40 billion through 2006.

Modest recovery in the later years as the cattle cycle turns.

FAPRI

Scenario Assumptions

For the scenarios, all baseline policies remain in place, i.e. AMTA payments remain.

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

More Assumptions

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.

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

Corn Value vs. MSIP Reference Value

270

280

290

300

310

320

330

340

01 02 03 04 05

Dol

lars

per

Acr

e

Value/Acre 1995-99 Reference

Modified SIP for Corn:Where the Baseline Is Important

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.

Over time, stronger prices and increasing yields reduce the gap between the value and the reference period.

FAPRI

Sorghum Value vs. MSIP Reference Value

120

125

130

135

140

145

150

01 02 03 04 05

Dol

lars

per

Acr

e

Value/Acre 1995-99 Reference

Modified SIP for Sorghum:Where the Baseline Is Important

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.

Over time, stronger prices and increasing yields reduce the gap between the value and the reference period.

FAPRI

Corn Loan Rate vs. Farm Price

1.50

1.60

1.70

1.80

1.90

2.00

2.10

2.20

2.30

2.40

00 01 02 03 04 05

Dol

lars

per

Bu

Baseline LR $2 Bil Scenario LRBaseline Farm Price

Loan Rate Formulas for Corn:Where the Baseline Is Important

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.

The scenarios maintain this convention with loan rates for all crops increased by the same percentage above baseline levels.

FAPRI

Sorghum Loan Rate vs. AWP

1.50

1.60

1.70

1.80

1.90

2.00

2.10

00 01 02 03 04 05

Dol

lars

per

Bu

Baseline LR $2 Bil Scenario LRBaseline Farm Price

Loan Rate Formulas for Sorghum:Where the Baseline Is Important

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.

The scenarios maintain this convention with loan rates for all crops increased by the same percentage above baseline levels.

FAPRI

Allocation of MLA Payments

Oilseeds8%

Rice8%Cotton

10%

Feed Grains50%

Wheat24%

Market Loss Assistance

Market Loss Assistance payments are allocated based on percentages from the previous assistance packages.

Feed grains receive 50% of the money under these rules.

Wheat receives 24% of the money.

FAPRI

$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

3 ways to spend an additional money above baseline spending over the 2001-05 crops.

Avg Annual Additional Spending

FAPRI

Methodology

The FAPRI baseline represents a deterministic view of the future conditioned on specific assumptions such as

– trend yields– stable growth in macroeconomic indicators.

However, this view does not provide an indication of the range of outcomes and the potential variability.

To capture this range, shocks were introduced into the FAPRI US modeling system for the major sources of variability.

FAPRI

Determining Sources of Variability

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.

Shocks are applied with correlations determined from historical observations

– a good corn yield most often is accompanied with a good soybean yield

FAPRI

90

100

110

120

130

140

150

160

170

00 01 02 03 04 05 06 07 08 09

Looking at one possible path doesn't provide enough information.

Program must be evaluated over a number of runs. We have done 500 simulations.

Graph shows 10 of the 500 corn yield paths used in this analysis.

Remember - all other shocks are being introduced at the same time.

FAPRIMultiple Draws Must Be Done,Example for Corn Yields

U.S. Corn Yield

U.S. Sorghum Yield

60

65

70

75

80

85

00 01 02 03 04 05 06 07 08 09

Multiple Draws Must Be Done,Example for Sorghum Yields

Looking at one possible path doesn't provide enough information.

Program must be evaluated over a number of runs. We have done 500 simulations.

Graph shows 10 of the 500 sorghum yield paths used in this analysis.

Remember - all other shocks are being introduced at the same time.

FAPRI

U.S. Corn Farm Price ($/Bu)

1.0

1.5

2.0

2.5

3.0

3.5

99 01 03 05 07 09

Baseline Price 25th & 75th Percent5th & 95th Percent

Generating Results, Developing Probability Ranges

The results of the 500 draws will give variability around production, consumption and prices.

We can develop probabilities ranges or the likelihood that price will be in a certain range.

FAPRI

U.S. Sorghum Farm Price ($/Bu)

1.0

1.5

2.0

2.5

3.0

3.5

99 01 03 05 07 09

Baseline Price 25th & 75th Percent5th & 95th Percent

Generating Results, Developing Probability Ranges

The results of the 500 draws will give variability around production, consumption and prices.

We can develop probabilities ranges or the likelihood that price will be in a certain range.

FAPRI

Change in Net CCC Outlays,$2 Billion Scenario

Scenarios designed to achieve the same average increase in CCC outlays for the 2001-05 crops.

Given FAPRI price projections, spending under SIP and LR scenarios increase more in early years and less in later years.

Similar patterns under the other spending levels.

$2 Billion Average Annual Additional Spending

($10 Billion Total)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

01 02 03 04 05 06

Fiscal Year

Bil

lion

Dol

lars

MSIP2 LR2 MLA2

FAPRI

Change in Per-Acre Returns2001-05 Average

0

10

20

30

40

50D

olla

rs p

er A

cre

MSIP2 LR2 MLA2

Change in Per-Acre Returns,$2 Billion Scenario

Of the 3 optionsRice 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

Rankings the same under alternative spending levels.

FAPRI

Assessing Variability

Thus far, we have focused on the average outcome based on the 500 simulations.

However, to get some idea of the variability, we can look at:

– The range of outcomes and probabilities associated with those outcomes.

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

Average spending levels are similar under all 3 programs ($12.6 Bil)

With fixed payments, there is a higher minimum under MLA.

In all cases, much more upside spending potential than downside.

Distribution of Gov't Outlays,$2 Billion Scenario

Average

FAPRI

Likelihood That Net CCC Outlays Exceed $10 Bil, $2 Billion Scenario

Rising prices and declining AMTA payments reduce chance that net outlays exceed $10B.

Fixed payments under MLA2 give greatest chance of net outlays exceeding $10 billion.

From 1986-99, net outlays surpassed $10 billion in 10 of 14 years.

Probability Net CCC Outlays Exceed $10 Billion

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

02 03 04 05 06

Fiscal Year

Pro

babi

lity

Base MSIP2 LR2 MLA2

FAPRI

Likelihood That Net CCC Outlays Exceed $15 Bil, $2 Billion Scenario

The infusion of additional money under all 3 scenarios greatly increase the likelihood that outlays exceed $15Bil.

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.

Probability Net CCC Outlays Exceed $15 Billion

0%

10%

20%

30%

40%

50%

60%

02 03 04 05 06

Fiscal Year

Pro

babi

lity

Base MSIP2 LR2 MLA2

FAPRI

Distribution of Corn Per-Acre Net Returns, 2002$2 Billion Scenario

75 100 125 150 175 200 225 250 275 300

Net Returns (Dollars per Acre)

Fre

quen

cy

MSIP2LR2 MLA2

Returns average $155 under MSIP2 and MLA2. Average is $151 under LR2.

SIP reduces more of the downside risk in returns.

Distribution of Corn Returns,$2 Billion Scenario

Averages

FAPRI

Distribution of Sorghum Per-Acre Net returns, 2001$2 Billion Scenario

50 75 100 125 150 175

Dollars per Acre

Fre

quen

cy

MSIP2 LR2MLA2

Returns average $132 under MSIP2 and $135 under LR2. Average is $128 under MLA2.

SIP reduces more of the downside risk in returns.

Distribution of Sorghum Returns,$2 Billion Scenario

Averages

FAPRI

Average returns under LR2 and MLA2 are $165/ac. Average under MSIP2 is $169.

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

25 50 75 100 125 150 175 200 225 250 275

Net Returns (Dollars per Acre)

Fre

quen

cy

MSIP2LR2 MLA2

Averages

FAPRI

Distribution of Wheat Per-Acre Net returns, 2002$2 Billion Scenario

25 50 75 100 125

Dollars per Acre

Fre

quen

cy

MSIP2LR2 MLA2

Returns average $72 under MSIP2 and $67 under LR2. Average is $73 under MLA2.

SIP reduces more of the downside risk in returns.

Distribution of Wheat Returns,$2 Billion Scenario

Averages

FAPRI

Distribution of Soybean Per-Acre Net returns, 2002$2 Billion Scenario

75 100 125 150 175 200

Dollars per Acre

Fre

quen

cy

MSIP2 LR2MLA2

Returns average $132 under MSIP2 and $135 under LR2. Average is $128 under MLA2.

SIP reduces more of the downside risk in returns.

Distribution of Soybean Returns,$2 Billion Scenario

Averages

FAPRI

Summary Points

The results of the analysis are not "universal"– They are influenced by baseline characteristics such as

Loan rates adjusting after 2001Relative price/loan rate relationships for different crops

With that in mind, the results of the $2 billion scenario generally hold for the other two as well, just at different magnitudes.

Acreage Impacts– Small in the aggregate.– MSIP shifts acreage from soybeans into other crops.– Soybeans, cotton, rice gain acreage under LR.

FAPRI

Summary Points

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.

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

MSIP Points

PROS Based on high income period of time Most downside protection

CONS Local yields vs. national yields Regional weather

FAPRI

Loan Rate Summary

PROS Favors areas with high yields and low yield variability

CONS No crop, no payment

FAPRI

Market Loss Assistance Summary

PROS Best for grain, wheat, and rice Greatest pass through of dollars from government to the farm

sector

CONS Least protection in bad years

FAPRI

Consideration for Future Analysis

Objectives Many different groups sitting at the Farm Bill table

For the given objectives, what should the farm program costs?

Look at history Need to reach $14-$16 billion in bad years In extreme cases, need to reach $18-$20 billion

FAPRI

Consideration for Future Analysis

What is the projected average cost over time?

Need a new baseline – March 2001

Current estimates have spending declining from $13 billion to $7 billion with an average of $8 billion per year

Which income enhancement is likely to work best?

FAPRI

Consideration for Future Analysis

Of the 3 counter-cyclical options, which worked best for

Rice?

Cotton?

Wheat?

Feed Grains?

Soybeans?

Total Farm?

FAPRI

Consideration for Future Analysis

PROS and CONS of each option

Has to be examined regionally Large yield differences

Regional analysis will require risk assessment With crop insurance

Are the options WTO compatible?

FAPRI

Texas Net Farm Income, 1970-1999 FAPRI

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

0

1

2

3

4

5

Billion D

ollars

Direct Government Payments

Market Net Income

U.S. Wheat Yield

30

34

38

42

46

50

00 01 02 03 04 05 06 07 08 09

Multiple Draws Must Be Done,Example for Wheat Yields

Looking at one possible path doesn't provide enough information.

Program must be evaluated over a number of runs. We have done 500 simulations.

Graph shows 10 of the 500 wheat yield paths used in this analysis.

Remember - all other shocks are being introduced at the same time.

FAPRI

Distribution of Rice Per-Acre Net returns, 2003

$2 Billion Scenario

50 100 150 200 250 300 350 400 450

Dollars per Acre

Fre

quen

cy

MSIP2LR2 MLA2

Returns average $242 under MSIP2 and $258 under MLA2. Average is $228 under LR2.

SIP reduces more of the downside risk in returns, especially relative to LR2.

Distribution of Rice Returns,$2 Billion Scenario

Averages

FAPRI

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

Corn Gross Returns per Acre, 2002

0%

10%

20%

30%

40%

50%

01 02 03 04 05

Base MSIP2 LR2 MLA2

FAPRI

Rice Gross Returns in 2003,$2 Billion Scenario

200

300

400

500

600

700

800

Percentile Based on Market Returns

Dol

lars

per

Acr

e

Market AMTA MLA LDP MSIP

MSIP2 MLA2LR2

FAPRI

Corn Gross Returns in 2002,$2 Billion Scenario

200220240260280300320340360380400

Percentile Based on Market Returns

Dol

lars

per

Acr

e

Market AMTA MLA LDP MSIP

MSIP2 MLA2LR2

FAPRI

Cotton Gross Returns in 2004,$2 Billion Scenario

200

250

300

350

400

450

500

Percentile Based on Market Returns

Dol

lars

per

Acr

e

Market AMTA MLA LDP MSIP

MSIP2 MLA2LR2

FAPRI

Soybean Loan Rate vs. Farm Price

4.00

4.50

5.00

5.50

6.00

00 01 02 03 04 05

Farm Price

Dol

lars

per

Bus

hel

Baseline LR Scenario LR Baseline Price

Loan Rate Formulas:Where the Baseline Is Important

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.

The scenarios maintain this convention with loan rates for all crops increased by the same percentage above baseline levels.

Soybean example given in the chart.

FAPRI

U.S. Wheat Farm Price ($/Bu)

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

99 01 03 05 07 09

Baseline Price 25th & 75th Percent5th & 95th Percent

Generating Results, Developing Probability Ranges

The results of the 500 draws will give variability around production, consumption and prices.

We can develop probabilities ranges or the likelihood that price will be in a certain range.

FAPRI

U.S. Soybean Farm Price ($/Bu)

2.0

3.0

4.0

5.0

6.0

7.0

8.0

99 01 03 05 07 09

Baseline Price 25th & 75th Percent5th & 95th Percent

Generating Results, Developing Probability Ranges

The results of the 500 draws will give variability around production, consumption and prices.

We can develop probabilities ranges or the likelihood that price will be in a certain range.

FAPRI

U.S. Cotton Farm Price ($/Lb)

0.3

0.4

0.5

0.6

0.7

0.8

99 01 03 05 07 09

Baseline Price 25th & 75th Percent5th & 95th Percent

Generating Results, Developing Probability Ranges

The results of the 500 draws will give variability around production, consumption and prices.

We can develop probabilities ranges or the likelihood that price will be in a certain range.

FAPRI

Likelihood of Net Returns Less than $150, $2 Billion Scenario

0%

10%

20%

30%

40%

50%

60%

70%

01 02 03 04 05 01 02 03 04 05

Base MSIP2 LR2 MLA2

Corn Cotton

FAPRI

Likelihood of Net Returns Less than $150, $2 Billion Scenario

0%

10%

20%

30%

40%

50%

60%

70%

01 02 03 04 05 01 02 03 04 05

Base MSIP2 LR2 MLA2

Corn Cotton

FAPRI

First, a word about the baseline...

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.

We need to remember a few things about the baseline because it does have a bearing on the outcome of the scenarios.

FAPRI

Modified SIP Formulas

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

Analyzing Alternative Policies

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.

Each of the scenarios has been analyzed using the same 500 sets of exogenous shocks.

The only changes are the policy adjustments defined in each scenario.

Impacts of the scenarios are evaluated at the mean (i.e. the average outcome) ,as well as over the range of possible outcomes.

FAPRI

Change in Planted Area2001-05 Average

-1.0

-0.5

0.0

0.5

1.0

Cor

n

Soyb

eans

Whe

at

Cot

ton

Ric

e

8-C

rops

Mil

lion

Acr

es

MSIP2 LR2 MLA2

Change in Planted Area,$2 Billion Scenario

MSIP - acreage shifts from soybeans into other crops.

Under LR, soybeans, cotton and rice gain acres at expense of grains.

No crop shifting under MLA payments due to decoupled nature.

Less than 1%of total

FAPRI

Percent Change in Crop Prices2001-05 Average

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

Corn Soybeans Wheat Cotton Rice

MSIP2 LR2 MLA2

Change in Crop Prices,$2 Billion Scenario

Price changes reflect planted are shifts.

In general, price changes are relatively modest.

FAPRI

Rolling a Pair of Dice

0

1

2

3

4

5

6

2 3 4 5 6 7 8 9 10 11 12

Range of Possible Outcomes

Fre

quen

cy

Probability Density Function,Think About Rolling a Pair of Dice

The range and likelihood of outcomes can be shown with a probability density function (PDF).

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

4

5

6

7

8

9

10

11

91 93 95 97 99 01 03 05 07 09

Dol

lars

per

Cw

t.

Farm Price AWP Loan Rate

US Rice Prices

Projected prices are similar to those observed in the early 1990s

– Much below the levels of the mid-90s.

For rice, LDPs remain a significant factor throughout the baseline.

FAPRI

U.S. Rice Farm Price ($/Cwt)

4

5

6

7

8

9

10

11

99 01 03 05 07 09

Baseline Price 25th & 75th Percent5th & 95th Percent

Generating Results, Developing Probability Ranges

The results of the 500 draws will give variability around production, consumption and prices.

We can develop probabilities ranges or the likelihood that price will be in a certain range.

FAPRI