The ACRE Decision Bruce A. Babcock Iowa State University Presented at the North Dakota Corn Growers...

The ACRE Decision

Bruce A. BabcockIowa State University

Presented at the North Dakota Corn Growers Association Annual Convention. Fargo, ND. February 11, 2009

Overview of ACRE (Average Crop Revenue Election)

• Farmers who choose ACRE– Must do so for all program crops– Must do so for remainder of farm bill (2012 crop)– Lose eligibility for countercyclical payments– Must give up 20% of direct payments– Have a 30% lower loan rate– Get a state revenue guarantee based on 2007/08

prices and 2004 – 2008 yields

10

12

14

16

18

20

22

24

Early 1980s Early 1990s Early 2000s 2008

Mill

ion

North Dakota Planted Acreage

0%5%

10%15%20%25%30%35%40%45%50%

Share of Acreage by Crop

Early 1980s

Early 1990s

Early 2000s

2008

ACRE Commodities

• Wheat, corn, grain sorghum, barley, oats, upland cotton, rice, soybeans, other oilseeds, peanuts, dry peas, lentils, small chickpeas, and large chickpeas

• About 90% of North Dakota planted to these crops

0%5%

10%15%20%25%30%35%40%45%50%

Wheat Soybeans Corn Oilseeds Barley

2008 Share of Acreage by Crop

ACRE’s State Revenue Guarantee

• Revenue = Price X Yield– Yield is state yield per planted acre– Price is NASS season average price (marketing year

price)

• ACRE Guarantee: 90% of the product of– Olympic average of state yield previous five years– Average of NASS price past two years

• ACRE can pay out due to low state yield or low price

Legend

COUNTIES

Corn0. - 9700

9700 - 23300

23300- 55000

55000 - 109000

109000- 285000

Corn Acres in 2008

Legend

COUNTIES

acres.SOYBEANS / none0 - 18000

18000 - 68000

68000 - 125000

125000 - 290000

290000 - 440000

Soybean Acres in 2008

Legend

COUNTIES

acres.WHEAT / none0 - 28500

28500. - 110000

110000 - 200000

20000 - 260000

260000 - 500000

Wheat (Approximate) Acres in 2008

Legend

COUNTIES

Barley acres0 - 6000

6100. - 16500.

16500.- 32000.

32000.- 66000.

66000. - 130000.

Barley Acres in 2008

0

5

10

15

20

25

30

35

40

45

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Wheat Yields Per Planted Acre

Actual Yield

0

5

10

15

20

25

30

35

40

45

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Wheat Yields Per Planted Acre

Actual Yield

Historical Average

0

5

10

15

20

25

30

35

40

45

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Wheat Yields Per Planted Acre and ACRE

Yield "Guarantee"

Actual Yield

Historical Average

Guarantee

0%

10%

20%

30%

40%

50%

60%

70%19

85

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

bu/a

cNorth Dakota Wheat Yield Payout

(% of ACRE Yield Guarantee)

Payout

Maximum payment

Value of Yield Guarantee

• Average payout = 3.5% of guarantee • At $5.00 per bushel price

– Average payout = $3.96 per acre – About 12 cents per expected bushel per planted

acre.

0

20

40

60

80

100

120

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Corn Yields Per Planted Acre

Actual Yield

0

20

40

60

80

100

120

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Corn Yields Per Planted Acre

Actual Yield

Historical Average

0

20

40

60

80

100

120

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Corn Yields Per Planted Acre and ACRE Yield

"Guarantee"

Actual Yield

Historical Average

Guarantee

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%19

85

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

bu/a

cNorth Dakota Corn Yield Payout

(% of ACRE Yield Guarantee)

Payout

Maximum payment

Value of Corn Yield Guarantee

• Average payout = 2.5% of guarantee • At $4.00 per bushel price

– Average payout = $6.05 per acre – About 7 cents per expected bushel per planted

acre.

0

5

10

15

20

25

30

35

40

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Soybean Yields Per Planted Acre

Actual Yield

0

5

10

15

20

25

30

35

40

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Soybeans Yields Per Planted Acre

Actual Yield

Historical Average

0

5

10

15

20

25

30

35

40

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Soybean Yields Per Planted Acre and ACRE

Yield "Guarantee"

Actual Yield

Historical Average

Guarantee

0%

5%

10%

15%

20%

25%

30%

35%

40%19

85

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

bu/a

cNorth Dakota Soybean Yield Payout

(% of ACRE Yield Guarantee)

Payout

Maximum payment

Value of Soybean Yield Guarantee

• Average payout = 6.0% of guarantee • At $8.00 per bushel price

– Average payout = $6.44 per acre – About 20 cents per expected bushel per planted

acre.

0

10

20

30

40

50

60

70

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Barley Yields Per Planted Acre

Actual Yield

0

10

20

30

40

50

60

70

1980 1985 1990 1995 2000 2005 2010

bu/a

cNorth Dakota Barley Yields Per Planted Acre

Actual Yield

Historical Average

0%

10%

20%

30%

40%

50%

60%

70%19

85

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

bu/a

cNorth Dakota Barley Yield Payout

(% of ACRE Yield Guarantee)

Payout

Maximum payment

Value of Barley Yield Guarantee

• Average payout = 3.5 % of guarantee • At $5.00 per bushel price

– Average payout = $6.30 per acre – About 12 cents per expected bushel per planted

acre.

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

Wheat Corn Soybeans Barley

$/a

cre

Value of an ACRE "Yield Guarantee"

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

Wheat Corn Soybeans Barley

$/a

cre

Value of an ACRE "Yield Guarantee" Relative to Direct Payments

Value of Yield Guarantee Value of Direct Payments

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

Wheat Corn Soybeans Barley

$/ac

re

Value of an ACRE "Yield Guarantee" Relative to 20% of Direct Payments

Value of Yield Guarantee 20% of Direct Payments

First Findings

• Yield portion of ACRE has value

• 20% of direct payments less than the “cost” of yield portion

• Could entice some farmers to sign up.

• But what about the price portion?

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Corn Soybeans Wheat Barley

$/bu

Prices Used to Set ACRE Price Guarantee

2007 2008 Estimated

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Corn Soybeans Wheat Barley

$/bu

Estimated 2009 ACRE Price Guarantee

ACRE Price

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Corn Soybeans Wheat Barley

$/bu

ACRE Guarantees vs Countercyclical Program Guarantee

ACRE Price CCP Trigger Price in 2010 CCP Trigger Price in 2009

Second Conclusion

• ACRE price guarantees much higher than CCP guarantees

• Higher guarantee increases likelihood of a payout

• How likely is it that price will trigger a payout under the two programs?– Need to look at 2009/10 projected season average

prices

4.05

4.10

4.15

4.20

4.25

4.30

4.35

4.40

4.45

4.50

Dec '09 Mar '10 May '10 July '10 Sept '10

$/bu

CBOT Corn Futures:Projected Marketing Year Price = $4.03

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Corn Soybeans Wheat Barley

$/bu

ACRE Guarantee and Projected 2010 Prices

ACRE Price 2009 Projected Price

Price Volatility

• We know that 2009/10 corn prices will not equal $4.03/bu

• Obtain market-estimated volatility from option premia– An at-the-money put option on Dec corn costs 50

cents per bushel– Price volatility = 33%

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00

$/bu

Market Estimate of the Distribution of Corn Prices in 2009/10

Average = $4.03

50% chance50% chance

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00

$/bu

Calculating the Chances of a Payout from Farm Programs

ACRE Price90% of ACRE Price

44% chance

ACRE put option worth 32 cents per planted bushel

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00

$/bu

Calculating the Chances of a Payout from Farm Programs

CCP Trigger Price

6% chance

CCP put option worth 5.4 cents per base bushel

What if Market Conditions Collapse

• Suppose projected corn prices drop by 35% to $2.62

• The ACRE price for 2009 largely locked in

• Maximum 10% annual drop in guarantee in 2010 and beyond

0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00

$/bu

Distribution of Corn Prices in 2009/10 with a 35% Market Collapse

LDP + CCP put option worth 20.1 cents per bushel

ACRE put option worth $1.10 per bushel

ACRE price guaranteeCCP Trigger Price

If Market Conditions Collapse

• Advantage to ACRE price guarantee even greater

• Limit on downward movement keeps ACRE advantage of price protection

• Eventually must be concerned with cap on payments and payment limitations

0.00

0.20

0.40

0.60

0.80

1.00

1.20

Corn Soybeans Wheat Barley

$/bu

Value of Price Guarantee from ACRE and CCP at Futures-Indicated Price Levels

ACRE CCP

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

Corn Soybeans Wheat Barley

$/bu

Value of Price Guarantee from ACRE and CCP with 35% Drop in Futures Prices

ACRE CCP

• Cannot simply add up the value of the yield guarantee and the value of the price guarantee

– Would understate value of ACRE guarantee because of double deductible

– Would overstate value of ACRE guarantee if prices and yields move opposite each other

But ACRE Guarantees Revenue

0

20

40

60

80

100

120

140

160

180

Wheat Corn Soybeans

$ m

illio

nTotal Expected LDP + CCP Payments and ACRE Payments:

Average Price at Futures-Indicated Levels

LDP+CCP ACRE

0

50

100

150

200

250

300

350

400

450

Wheat Corn Soybeans

$ m

illio

nTotal Expected LDP + CCP Payments and ACRE Payments:

Average Price at 35% Lower Level

LDP+CCP ACRE

0

50

100

150

200

250

300

350

Wheat Corn Soybeans

$ m

illio

nTotal Expected Payments from Traditional Programs and ACRE:

Average Price at Futures-Indicated Levels

Traditional ACRE

0

100

200

300

400

500

600

Wheat Corn Soybeans

$ m

illio

nTotal Expected Payments from Traditional Programs and ACRE:

Average Price at 35% Lower Level

Traditional ACRE

Summary of Findings

• ACRE unambiguously provides more average support than current farm programs

• The difference in farm support grows as market price drops

• Reasonably good chance that actual ACRE payment will be lower than loss in direct payment because prices will be high

Reasons for Not Choosing ACRE

• Lack of yield history– FSA could fix this by simply substituting county

average yields

• State yields do not track my yields– ACRE does not substitute for crop insurance, it

substitutes for CCPs and part of DPs

• Why not use the 20% of direct payments and buy more crop insurance rather than ACRE?

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

65 to 70 70 to 75 75 to 80 80 to 85

$/ac

reAdditional Benefit from Buying Up in Crop Insurance for

Cass County Wheat Producer

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

65 to 70 70 to 75 75 to 80 80 to 85

$/ac

reAdditional Producer Premium from Buying Up in Crop

Insurance for Cass County Wheat Producer

0.0

0.5

1.0

1.5

2.0

2.5

3.0

65 to 70 70 to 75 75 to 80 80 to 85

Return per Additional Dollar Paid for Increased Crop Insurance Coverage

0

2

4

6

8

10

12

Wheat Corn Soybeans

Return to ACRE per Dollar Given up in Direct Payments

High Price Low Price

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

65 to 70 70 to 75 75 to 80 80 to 85

A Comparison of Return per Additional Dollar Paid for ACRE and Crop Insurance

Crop Insurance ACRE