Cap and Trade: Impacts of H.R. 2454 on U.S. Agriculture

Cap-and-TradeImpacts of H.R.2454 on U.S.

Agriculture


Agriculture

March2010

Presented at the Commodity Classic March 3, 2010

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Cap-and-Trade Overview

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GH

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Emission Reduction

Emission Projections without Cap-and-Trade (EPA)

Emissions with Cap-and-Trade = "The Cap"

Costs

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Cost Drivers for Agriculture

BasicsCarbon Cap declines

Carbon price increases (free today)

Energy prices increase

Fuel and fertilizer prices increase = Cost of production increases

Freely distributed allowances to fertilizer industry help offsetfertilizer price increases until 2035

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Cost DriversThree BIG Questions

1. What is the carbon price?- Future energy demand- Alternative energy supply- Offset supply

2. What is the impact on energy prices?

3. How does that impact cost of production?...

(nominal $)2020 2030 2035

Carbon Price 31.75 64.83 92.64 Diesel (cents/gallon) 32.57 78.31 122.20 Natural Gas ($/thous.ft.3) 1.47 3.81 6.81

Cap and Trade Energy Price Impact (relative to reference case)

EIA Base

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U.S. Wheat Production Cost Impacts –(Avg. Farm)

*Does not include fuel or fertilizer efficiency increases beyond that assumed in the reference case. Source: Informa Economics, EIA and ERS

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2015 2020 2025 2030 2035

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Added Fertilizer Impact - (zero allowances)FertilizerTransport (Farm-Elevator/Processor)Fuel,Lube, and Electricity

$1.67 / 1.3% $2.67 / 1.6%$3.64 / 1.9%

$9.52 / 4.1%

$21.06 / 7.3%

$ per Acre / % of Reference Case Variable

Key Policy Message: Fertilizer allowances are critical.

The cost of cap-and-trade to the average wheat grower = $4/ac by 2025 and $21/ac by 2035.

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Example: Prairie Gateway Wheat Farm Budget -2025

Nominal$

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2025 Ref 2025 C&T 2025 C&T(no fert.

allowances)

$/A

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Revenue

Increase due to C&T

Other

Seed

Repairs

Fuel, lube, andelectricity

Fertilizer

Net Revenue$112/acre

Costs



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Cost Impacts Relative to Corn and Soybeans

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Corn Wheat Soybeans Corn Wheat Soybeans Corn Wheat Soybeans

205 bu/acre= $0.03/bu

48 bu/acre =$0.08/bu


215 bu/acre= $0.09/bu


56 bu/acre =$0.1/bu

226 bu/acre= $0.22/bu

52 bu/acre =$0.4/bu


1.2% 1.9% 1.2% 3.7% 4.1% 2.1% 7.8% 7.3% 3.3%

2025 2030 2035

Cos

t of P

rodu

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pact

s, $

/acr

e (c

ost a

bove

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Fuel,Lube, and Electricity Fertilizer Transport (Farm-Elevator/Processor) Added Fertilizer Impact - (no offset assumption)

w/Fert. Offset AssumptionYield Scenario/$perBu Impact

% Reference Variable Costs

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Conclusions

Impact on wheat production costs is less than corn but more than soybeans.

Impacts are minimal in the short-term; up until 2025.

Fertilizer allowance assumptions are critical.

On a regional basis:Short-term: impacts are higher in the Prairie Gateway due to energy used for irrigation.

Long-term: regions (e.g., Prairie Gateway and Northern Great Plains) and farmers with lower nitrogen based fertilizer usage will be at a distinct advantage.

Benefits: Carbon Offset Opportunities

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Carbon Offset Credits – What are they?

C&T creates a tradable market for GHG emissions

Agriculture is not a capped sector under C&T

However, by reducing carbon, agriculture can sell a carbon offset credit for every ton of GHG emissions reduced.

Sell these credits at the market carbon price to capped sectors.

Capped sectors use these credits just like allowances.

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How do I get carbon offset credits?0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

Afforestation of cropland /1Croplands shifted to perennial grasses

Conservation Buffers/2Restoration of wetlands

Conservation to No-Till /3Improved crop rotations and winter cover crops

Elimination of summer fallowImproved fertilizer manager

Use of organic manure and byproducts /4Improved irrigation management

Afforestation of pastureRangeland management

Improved use of fertilizersUse of organic manure

Planting of improved speciesGrazing management

CR

OPL

AN

D:

Land

-Use

Cha

nges

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ice

Cha

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Gra

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Land

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agem

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Carbon Sequestration Rates - Mt CO2e/ac

Average High Maximun

Source: USDA, CCX, DOE, Informa Economics

Key Policy Message: Methodology used to calculate SRs can have large impact on net farm revenues and potential cropland acreage shifts.

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What is the Revenue Potential? Practice Sequestration Rate 2012 2015 2020 2025 2030 2035

Mt CO2e/ac Carbon Credit - $/Acre * Afforestation of cropland /1 1.90 25 38 62 100 160 255 Croplands shifted to perennial grasses 1.25 19 25 41 66 105 167 Conservation Buffers/2 0.70 11 14 23 37 59 93 Restoration of wetlands 0.37 6 7 12 19 31 49

Conservation to No-Till /3 0.66 10 13 22 35 56 89 Improved crop rotations and winter cover crops 0.29 4 6 10 15 25 39 Elimination of summer fallow 0.15 2 3 5 8 12 20 Improved fertilizer manager 0.15 2 3 5 8 12 20 Use of organic manure and byproducts /4 1.28 20 26 42 67 108 172 Improved irrigation management 0.15 2 3 5 8 12 20

Afforestation of pasture 1.48 23 30 48 78 125 198 Rangeland management 0.37 6 7 12 19 31 49

Improved use of fertilizers 0.55 8 11 18 29 46 74 Use of organic manure 1.28 20 26 42 67 108 172 Planting of improved species 0.73 11 15 24 39 62 98 Grazing management 1.10 17 22 36 58 92 147

Carbon Price (nominal$/CO2e) 19 25 41 66 105 167

* Sequestration rates are discounted by 20% to reflect potential reversals. Source: USDA, CXX, DOE, IEA, Informa Economics.

Key Policy Messages: (1) Limitation on # of Re-enrollment periods will significantly impact potential revenues in the out years (2) Ability to stack carbon credits could add significantly to potential revenue opportunities

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Average No-Till Carbon Sequestration Rate by Region and Major Crop

HeartlandHeartlandHeartlandHeartlandHeartlandHeartlandHeartlandHeartlandHeartland

Northern CrescentNorthern CrescentNorthern CrescentNorthern CrescentNorthern CrescentNorthern CrescentNorthern CrescentNorthern CrescentNorthern Crescent

Northern Great PlainsNorthern Great PlainsNorthern Great PlainsNorthern Great PlainsNorthern Great PlainsNorthern Great PlainsNorthern Great PlainsNorthern Great PlainsNorthern Great Plains

Prairie GatewayPrairie GatewayPrairie GatewayPrairie GatewayPrairie GatewayPrairie GatewayPrairie GatewayPrairie GatewayPrairie Gateway

Eastern UplandsEastern UplandsEastern UplandsEastern UplandsEastern UplandsEastern UplandsEastern UplandsEastern UplandsEastern Uplands

Southern SeaboardSouthern SeaboardSouthern SeaboardSouthern SeaboardSouthern SeaboardSouthern SeaboardSouthern SeaboardSouthern SeaboardSouthern Seaboard

Fruitful RimFruitful RimFruitful RimFruitful RimFruitful RimFruitful RimFruitful RimFruitful RimFruitful Rim

Basin and RangeBasin and RangeBasin and RangeBasin and RangeBasin and RangeBasin and RangeBasin and RangeBasin and RangeBasin and Range

Mississippi PortalMississippi PortalMississippi PortalMississippi PortalMississippi PortalMississippi PortalMississippi PortalMississippi PortalMississippi Portal

© 2009 Informa Economics, Inc.

No Till Sequestration Rates(CO2e Tonnes per Acre)

0.61

CornSoybeansWheatCotton

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Distinction between Continuous and Rotational No-Till

0% 10% 20% 30% 40% 50% 60% 70%

Mississippi Portal

Prairie Gateway

Southern Seaboard

Eastern Uplands

Fruitful Rim

Basin and Range

Heartland

Northern Crescent

Northern Great Plains

US

Rice

Cotton

Wheat

Soybeans

Corn

Key Policy Message: Addressing additionality - Distinction btw continuous and rotational

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WheatNet Impact: Benefits of no-till – Costs

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Net Impact for Adopters (no adoption costs)

Net Impact for Non-Adopters

Cost for non-adopter (no offset revenue): $4/ac by 2025 and $21/ac by 2035.

Net Gain for no-till adopter (no adoption costs): $25/ac by 2025 and $51/ac by 2035.

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Net Impact for Adopters (w/ est. no-till costs)

Adopting no-till does not come without a cost (e.g., yield drag, equipment investment, risk).Net Gain for no-till adopter (with/ est. adoption costs): $17/ac by 2025 and $47/ac by 2035.

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Net Impact for Adopters (no adoption costs)Net Impact for Non-AdoptersNet Impact for Adopters (w/ est. no-till costs)Net Impact for All Wheat (w/ est. no-till costs)

Not every wheat farmer will be able to practice no-till.

Net Industry Gain (w/ no-till as only offset): $4/ac by 2025 and $35/ac by 2035.

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Example: Prairie Gateway Wheat Farm Budget

Nominal$

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2025 Ref 2025 C&T 2025 C&T(no fert.

allowances)

$/A

cre

Carbon Credit

Revenue

No-till Costs

Increase due to C&T

Production Costs


Costs



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Conclusions (no-till)

Wheat has a larger potential gain than corn but smaller than soybeans.

On average, U.S. wheat producers could benefit by approximately $35/acre from cap-and-trade by 2035.

Some farmers/regions will not benefit to the same degree as others --- benefit will primarily be driven by the carbon SR.

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There are opportunities other than no-till Practice Sequestration Rate 2012 2015 2020 2025 2030 2035

Mt CO2e/ac Carbon Credit - $/Acre * Afforestation of cropland /1 1.90 25 38 62 100 160 255 Croplands shifted to perennial grasses 1.25 19 25 41 66 105 167 Conservation Buffers/2 0.70 11 14 23 37 59 93 Restoration of wetlands 0.37 6 7 12 19 31 49

Conservation to No-Till /3 0.66 10 13 22 35 56 89 Improved crop rotations and winter cover crops 0.29 4 6 10 15 25 39 Elimination of summer fallow 0.15 2 3 5 8 12 20 Improved fertilizer manager 0.15 2 3 5 8 12 20 Use of organic manure and byproducts /4 1.28 20 26 42 67 108 172 Improved irrigation management 0.15 2 3 5 8 12 20

Afforestation of pasture 1.48 23 30 48 78 125 198 Rangeland management 0.37 6 7 12 19 31 49

Improved use of fertilizers 0.55 8 11 18 29 46 74 Use of organic manure 1.28 20 26 42 67 108 172 Planting of improved species 0.73 11 15 24 39 62 98 Grazing management 1.10 17 22 36 58 92 147

Carbon Price (nominal$/CO2e) 19 25 41 66 105 167

* Sequestration rates are discounted by 20% to reflect potential reversals. Source: USDA, CXX, DOE, IEA, Informa Economics.

Fertilizer Management = + $20/ac by 2035

Elimination of Summer Fallow = + 20/ac by 2035

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Examples of Other Offset Opportunities

Elimination of Summer Fallow/Cover CropBenefits $20/acre carbon payment (2035). Reduced erosion If using a cover crop,

Reduction in weed, pest and disease pressuresIf cover crop is a legume, can help fix nitrogen in the soil$39/acre carbon payment if using a cover crop (2035)

CostsReduced moisture – summer fallow is often used to store water in soil prior to seeding Planting costs if using a cover crop

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Examples of Other Offset OpportunitiesImproved Fertilizer Management

Benefits $20/acre carbon payment (2035).

Costs

Improved fertilizer management could include:Systems to better match supply and demandSub-surface applications Use of ammonium nitrogen sources not mobile forms of nitrogen such as nitrate and urea Use of advanced fertilizers, examples:

Slow release fertilizers Stabilized nitrogen fertilizers A nitrification inhibitor

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Conclusions – Carbon Offset Opportunities

There are a number of potential revenue opportunities available to farmers under C&T.

If structured properly, C&T could benefit a large number of wheat farmers.

However, not everyone will benefit to the same level.

Legislation is not open or closed to additional opportunities.

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Top Policy Issues

Allowances to fertilizer industry are critical in keeping production cost impacts down

Methodology used to calculate SRs can have large impact on net farm revenues and potential cropland acreage shifts.

Clearly establish minimum set of offset practices. The Bill should establish the current list of offset practices as a minimum set – not as examples.

Limiting the number of offset credit periods in which a producer can re-enroll their offset practice will limit offset credits available to farmers in later years when the cost impact of cap-and-trade is greatest.

Renewable Electricity Standard

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Renewable Electricity Standard (RES)

C&T creates a federal RES, which requires 20% of electricity by 2020 to be from renewable sources.

Creates increased demand for wind, solar and renewable energy crops.

Potential to increase revenues, in certain scenarios.

Currently enacted state RESs mitigate demand increase due to C&T.

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Reference Scenario(No Cap-and-Trade)

Reference Case Renewable Electricity Generation

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2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

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kwh)

Wind Solar Wood and Other Biomass Municipal Solid Waste Geothermal Conventional Hydropower

Source: EIA

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Biomass Contributes Largest Share of Increase under C&T

Additional Renewable Energy Generation by Source (Basic - Reference)

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2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

Elec

tric

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ener

atio

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illio

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low

atth

ours

)

Wind Solar Wood and Other Biomass Municipal Solid Waste Geothermal Conventional Hydropower

Infrastructural issues limit further wind expansion. Other gov’t programs, such as BCAP improve biomass

economics

Source: EIA

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RES Impact on Agriculture

2020 Total Renewable Electricity Increase171 billion kwh

2020 Biomass 161 billion kwh = 32 million tons;

Electricity: $15.7 billion

Additional Energy Crop Acres1.6-4.8 million

Scenario Assumptions:

Energy crops account for 50-75% of biomass increase

Energy crop yields of 5-10 dry tons/acre

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Specific Case StudyKansas Wheat – Switchgrass Example

2011 2012 Year 3-10SWITCHGRASS CASH FLOWYield 1.50 4.59 6.70 FARMGATE COSTS (includes labor)Establishment Costs ($/acre) 52.40 13.44 -

Establishment Costs 209.62 53.76 - BCAP 157.21 40.32

Production Costs ($/acre) 65.34 164.40 283.80 Farmgate Costs ($/acre) 117.75 177.84 283.80 GROWER REVENUE Grower Payment ($/acre) 39.40 110.27 250.68

Grower Payment ($/ton)* 26.27 24.02 37.22 BCAP Payments ($/acre) 39.40 110.27 36.26

BCAP Matching Funds 39.40 110.27 BCAP Annual Payment ** 36.26

Carbon Payment ($/acre) - 20.06 31.37 Grower Revenue ($/acre) 78.80 240.61 318.31 NET RETURNSNet Return ($/acre) (38.95) 62.77 34.52 * Based on a delivered feedstock price of $50/ton** Payments distributed through 2017

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Specific Case StudyKansas Wheat – Switchgrass Example

Average Annual Return ($/acre) NPV 2011-2020

Prairie Gateway Wheat@ Avg. Yields 56.89 409.17 @ Yields 20% below Avg. 11.94 87.70

SwitchgrassBase Scenario (Delivered Feedstock =$50/ton) 30.00 221.50 Delivered Feedstock =$60/ton 111.82 799.09 Delivered Feedstock =$40/ton (52.16) (359.27)

Acreage Shift Implications

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Acreage Shift Assessment

1. Early on, the majority of the acreage shifts due to afforestation will likely come from pastureland.

2. Initially, the majority of cropland shifts will be to perennial crops, with the exception of certain regions where barriers to entry for forestry are lower.

Increased demand for forage and energy crops (RES, RFS, and pasture shift)Less riskAdditional income streamLower start-up costsCultural reasons – “Farming as a way of life”

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Acreage Shift Assessment

3. As the carbon price increases, particularly in the years beyond 2035, more cropland can be expected to go into forestry.

4. Yet, even at higher carbon prices (up to 2035), prime cropland will not shift to forestry or perennial crop production.

5. Regions and crops with larger net returns can expect to see less acreage shifting to these alternative carbon crops than regions with lower net returns.

Wheat acreage can be expected to decline the most relative to corn and soybeans

Potential Carbon Revenue Opportunities for Livestock

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Enteric Fermentation

Enteric fermentation emissions are twice as large a market as GHGs from manure.

Ruminant animals are the source for over 95% of enteric fermentation emissions = Greater potential to gain carbon credits for emission reductions.

GHGs must be lowered through increased efficiencies in production, changing feed rations, or adding additives to the feed ration.

Potential to reduce enteric fermentation via an additive is approx. 25% .

Feedlots that feed steers for 150 days would receive $2.24 per head revenue by adding an additive.

Cost of additive?

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2007 CH4 Emissions from Enteric Fermentation

Sheep1%

Swine1%

Goats0%

Horses3%

Beef72%

Dairy23%

Source: USDA “Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990 –2007”

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Manure Management

Dairy and swine have the greatest opportunity to reduce the GHG emissions through manure mgmt.

Most feedlots and poultry operations are dry collection systems.Limited opportunity from runoff of dry systems.

The two main methods to reduce GHG off of manure:Methane digesters

Large investment costs currently limit its adoption to large operations. Future energy prices will influence economics of methane digesters.

Burning/flaring off the methane Less capital intensive Doesn’t generate energy byproduct.

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Industry Revenue Opportunities

Dairy has the greatest opportunity to capture carbon revenues via C&T legislation.

Poultry operations have few opportunities Swine operations will have some opportunities to

benefit via manure mgmt changes. Feedlots will have some opportunities to benefit via

reductions in enteric fermentation emissionsCow/Calf sector – landowners have more options –

reduces supply to feedlots

EPA Regulated Scenario

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EPA Regulated Scenario Background

Under the Clean Air Act (CAA), any entity that has the potential to emit more than 100 tons of a regulated pollutant must obtain a permit to operate.

In 2007, the Supreme Court, in Massachusetts v. EPA, ordered the EPA to determine whether heat-trapping gases harmed the environment and public health.

On December 7, 2009, the EPA announced its determination that GHGs "threaten the public health and welfare of the American people,"

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EPA Regulated vs. C&T Scenario

Cap-and-Trade is more efficient than direct regulation = Higher production cost impacts.

Direct Regulation does not offer agricultural producers additional revenue opportunities from carbon offsets.

EPA regulations could result in the direct regulation of agricultural producers’ GHG emissions; whereas, current cap-and-trade legislation excludes agriculture from GHG emission regulations.

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EPA Regulated Scenario Cost Impacts

2025 Example

At minimum – impacts presented for cap-and-trade2025 = $3.64/acre increase

Plus …No fertilizer allowances (adds $3.39/acre)

No offsets to mitigate carbon price or as a revenue opportunity

Inefficiency cost – direct reg. is less efficient than market based approach

Direct ag regulation adds a cost of compliance

Production cost impacts could potentially be multiple times morethan that of cap-and-trade, with no offset revenue opportunity.

Final Thoughts and Conclusions

For additional information, please contact :

Juan SacotoSenior Vice President; [email protected]

Crystal CarpenterConsultant; [email protected]


Agriculture


Agriculture

March2010

Presented at the Commodity Classic March 3, 2010

48

News & Politics

Cap and Trade: Impacts of H.R. 2454 on U.S. Agriculture