The risk of a trade disruption for American Agriculture

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 Use of Enterprise Units in Crop Insurance

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:

  • Basic unit – All insurable acreage of the insured crop in the county on the date coverage begins for the crop year: (1) In which a producer has 100 percent crop share; or (2) Which is owned by one person and operated by another person on a share basis.
  • Optional Unit – Subdivision of basic unit.
  • Enterprise unit – All insurable acreage of the same insured crop or all insurable irrigated or non-irrigated acreage of the same insured crop in the county in which a producer has a share.

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

The Four Percent Rule of Crop Insurance

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

Where have the Generic Acres Gone? Where will they go?

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

  • With projected declines in soybean and corn ARC payments in the future, perhaps these crops will become less attractive for generic base planting.
  • With the cotton industry push for a cottonseed program, what will become of the generic base is a key question for the farm bill.
  • Generic base was born of the ‘planted acre versus base acre’ debate during the last farm bill and will be integral to that conversation again.

[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

Sorting Through Big Ag Data Part 2

  • Many are concerned with the privacy issues associated with precision agriculture data. These are real concerns.  I have worked with private farm data all my career, but precision maps are a particularly difficult kind of data to protect as geo-referenced maps can be quickly matched with other geo-located files and identities revealed.  Because of the size of data and for security reasons, I think we will see this data storied securely and rather than sharing data sets, and analysts will come to the data, run analysis, and walk away with results only.
  • Many producers will interact/share data with various machinery companies, input suppliers, consultants and others. Some will want to lock you into their system, and many producers are faced with the challenge of moving information such as a field boundary map or fertility prescription to various users.  Producers need a safe place to store this data, and seamless means to move this information to fertilizer applicators, USDA/FSA.  I am proud that Mississippi State University is a founding member of the Ag Data Coalition that involves farm organizations, agribusiness firms, and universities committed to helping producers control and utilize their data.  I encourage you to check it out at http://agdatacoalition.org/
  • Getting advice from a black box. It seems that almost every input supplier now has an app or software that is designed to help farmers make decisions.  In some cases, these are going to be really useful farm management tools.  There are some that impress me a lot. I also believe that some are way to entice farmers to give data to service provider or to make it difficult to leave a service provider.  I am also struck by the similarity of the sales pitches made by some big data based decision aids and that of the market advisory services that have a great sales pitch but when evaluated, have no better results than flipping a coin.
  • I just helped organize a conference on big ag data at the Agricultural and Applied Economics meetings. We had big name speakers from many disciplines speak.  In the end, there are limits on what one can learn from unstructured ag data that may not include some really important variables.  Using machine learning to find correlations among millions of records can lead to new discovery, but it can also find spurious correlations that may lead to bad decisions.  We will still need well designed statistical studies to answer some big questions about causation.
  • Big data begs several policy questions such as rural broadband access, funding for research on the topic, and the role of USDA data collection. I once worked at USDA and saw the hard work that goes into collecting agricultural data that is unbiased and statistically sound.  However, over my entire career I have watched as hundreds of ‘experts’ make a living claiming to know better than the USDA reports.   What you can’t find is a multitude of studies assessing the accuracy of these experts like one can find for the USDA reports.  I think we are beginning to see a new wave of ‘we know better than USDA’ business models that charge a fee and have not been verified to really be better.  Let the buyer beware, and let’s remember why USDA was asked to do these reports – to insure everybody in the ag sector had equal access to market information.

Sorting Through Big Ag Data Part 1

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.

  • Your farm data has value to you, but don’t buy all the hype. Your data has value to you if it helps you make decisions that make you more money. But remember, this will be true only if it really is better than what you already knew.  For example, does a variable rate technology map make a difference is a very uniform field?  Probably not.  Another possibility is if you get information faster. But again, is there a critical decision that makes use of the timelier data?
  • Many talk of the 4 V’s of big data – volume, velocity, variety, and veracity. Volume because of the sheer quantity of data being generated by our farms.  Velocity, reflecting the speed at which data arrives. Variety reflecting the wide array of data – images, sensor readings, numerical data etc.  Finally, veracity reflecting that much of the data produced is of poor quality due to a lack of calibration or some other reason.  Bad data= bad decisions.
  • Your farm data has value to others. Machinery companies can learn how to build a better combine, a seed dealer can learn how a variety performs in actual field conditions, or a company can use your neighbor’s data to benchmark your farm against peers.  However, Terry Griffin of Kansas State points out that data is not like most goods.  If I use a gallon of gas, you can’t have it.  It’s gone.  But I can use my farm data and I can give it or sell it to others and they can use it too.  I think we are beginning to see that it is often not individual data but aggregated data that may be what has the greatest value anyway.
  • The question of data ownership is a murky legal territory. What is paramount for producers to understand is that data contract and the associated fine print are important.  In many ways this is what determines who has access to your farms data.  I recommend you check out the Ag data transparency evaluator at http://www.fb.org/agdatatransparent/  Rather than ownership perhaps the useful concern is who has access to my data.

Will farm programs be cut even before the next farm bill starts?

I had the privilege of serving as a chief economist for the U.S. Senate Committee on Agriculture, Nutrition, and Forestry during the last farm bill debate.  The cost of legislation was paramount with the mandated goal of reducing the Congressional Budget Office (CBO) score of the bill.  Roughly speaking all the program crops were asked to take about a 30% reduction in the CBO estimate of farm program spending.  Note that CBO looks forward 10 years and compares the cost of new legislation to a continuation of existing legislation.  One must also understand that the CBO agricultural baseline changes from year to year as market conditions change.  One should understand predicting program costs that far into the future is a highly imprecise process.

Many groups have turned their attention to the expiration of this bill.  So it is fair to ask where will the baseline for the big three farm support programs (ARC, PLC, crop Insurance) be at when CBO is asked to score a new farm bill.  Figure 1 shows the March 2016 CBO baselines for County ARC, PLC, and crop insurance.  Examining this chart, one can see that from 2018 on:

  • CBO assumes that at expiration of this bill producers will be allowed a ‘do over’ on the ARC vs PLC choice. Some switch from ARC to PLC is expected.
  • Crop insurance is projected to increase slowly and average around $9 billion/year.
  • PLC a program widely adopted by rice, peanuts and a substantial amount of wheat is projected to remain at around $3 billion/year in out years.
  • County ARC annual cost is expected to slide 85% from a peak of $6 billion to around $1 billion. This especially affects corn, soybeans and some wheat producers. This is primarily due to the fact that the 5-year Olympic average price used in ARC will fall dramatically as the high prices of a few years ago are dropped.
  • The baseline is likely to shrink in the next 24 months primarily due to dropping the recent high ARC payment levels and replacing them with out-years with lower payment levels. For example, the $6,099 Billion for ARC in 2017 will likely be replaced with a value near one billion. This reduces money available for the next farm bill.

 

CBO Baseline 2016

 

So what does this mean?

  • Crop insurance will likely remain a focal point for policy because it is the biggest pot of funds. That also means it will be attached as a source of funds for other programs.
  • Three commodities are facing dramatic declines in baseline funding – corn, soybeans, and to a lesser degree wheat.
  • Participation rates affect these outcomes. For example, the fact that actual STAX participation has been below what CBO expected, means expected increases in cotton crop insurance program cost in the last farm bill did not materialize.

 

The ARC County Yield Problem – Not if, But When and Where

The county yields plugged into the Agricultural Risk Program (ARC) calculation have come under fire recently for perceived inaccuracy and varying dramatically across nearby counties.  I was there when the last farm bill was written, there were concerns about the county yields, but a lot of people – Hill staffers, farm groups, and political appointees said surely the USDA can find a way to do this.  Basically, this is a statistical problem and most of us hate statistics. I will try to shed some light here.

Be careful what you wish for

NASS uses a statistically survey approach to estimating yield. It is probably about as cost effective as one can approach the task.  Pollsters, marketing firm, and researchers use these techniques all the time. But here is what you must know.  NASS reported hundreds of county corn yields and then crop reporting districts, state, and national aggregates for 2015.  Note also NASS did not report other counties due to small samples.  The fundamentals of statistical surveying imply the accuracy of NASS estimates increases with each higher level of aggregation.  The bottom line is while state and national numbers are highly credible in most cases, lower levels will simply be less accurate.  Well-established rules of survey sampling dictate the primary way to get better NASS county yield estimates is to send more surveys into the county which will cost money and will necessitate greater respondent burden.  This is an increasing problem over time as there are fewer farmers to be surveyed.  So even if attempted it might not work.

RMA data is great – where there is a lot of it

What about RMA data?  RMA does collect yields from participants and in many locations reaches 80 to 90 percent participation rates.  But participation is not as randomized like the NASS survey, and in a county with an 80% participation rate one may ask what are the characteristics of the 20% not in the program.  Are they the best yielding farms or the worst or neither?  I am unaware of research that answers this question.  I will note the RMA has develop their own county yield estimates for use in area insurance products including STAX and SCO.  But they also encounter counties with limited crop insurance participation and thin data.

Statistical stews

Note that RMA does not mix NASS and their own data so that the historical benchmark is consistent with the covered year.  I have looked at this some in the past and the RMA and NASS data often do not seem to match up.  The RMA data was sometimes lower and sometimes higher than NASS yields.  When NASS and RMA are mixed, you get a statistical stew that probably no one can sort out.

Farmers prefer individual protection if they can get it

Even if we get amazingly accurate county estimates will it be enough? I doubt it.  It is pretty clear farmers want protection that is very highly correlated with their own yield – so the county triggers when the farm needs it.  In 2014 before the introduction of STAX and SCO only two percent of crop insurance acres where insured with area insurance plans.  Why? In part, there are real and perceived variation of yields within counties.  A grad student in our department just defended a thesis showing a dramatic lack of correlation of farm yield with county yields in some counties.  In one county, she found the farm-county yield correlation ranged from 0.18 to 0.93 (perfect would be 1.0).  At 0.93 you have a pretty good risk management tools.  At 0.18 you are pretty close to having payments with no relationship with farm losses.  Remember ACRE with a state trigger was adopted in 2008.  The fix was county yield in 2014.  What next?

A jumpy clutch  

My Dad started me on a Farmall Super C tractor.  It had what he called a jumpy clutch, which meant it went from disengaged to engaged in what felt like a ¼ inch of release.  Many fail to recognize that ARC goes from no payment to maximum payment with a 10% change in revenue.  This mimic a design that my colleagues Barry Barnett and Steve Martin drew up for Steve’s dissertation many years ago.  This differs from crop insurance the triggers at a given coverage and then reaches maximum payment at zero yield.  The 10% range in ARC makes payments react quickly to slight differences in county yield. So county A has a revenue 14% below average and neighboring county B has a revenue 5% worse.  County A gets zero ARC payment and County B gets half the maximum.

‘Fair Boundaries’

The average county in the United States is 997 square miles while the largest county in the lower 48 states is San Bernardino County California at 20,105 square miles.  In Oregon the largest county is 23 times larger than the smallest county. All this just points out that counties in the U.S. are not defined in anything like equitable agricultural regions.  This impacts the magnitude of payments and the correlation of farm-county yields. County size matters but so does crop acreage and heterogeneity within the area.

So what next?

Does USDA need to produce three slightly different county yields – the NASS, RMA, and FSA number?  Compromises in the farm bill probably created some of this confusion.

Georeferenced data may help a lot someday. That day is nearing as USDA migrates to using more common land unit information for RMA and FSA.  Layering of soil, crops and other information may give us the ability define areas based more sophisticated grouping.  Here at Mississippi State we are working with National Commodity Crop Productivity Index (NCCPI) data that makes me hopeful.

But in the end, declining price guarantees in the ARC Olympic average for 2017 and beyond may make this a less important issue anyway.  The Congressional Budget Office projects a dramatic decline in ARC payments for many crops for the 2017 year and beyond.  This means less likely payments and smaller payment if they do occur.

Regional Differences in Crop Insurance Base Rates

Base county rates reflect the starting point for crop insurance rates for an insured crop in a particular county.  A particular insured unit’s rate will be derived by adjusting the base county rate to reflect yield versus revenue coverage, coverage level, unit structure, and unit APH relative to base county yield.  Differences in base county rates reflect differences in yield risk derived from historical crop insurance losses.  Figures 1-4 reflect the 2016 base rates for corn, cotton, rice, and soybeans.  A lower base rate reflects a less risky region.  Often large contiguous areas have similar risk levels.  Also, a low yield risk crop such as rice has generally lower rates than other crops.

Figure 1
Figure 1
Figure 2
Figure 2
Figure 3.
Figure 3.
Figure 4.
Figure 4.

A National Look at Crop Insurance Subsidy Per Acre

 

Lots discussion of crop insurance subsidy these days.  Here is a breakdown of county average subsidy/acre in 2015.  The average for the county is a function of the crops grown in the county.  Generally highest values are in specialty crop regions. (Note some insurance programs are not reported by acre and are not included.)2015 subsidy per acre