August 18, 2003
ABOUT COUNTER CYCLICAL PAYMENTS
to the surprisingly small production numbers for this fall's corn and soybean
crop are still being digested. One of the topics that market strategists are rethinking
is how the new counter cyclical payments program will fit into the marketing plan
this fall and especially what price vulnerabilities or opportunities are created
by this new program. Recent changes in the August 12 wheat supply and demand updates
from USDA will illustrate the price vulnerabilities that could face corn and soybean
producers this fall.
First the quick review. Counter
cyclical payments are made when the 12 month (marketing year) national average
price received by farmers falls in a range between the national loan (on the low
side) and the target price minus the direct payments on the high side. For wheat
these boundaries are $2.80 per bushel (national loan) and $3.34 per bushel ($3.86
target minus $.52 direct payment). The vulnerability arises because the level
at which an individual prices may be substantially different than the national
average price for the entire marketing year.
at what happened to wheat on August 12 when USDA raised their estimate of the
average farm price for the 2003 to 2004 marketing year by 30 cents per bushel.
On July 9 a central Illinois elevator's wheat bid was $2.90 per bushel and the
mid-point of the USDA's estimate of the average farm price was $3.10 (range $2.80
to $3.40). An individual who priced their wheat on this date near harvest would
net $2.90 from the market and have an anticipated counter cyclical payment of
an additional $.24 per bushel ($3.10 minus $3.34).
of the August report, however, the USDA increased their estimate of the mid-point
of the average farm price estimate for the 2003 to 2004 crop to $3.40 (range $3.10
to $3.70). An individual who sold out of the field would net $2.90 from the market,
but now have no anticipated counter cyclical payment. It is important to note
that this potential loss of 24 cents per bushel of counter cyclical payments has
nothing to do with USDA, but rather with market forces that can quickly change
farm prices, and the manner in which Congress decided to calculate the counter
What are some implications for
corn and soybeans? Counter cyclical payments for corn will be made if the average
farm price falls in a range from $1.98 to $2.32. The mid-point of the August USDA
price range is $2.20 per bushel (range $2.00 to $2.40). This would suggest 12
cents of counter cyclical payments. If market prices for corn should prove bearish
this year, counter cyclical payments could increase to as much as 34 cents per
bushel, and if the price pattern proves more bullish than the mid-point of current
USDA estimates, the counter cyclical payment could fall to zero.
soybeans, counter cyclical payments will be made if the average farm price falls
in a range of $5.00 to $5.36 per bushel. The mid-point of the current USDA price
estimate for the 2003 to 2004 marketing year is $5.05 (range $4.55 to $5.55).
This would suggest a 31 cent per bushel counter cyclical payment at this time,
near the maximum of 36 cents per bushel.
anticipated counter cyclical payments are already reasonably small. The most that
can be lost is 12 cents per bushel if subsequent prices rise, with the possibility
that they could increase to 34 cents if the average yearly price falls to $1.98
On the other hand, the potential price
impact per bushel on soybeans is larger. Anticipated counter cyclical payments
are already near a maximum with the potential they could drop to zero. Thus, the
incentive to attempt to protect soybean counter cyclical payments may be larger.
there are not market solutions to offset these uncertainties created by the mechanism
of payments under the current farm program. However, as a starting point, here
are three strategies to ponder. First, most producers will strive to do their
best job of pricing their corn and soybeans with no follow-up strategy to attempt
to outguess the counter cyclical payments. A second strategy would be to diversify
pricing throughout the marketing year, so that an individual's price received
would be reasonably close to the season average in their area. Finally, those
who price substantial portions of their crops around harvest or early in the marketing
year could follow-up by buying futures or call options on a portion of their crop
sales. The difficulty here is that rising futures may reasonably protect losses
of counter cyclical payments, but falling futures cannot be offset in gains of
counter cyclical prices beyond their maximum.
option strategies such as vertical call spreads could also be used, but each strategy
has its complications. Therefore, those who alter their pricing strategy to use
futures and options to attempt to protect counter cyclical payments clearly need
to understand the implications if futures prices should rise or fall.