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Countercyclical payments     Send a link to a friend

[AUG. 19, 2003]  URBANA -- Producers might want to consider three strategies as a starting point for dealing with questions created regarding federal countercyclical payments that might be made for corn, soybean and wheat crops, said a Purdue University Extension marketing specialist.

"Unfortunately, there are not market solutions to offset these uncertainties created by the mechanism of payments under the current farm program," said Chris Hurt. "Here are three strategies that producers might 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 countercyclical 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 in the last option, Hurt added, is that rising futures may reasonably protect losses of countercyclical payments, but falling futures cannot be offset in gains of countercyclical prices beyond their maximum.

He noted that other 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 countercyclical payments clearly need to understand the implications if futures prices should rise or fall," he said.

Such concerns are raised as the market continues to weigh the surprisingly small production numbers for this fall's corn and soybean crop contained in the last USDA estimate. One of the topics that market strategists are rethinking is how the new countercyclical 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 Aug. 12 wheat supply and demand updates from USDA will illustrate the price vulnerabilities that could face corn and soybean producers this fall," said Hurt.

Countercyclical 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 cents in 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," said Hurt.


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"Look at what happened to wheat on Aug. 12, when USDA raised its estimate of the average farm price for the 2003-04 marketing year by 30 cents per bushel. On July 9, a central Illinois elevator's wheat bid was $2.90 per bushel, and the midpoint of the USDA's estimate of the average farm price was $3.10 (range $2.80 to $3.40). An individual who priced his or her wheat on this date near harvest would net $2.90 from the market and have an anticipated countercyclical payment of an additional 24 cents per bushel -- $3.10 minus $3.34."

As of the August report, however, the USDA increased its estimate of the midpoint 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 would now have no anticipated countercyclical payment.

"It is important to note that this potential loss of 24 cents per bushel of countercyclical 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 countercyclical payments," said Hurt.

Hurt examined the implications of the wheat scenario for corn and soybeans. Countercyclical payments for corn will be made if the average farm price falls in a range from $1.98 to $2.32. The midpoint of the August USDA price range is $2.20 per bushel (range $2 to $2.40). That would suggest 12 cents of countercyclical payments.

"If market prices for corn should prove bearish this year, countercyclical payments could increase to as much as 34 cents per bushel, and if the price pattern proves more bullish than the midpoint of current USDA estimates, the countercyclical payment could fall to zero," said Hurt.

For soybeans, countercyclical payments will be made if the average farm price falls in a range of $5 to $5.36 per bushel. The midpoint of the current USDA price estimate for the 2003-04 marketing year is $5.05 (range $4.55 to $5.55). This would suggest a 31-cent-per-bushel countercyclical payment at this time, near the maximum of 36 cents per bushel.

"For corn, anticipated countercyclical payments are already reasonably small," said Hurt. "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 or less.

"On the other hand, the potential price impact per bushel on soybeans is larger. Anticipated countercyclical payments are already near a maximum, with the potential they could drop to zero. Thus, the incentive to attempt to protect soybean countercyclical payments may be larger."

[University of Illinois news release]

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