Risk-Free Farming? Risk-Return Analysis of Soybean Farming under the 2002 Farm Bill

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Risk-Free Farming?
Risk-Return Analysis of Soybean Farming
under the 2002 Farm Bill
Bruce A. Babcock
Center for Agricultural and Rural
Development
Iowa State University
Risk and Return in a Free-Market
Economy
• Capitalism works when those with capital
are induced to invest by the expectation of
a higher return on invested capital than on
non-invested capital.
Risk-Return Tradeoff
Expected
Return
Risk
Are Farm Programs CounterProductive?
• One justification for farm programs is that
U.S. farmers need support because of
their exposure to a great amount of risk.
• But won’t a reduction in risk also reduce
expected returns?
• Perhaps, but farm programs also
increased expected or average returns.
Structure of Program Payments
for Soybeans
Target Price
Not
Tied
To
Prod
Prod
Req.
$5.80
Regardless
Of Market
Fixed
Payment
$0.44
$5.36
Counter-Cyclical
Payment
Loan Rate
Only If…
Loan Deficiency
Payment
$5.00
2004 Acres Insured in Iowa
7,000,000
6,000,000
5,000,000
4,000,000
CORN
SOYBEANS
3,000,000
2,000,000
1,000,000
0
Actual
Production
History
Crop
Revenue
Coverage
Group Risk Group Risk
Income
Plan
Protection
Income
Protection
Revenue
Assurance
Insurance Coverage by Iowa Farmers in 2004
3,500,000
3,000,000
2,500,000
2,000,000
CORN
SOYBEANS
1,500,000
1,000,000
500,000
0
50
55
60
65
70
75
80
85
90
Distribution of Local Soybean Prices at Harvest 2005
Nov 2005 CBOT Price= $5.80, Expected local basis = $0.30)
450
400
300
250
200
150
100
50
$/bu
9.
4
M
or
e
8.
6
7.
8
7
6.
2
5.
4
4.
6
3.
8
3
2.
2
1.
4
0
0.
6
Probability
350
Distribution of Soybean Yields in Webster County
(Expected Yield = 45 bu/ac)
0.07
0.06
0.04
0.03
0.02
0.01
bu/acre
78
72
66
60
54
48
42
36
30
24
18
12
6
0
0
Probability
0.05
Distribution of Harvest-Time Net Market Revenue
Variable Costs = $130/acre
0.1
0.09
0.08
Probability
0.07
0.06
0.05
0.04
0.03
0.02
0.01
0
-50
10
70
130
190
$/acre
250
310
370
Distribution of Harvest-Time Net Market Revenue Plus
Direct Payments
0.1
With direct
payments
0.09
0.08
Probability
0.07
0.06
0.05
0.04
0.03
0.02
0.01
0
-50
10
70
130
190
$/acre
250
310
370
Distribution of Harvest-Time Net Market Revenue Plus
CCPs
0.1
With
countercyclical
payments
0.09
0.08
Probability
0.07
0.06
0.05
0.04
0.03
0.02
0.01
0
-50
10
70
130
190
$/acre
250
310
370
Distribution of Harvest-Time Net Market Revenue Plus
LDPs
0.1
0.09
With LDP
0.08
Probability
0.07
0.06
0.05
0.04
0.03
0.02
0.01
0
-50
10
70
130
190
$/acre
250
310
370
Distribution of Harvest-Time Net Market Revenue Plus
DP, CCP, and LDP
0.10
With DP, CCP,
LDP
0.09
0.08
Probability
0.07
0.06
0.05
0.04
0.03
0.02
0.01
0.00
-50
10
70
130
190
$/acre
250
310
370
Distribution of Harvest-Time Net Market Revenue Plus RA
0.16
With Revenue
Assurance at 75%
Coverage
0.14
Probability
0.12
0.10
0.08
0.06
0.04
0.02
0.00
-50
10
70
130
190
$/acre
250
310
370
Distribution of Harvest-Time Net Market Revenue Plus
DP, CCP, LDP, and RA
0.14
0.12
Probability
0.10
0.08
0.06
0.04
0.02
0.00
-50
10
70
130
190
$/acre
250
310
370
Effects of Government Programs
• With no government programs, probability
of negative net revenue is about 5% (1 in
20 years).
• With government programs probability of
net revenue less than $60/acre is less
than 1%; probability of net revenue less
than $70/acre is less than 5%.
• Average net revenue increases from
$114/ac to $145/ac.
Effect of Programs on Wheat
28%
24%
Probability
20%
With All Government
Support
16%
12%
8%
4%
0%
-60
-30
0
30
60
90
120
150
180
210
240
Market Receipts Less Variable Costs ($/ac)
270
300
330
Effects of Government Payments on Cotton
28%
24%
With All Government
Support
Probability
20%
16%
12%
8%
4%
0%
-400 -300 -200 -100
0
100
200
300
400
500
600
Market Receipts Less Variable Costs ($/ac)
700
800
900
Effects of Government Programs
on Iowa Cash Renters
• Cash rents will increase due to the
increase in expected returns.
• Cash rent is also a variable cost of
production.
• How much will cash rents increase?
– Depends on returns to corn land.
Effect of Government Programs on Corn
0.12
Probability
0.10
0.08
0.06
0.04
0.02
0.00
-150
-70
10
90
170
$/acre
250
330
410
Effects of Government Programs
on Iowa Cash Renters
• Expected returns to corn production
increase by about $75 per acre.
• So assume that programs increase cash
rents by $50 and that cash rents for Iowa
land without the programs equal $100.
Effect of Government Programs on Net Returns from
Iowa Soybean Producer Who Cash Rents Land
0.14
0.12
Probability
0.10
0.08
0.06
0.04
0.02
0.00
-150
-75
0
75
$/acre
150
225
A Comparison of Risk and Returns for Cash Renter
0.16
No programs except
revenue assurance
0.14
Probability
0.12
0.10
Current
situation
0.08
0.06
0.04
0.02
0.00
-150
-75
0
75
$/acre
150
225
Final Words
• Government programs and crop insurance
greatly reduce the risk of farming for
operators who farm their own land.
• It could be argued that land renters would
be better off with RA and no other
programs.
Implications
• Risk reduction/return increase only occurs
with government programs:
– Incentives increase to plant only program
crops
– Incentives increase to focus on maximum
yield rather than maximum quality
Greater returns to managing commodity
production rather than managing possibly new
ventures
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