Commodity reference prices are used in both the price loss coverage (PLC) and agriculture risk coverage (ARC) programs to calculate program benefits. For most commodities, reference prices have not increased since their establishment in the 2014 Farm Bill. One of the major farm bill changes farm groups would like to see in the next farm bill is an increase in reference prices to catch up with input price inflation. However, a feature added to the 2018 Farm Bill allows for reference prices to increase along with commodity prices. Since most commodity prices have increased over the past few years it is interesting to see whether reference prices are likely to increase.
Section 1101 of the 2018 Farm Bill (P.L. 115-334) allows for the “effective reference price” for a commodity to replace the statutory reference price if 85% of the previous five-year Olympic average of the national marketing year average price is greater than the statutory reference price (Schnepf). The “effective reference price” may increase to as much as 115% of the statutory reference price.
Table 1 contains the statutory reference prices and calculated commodity “effective reference prices” for 2023 through 2028 determined using historical prices and CBO May 2022 commodity price estimates. The statutory reference prices are blue. If the projected “effective reference prices” are green or red that means the commodity prices have risen enough to generate a higher “effective reference price”. If the calculated reference price is green it means the “effective reference price” is less than 115% of the statutory reference price. If the calculated reference price is red it means the “effective reference price” is greater than 115% of the statutory reference price and would be set at 115% of the statutory reference price.
Corn, soybeans, oats, grain sorghum, mustard seed, sunflower, safflower and large and small chickpeas could see an increase in “effective reference prices” over the next six years depending upon whether CBO’s price estimates are realized. While many commodities such as wheat have experienced significant price increases, prices have not increased enough to overcome only being able to use 85% of the Olympic average of the previous 5 years commodity prices. If the “effective reference prices” in Table 1 are realized then the cost of increasing reference prices for all commodities should be significantly lower when cost estimates are developed during farm bill discussions.
Table 1. Statutory Reference Prices and Calculated “Effective Reference Prices” Based Off of Historical and CBO Estimated Prices for Covered Commodities.
Over the past five years, the federal crop insurance program has become a more important part of the farm safety net – relative to ARC/PLC and the marketing loan. There are several reasons for this, but the two most important are 1) higher commodity prices have made ARC/PLC and the marketing loan less likely to provide any benefits and 2) the crop insurance program uses the futures market to establish initial and harvest-time prices used in insurance calculations that are based on a monthly average of futures closing prices for a specified contract month. When commodity prices are trending upward, like they have been over the past few years, crop insurance protection increases along with higher futures market prices.
The correspondence, or lack thereof, of rice planted acres for four Southern rice growing states with the marketing year average price reported by USDA around October 1st of the year prior to planting and the projected insurance prices was evaluated over the 2016 to 2022 period. The previous year’s marketing year average price was used to evaluate whether it was signaling for more or less acres for the next year. The projected (initial) insurance price is determined just prior to planting. The three states (Arkansas, Mississippi and Texas) that use the same futures contract to establish projected and harvest time prices are grouped together in the graphs followed by the graph for Louisiana.
The graphs indicate both marketing year average prices and insurance projected prices are generally trending upward since 2017. Planted acres for Arkansas and Mississippi and Louisiana do not exhibit an upward trend. Producers in these states generally have multiple crop alternatives to rice that may be drawing acres away from rice based on the relative profitability of the alternatives to rice. Texas producers generally have fewer viable alternatives to rice production, which appears to be revealed in the upward trend in planted acres. Another consideration to keep in mind is that even though rice prices have increased over the past few years, generally speaking, prices still remain below the full cost of production for producers in Southern rice growing states, particularly when accounting for the deductible associated with insurance policies.
Author: Joe Outlaw
Professor and Extension Economist, Co-Director Agricultural & Food Policy Center at Texas A&M University
Author: Bart Fischer
Research Assistant Professor, Co-Director Agricultural & Food Policy Center at Texas A&M University
From wild swings in commodity prices to an explosion in input costs that would make the Consumer Price Index (CPI) blush, agricultural producers have been riding a rollercoaster over the past year. The purpose of the farm safety net – the combination of Federal crop insurance and the traditional farm bill programs like Agriculture Risk Coverage (ARC) and Price Loss Coverage (PLC) – is to help producers manage these risks. However, unprecedented pressure from the COVID-19 pandemic and natural disasters, along with the inflated input costs, have exposed gaps in the current farm safety net. One of the concerns on the minds of most producers at this point is how the farm safety net will perform in 2023 if commodity prices fall and input costs remain at elevated levels. In this article, we look at this question in the context of cotton.
This summer, USDA’s Economic Research Service (ERS) forecasted a U.S. average total cost of production for cotton in 2023 of $794/ac. Assuming an average yield of 847 lbs/ac (based on the 5-year harvested-acre average for upland cotton from 2017-21), the total average cost of production for cotton in 2023 would be an estimated $0.9374/lb. The question: how much of the cost incurred by producers will be protected by the farm safety net?
Federal crop insurance is the cornerstone of the farm safety net. The insured price for cotton in the spring will be based on the Cotton #2 Dec ’23 futures contract (CTZ23). While the price is based on a month-long average (with the discovery period depending on your location), this example simply uses yesterday’s closing price ($0.731/lb) as a proxy for how the safety would perform if the insured price were established at yesterday’s levels (Figure 1). For a grower with Revenue Protection (RP) at a 75% coverage level, they are effectively protecting $0.5483/lb (= $0.731/lb x 75%). Even in the case where a grower purchases STAX at a 90% coverage level (in addition to RP), they still are only able to protect $0.6579/lb (= $0.731/lb x 90%). In other words, a producer would only be able to insure, on average, 70% of their total cost of production (= $0.6579/$0.9374).
But, won’t PLC help fill in the gap given it is designed to help in low-price scenarios? With cottonseed prices at $343/ton (NASS August 2022), a lint value of roughly $0.637/lb equates with a seed cotton equivalent of $0.367/lb (the PLC seed cotton reference price). In other words, if cottonseed prices for the marketing year averaged $343/ton, lint prices would have to fall below $0.637/lb before PLC would trigger support. If the marketing year average price were to hover around the insurance price in our example ($0.731/lb), PLC would end up paying nothing.
Naturally, any number of different scenarios could transpire. For example, prices could rebound before planting. Input costs could fall between now and the spring. And, above-average yields could blunt the impact of lower prices. In the case of yields and given the example above, if prices averaged $0.731/lb, yields would need to be more than 28% above average to break even. While that is possible (especially in isolated areas), neither producers (nor their lenders) can bank on yields that are 28% above average.
This scenario clearly highlights just one example of the gaps that exist in the current farm safety net. It also highlights the importance of the upcoming debate on the 2023 Farm Bill. While pundits are prognosticating over whether there will be a simple extension of the current farm bill next year, agricultural producers may not be able to wait. Even if the markets end up breaking their way, they currently are exposed to a considerable amount of risk and the prospect of significant losses.
Figure 1. Cotton #2 December 2023 ICE Futures Contract (CTZ23)
One of the most asked questions we get is whether the next farm bill will contain a reference price increase for covered commodities to offset higher input prices. Both the price loss coverage (PLC) and agriculture risk coverage (ARC) safety net programs use reference prices in their respective calculations. Focusing on PLC, with relatively high market prices, it would seem that now is the time to increase reference prices as market prices for many covered commodities are above their respective reference prices. This would mean reference prices could be raised modestly without triggering much, if any, payment. This analysis sets aside the question of whether the agricultural committees will have any more money to write the next farm bill.
Table 1 provides the ratio of marketing year average prices to reference prices for seven covered commodities from 2023 to 2032. The results in Table 1 that are green indicate the market price is above the reference price for the commodity for that year. And conversely, ratios that are red indicate market prices that are below reference prices. One of the first things that jumps out in the table is that the 2023 marketing year has all but peanut prices higher than their respective reference prices. CBO projects prices to decline below reference prices for all but corn and soybeans over their projection period. Generally, this wouldn’t bode well for the agricultural committees being able to increase reference prices; however, the last column in the table contains base acres for each of the covered commodities. Two of the biggest crops in terms of base acres (corn and soybeans) that account for more than 146 million base acres are projected to experience prices above their respective reference prices. The remaining commodities with relatively lower marketing year average prices account for less than 100 million acres, with wheat accounting for more than one-half of the total.
Time will tell whether reference prices can be increased, which will largely depend on an infusion of new money into the farm bill process. Proponents should feel cautiously optimistic that a reference price increase could be feasible.
Table 1. Ratio of Marketing Year Average Prices to Reference Prices and Base Acres.
In a previous Southern Ag Today article, I discussed the concept of unintended consequences which is a topic we talk a lot about in agricultural policy. Generally speaking, unintended consequences result from a lack of knowledge and/or lack of analysis of the potential consequences of a policy change. The previous article focused on the unintended consequences associated with government policies that created the U.S. ethanol industry. This article looks at the Securities and Exchange Commission (SEC) proposed rule changes that would require climate-related disclosures of publicly traded firms.
On March 21, 2022, the SEC proposed rule changes that would require certain climate-related disclosures in their registration statements and periodic reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition, and certain climate-related financial statement metrics in a note to their audited financial statements.
According to the SEC, the proposed rule “would require a registrant to disclose information about its direct greenhouse gas (GHG) emissions (Scope 1) and indirect emissions from purchased electricity or other forms of energy (Scope 2). In addition, a registrant would be required to disclose GHG emissions from upstream and downstream activities in its value chain (Scope 3), if material or if the registrant has set a GHG emissions target or goal that includes Scope 3 emissions.” Required disclosures for each of the three scopes would be phased in over a period of time.
This proposal generally requires publicly traded companies to provide investors more information about GHG emissions coming from business activities. However, as reported by the American Farm Bureau Federation (AFBF), “While farmers and ranchers are not public companies and therefore not ‘registrants’ that are required to report directly to the SEC, their obligations through their regulated customers could be enormous….requirements for Scope 3 greenhouse gas emissions not only directly affects farmers’ and ranchers’ operations, but could create several substantial costs and liabilities, such as reporting obligations, technical challenges, significant financial and operational disruption and the risk of financially crippling legal liabilities.”
While the proposed rule’s focus is to provide investors more information about the GHG emissions of publicly traded companies, depending upon 1) if the rule is adopted and 2) how it is implemented, it could have implications for U.S. farmers and ranchers because as AFBF points out, “for agriculture, food, and forestry manufacturing alone, there are nearly 2,400 companies registered with the SEC that would be subject to reporting Scope 3 emissions from its farm suppliers.”
Livestock producers are making hard decisions this summer and fall as widespread drought conditions limit pasture, hay, and, in some places, water availability across the southern and western states. Drought losses can result in additional costs for purchased hay (for those who can find a hay source), selling calves early, retaining fewer replacement heifers, or culling cows to reduce pressure on pasture and rangeland. Drought disaster programs are available to help offset some of the additional costs. For example, the Emergency Assistance for Livestock, Honey Bees and Farm-Raised Fish (ELAP) program can help offset the added cost of transporting hay from greater distances this year. Forage management and supplementation can also stretch available grazing to reduce the need for winter hay feeding in some areas. However, in many cases, producers will be reducing herd sizes through additional cattle sales.
Drought related costs and losses will be reflected on 2022 tax returns for many producers across the country. Understanding how those losses must be reported come tax season and what documentation to retain will aid in properly reporting expenses and program payments. Drought related farm expenses and payments from drought disaster programs are fairly straightforward. For example, if a producer purchases hay in 2022 sourced from farms in states at a greater distance than previous years, they may be eligible for the ELAP transportation cost offset mentioned previously. The producer would report the cost of hay and hauling as farm expenses. The ELAP disaster payment for excess transportation cost would be reported as income. For more information on USDA disaster program documentation requirements, see factsheet: https://extension.okstate.edu/fact-sheets/usda-program-recordkeeping-requirements.html
Cattle sales will also be reported on tax returns, but these decisions are a little more complicated. Gains from breeding, dairy or draft cattle sales in excess of normal due to drought may be deferred for up to two years, as long as the dollar value of the cattle are replaced within those two years. Record keeping is critical. The producer can only defer cattle sales that are above what would typically be sold under normal production conditions. Two tax provisions exist to avoid the adverse tax consequences of selling more animals than normal due to weather related conditions. One applies only to breeding, dairy and draft animals that will be replaced. The second applies to market animals where the income from the additional animals sold are reported in the year that they would have normally been marketed.
Consider an example for breeding animals: Over the past 3 years, my cattle operation sold 30 calves weighing 650 pounds and 4 cull cows as an annual average. Due to drought in 2022, I sell 5 replacement heifers I would ordinarily have retained and 10 cows (6 more than the average) for $10,000. I can defer reporting the $10,000 of income from the excess animal sales (the 5 replacement heifers and the 6 cows) by electing to replace those sold by buying at least $10,000 of replacement breeding animals by December 31, 2024. If I do not spend at least $10,000 on replacement animals, I must amend the 2022 return and report the difference as income in that year. Should my county or a contiguous county be declared a federal disaster area, the replacement period is extended to 4 years and the animals will not have to be replaced until the end of 2026. The replacement animals must also be of the same type and purpose of the animals sold (dairy animals for dairy animals or breeding for breeding). This tax provision is under Internal Revenue Code Section 1033(e).
Now consider an example for the sale of any livestock (other than poultry) due to weather related conditions, and this time the county I raise cattle in is declared a federal disaster area (which is a requirement for this provision). Using the same facts as the prior example, I sold 6 more cows and 5 replacement heifers plus 15 head of calves (that would have normally been sold in 2023) for $20,000. Combined, this is more livestock than what would have normally been sold had the drought conditions not existed. This tax law provision allows me to elect to report the $20,000 of income in 2023 instead bunching this excess income in 2022. This tax provision is under Internal Revenue Code Section 453(g).
Documentation is critical for all drought related losses. Specifically for your taxes keep the following in your tax records:
Evidence of the weather-related conditions that forced the sale or exchange of animals.
Number and kind of livestock sold or exchanged.
Number of livestock of each kind that would have been sold or exchanged under normal business circumstances (generally, the average number of animals sold over the three preceding years).
The amount of gain realized on the sale or exchange.
The amount of income to be postponed
It will be important to discuss the application of these tax provisions with your income tax advisor. Sources of drought information include the Drought Monitor Maps which indicate drought intensity by state and region. In addition, USDA reports which counties are currently considered drought disaster areas and are eligible to receive federal disaster programs, and disaster declarations generally are available from State and Federal government websites and stakeholder announcements. Tax season seems like it is far off on the horizon still, but better understanding how drought related losses will be reported may aid in documentation of losses today.