9/11/98

Contacts:
Dermot Hayes, Economics, 515/294-6185
Bruce Babcock, Economics, 515/294-5764
Susan Thompson, Agriculture Information, 515/294-0705

TWO PAYMENT OPTIONS AVAILABLE TO FARMERS

AMES, Iowa -- Low prices for corn and soybeans have triggered two federal price support programs for farmers. Researchers at Iowa State University have looked at which program might be best.

One program is a loan deficiency payment (LDP) that pays producers the difference between county level prices and that county's loan rate.

The other option is the traditional loan program where the producer puts grain in storage and uses it as collateral for a loan. If market prices exceed the county's loan rate plus accrued interest, the producer can repay the loan anytime within its nine-month term and sell the crop. If an acceptable price increase doesn't occur, the producer can keep the difference between the loan rate and the posted county price on the day of sale.

Producers can enroll in the loan program, or take the LDP, but can't do both. The best choice will ultimately depend on what market prices do in the coming months. But since most farmers will be making their choice at harvest, experts say their decisions will have to be made based on what is most likely to happen.

ISU economists Dermot Hayes and Bruce Babcock ran several different price and situation scenarios through their computer models. They used a producer in Union County with 10,000 bushels of corn as an example.

The loan rate in Union County is $1.77 a bushel. They assumed a cash price at harvest of $1.69, a December futures price of $1.99 and a July futures price of $2.25. They also assumed a local price of 30 cents below the nearby futures price.

The researchers said at these prices, storage is encouraged. "There is a 26-cent return from storing grain from harvest to July. With typical storage costs of one-cent per bushel per month, producers should realize a net return of 17 cents per bushel," they said.

Producers have several choices. For instance, they can sell at harvest and take the LDP or use the loan program. Producers who sell at harvest can get the county price plus the LDP, which will equal the loan rate. Or they can guarantee themselves the same amount by putting the grain under loan. The difference is that by selling at harvest, they lose any opportunity to benefit if the corn market improves.

"The possibility of selling at a higher price with the price guarantee of the loan rate means producers will always be better off storing the grain under loan than taking the LDP and selling cash grain," Hayes and Babcock said. "Being in a position to benefit from upside price movements without having to worry about downside movements is better than not being in the market."

Another possibility is to take the LDP and store the grain, rather than selling for cash at harvest. Hayes and Babcock said if prices strengthen, private storage would be better than the loan program. But if prices fall, the opposite would be true.

The research team assigned probabilities to various price outcomes and compared the expected values of each of the two alternatives. The results favored the loan program.

A third choice would be for producers to take the LDP and store the grain, but then use the futures market to lock in a July price. Whether or not this option returns more than the expected value of putting the grain under loan will depend on the July futures quote in comparison with current cash prices.

"When the July futures is close to the current price, it won't be possible to lock in a premium and the loan program will dominate. When the July futures is much higher than current cash markets, taking the LDP and locking in a July price may return more than using the loan program," the researchers said.

But when looking at a wide range of July futures and local prices, Hayes and Babcock concluded, "It is unusual for the futures market to show a large enough storage premium to make it worthwhile to take the LDP and lock in a futures price. Producers are almost always better off putting their grain in the loan program."

The rules surrounding these programs are complex. Economists at ISU say it's important for producers to work closely with their local Farm Service Agency officials before harvest to make sure they understand the rules and have completed the proper forms.

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