Key Risk Management Decisions Coming Soon01/31/2019
Producers have multiple tools to manage production and marketing risk, including the 2018 Farm Bill commodity programs, the ongoing crop insurance policies and, of course, various marketing tools. Considering each of them in some detail reveals not only how they can be used to manage risk, but also how they should integrate into a comprehensive risk management plan.
The 2018 Farm Bill reauthorized the existing Price Loss Coverage and Agricultural Risk Coverage programs with some modest changes. Most significantly, producers face a new decision between the two when they enroll in the 2019 commodity program.
They will face the PLC versus ARC decision again in 2021, and annually thereafter. This decision is the same one producers faced in 2014, but under substantially different market conditions.
If the choice is PLC, a producer is effectively signing up for income support that triggers when the national marketing year average price drops below the reference price. With corn as an example, the PLC payment triggers when the market price drops below $3.70 per bushel. But the payment is limited to 85% of the base acres for each crop and is paid on a payment yield that is likely about 80% of expected yields. So, a producer enrolled in PLC on base acres that are planted to the crop in the base effectively has a hedge in place at the reference price, but only on about 68% of the expected production.
If the base acres are enrolled in ARC at the county level (ARC-CO), the protection is tied to 86% of a benchmark revenue level equal to the five-year Olympic average yield (trend-adjusted in the new farm bill) multiplied by the five-year Olympic average price (with the reference price as the minimum in the calculation). For corn in the example, the protection effectively starts at 86% of the $3.70 reference price given trend yield projections, or about $3.18 per bushel. The ARC-CO program provides both price and yield protection on the first 10% of revenue lost below that level. Again, looking at only the price component, that would be a band of protection from about $3.18 down to $2.71 per bushel, but only on 85% of the base acres.
Few changes were made to the crop insurance programs under the new farm bill, save for some clarification on the proper management of cover crops to maintain crop insurance eligibility. So, producers face the same basic crop insurance decision between Yield Protection (YP), Revenue Protection (RP) with the harvest price component, and Revenue Protection with the Harvest Price Exclusion (RP-HPE). Producers also may consider area yield and revenue plans, as well as the relatively new Whole Farm Revenue Protection plan to cover revenue on the farm across multiple crops, along with the Supplemental Coverage Option (SCO) to add county-level coverage on top of a lower farm-level policy.
With most producers using RP and most choosing the trend-adjusted yield option, producers are effectively protecting their crop from revenue losses below a given percentage of trend yield times the higher of the base or harvest-time futures price. With current December 2019 corn futures trading about $4 per bushel, a producer choosing 80% coverage is effectively protecting against revenue losses below $3.20 per bushel and trend yields as well as yield losses if prices move higher.
Numerous marketing tools provide additional opportunities for producers to manage risk, specifically price risk. Whether covering futures price risk through futures and options strategies or using cash marketing contracts to hedge futures, basis or local cash price levels, producers have the decision not only of what tools to use but of how much of expected production to price.
Research at UNL in 2013-2014 found that more than 50% of producers across Nebraska, Iowa and South Dakota hedged at least some part of their production. The research also found a positive correlation between buying insurance and using hedging tools. This may be an obvious conclusion, but it confirms the economic argument that insurance provides producers the confidence to act on managing price risk. The harvest price component of RP specifically does this by covering lost bushels under higher prices that may have been committed in a forward contact.
Comprehensive risk management
With all the risk management tools available to producers, it is important to consider them as part of an overall risk management portfolio and not as separate decisions. For example, consider that producers enrolled in PLC effectively have a hedge in place on part of their expected production if prices fall below the reference price, much like a free put option with a strike price equal to the reference price.
If the same producers also buy an RP policy, they have a revenue guarantee that provides additional protection from lower prices. Add on a hedging strategy that complements an RP policy and you can envision producers trying to manage the same price risk multiple times with multiple tools. There is a role for each tool in the strategy, but it is important to understand how the tools work together and develop an effective strategy that protects actual risk without duplicating coverage or creating other unintended risks.
These decisions will be coming up quickly for producers. Crop insurance will come first with a March 15 deadline for coverage on 2019 spring-planted crops. The commodity program decision between PLC and ARC likely will follow as USDA’s Farm Service Agency implements the new farm bill and rolls out the new commodity program decision likely in late spring into the summer.
And the marketing decision already should be part of an ongoing plan under constant analysis and attention. Keeping attention to all these decisions and their interaction will be an important part of producers’ management plans for the year ahead.
Lubben is an Extension policy specialist at the University of Nebraska-Lincoln.
Source: Brad Lubben, Nebraska Farmer