Distorting Grain Markets, Providing Major Benefit to Non-US Producer
Normally crop insurance has a propensity for overproduction. These are not normal times. This year it is the opposite. A feature of crop insurance covering nearly 90% of Midwest farmers is creating a paid set-aside which is distorting the grain market. It is forcing the market to bid against the prevented plant (PP) payment to offset the damage created by Mother Nature. The impact is unintentional and is only exposed by the extreme delays in 2019 planting. Those of you under the age of 40, google set-aside policy to see how US Ag programs of the 1970’s and 80’s promoted production for non-US producers. South America is a major benefactor of the recent market rally, as they were back in the 70’s and 80’s. PP forces the market to bid until enough planting is complete. Will planting proceed enough this week or will it push into July? What will Mother Nature dictate? More importantly, what happens to prices once the bidding is done? How many will suffer “Buyer’s Remorse”?
US corn and soybean farmers are faced with a decision they have never had to make. The choices are: 1: plant a crop late, guessing a yield and risking adverse summer weather, or 2: take the prevented plant payment provided as part of crop insurance. While #2 provides closest to a “Bird in the Hand” option, the decision is complicated by the lack of details from Washington on the amount of payment from Disaster Aid ($19 Bil) and the Market Facilitation Program (MFP) ($16 Bil).
The proof PP is market distorting is rather simple – isolate PP. Take away PP and how would the farmer respond to being forced to plant a crop late with reduced yields? Nearly ninety percent of Midwest farmers have insurance providing minimum revenue. If either the crop income or the insurance provides the opportunity for a return to the land cost, the crop gets planted. In most cases the insurance does provide a return to the land cost. Neither option provides, nor is likely to provide, a profit today. The risk is minimized for planting a crop and the crop must be planted to receive insurance. The program would incentivize planting beyond economic sanity, producing oversupply. In this case without PP, the market has the role of dictating which crop gets planted and balancing price against the impact to balance sheets caused by late planting.
A second proof of distortion would be to look at the factors in the decision to plant a crop. In other years, the decision to plant is based on the potential returns of growing the crop. PP is not a factor. In 2019, PP creates the opposite effect. PP creates another option for farmers to receive a return to land costs. The PP option provides an incentive not to #plant19, but to set-aside acres. This year the decision is dictated by the bid provided by PP versus the market bid. The PP bid is based on an arbitrary date and an arbitrary value created by the Risk Management Agency – part of the USDA. The PP bid is not economic and creates an inflated bid for #noplant19. Is it distorting? How else could you explain a scenario where a farmer with owned ground and very low land cost, leaves that land unplanted.
This is how it works. If the crop is unable to be planted by the late planting date, the producer is eligible to receive a portion of the full indemnity of the insured crop. Prior to 2019 PP was not a significant factor because planting was essentially complete by the late planting dates. Late planting dates are as follows: Corn: May 25 – June 5; Soybeans: June 10 -20. The crop would be uninsured if planted 20 days following the late planting date. Example: insured revenue = proven yield * price * coverage rate. A typical IL, IA producer looks like: 200*$4*85%=$680/acre of insured revenue. PP would pay 55% = $374/acre. Soybean PP payments are mostly under $300/acre. These numbers vary across the corn belt and for each producer. When does the farmer not plant and take PP? The decision is individual for each farmer. The decision hinges on these factors:
- Potential yield – late plant has impacted yield; they must guess summer weather.
- land cost – higher costs incent planting; range is zero for owned land up to $400/acre.
- crop input already applied – in some cases $100+/acre has already been applied incenting planting.
- APH – lower proven yield lowers PP payment and incents planting.
- MFP – it is a guess how MFP will pay, and how much the Disaster Aid will provide for PP. The consensus seems to be that MFP would pay more than Disaster Aid.
The range of factors impacting individual farmers PP decisions creates nearly a 50c/bushel range in a price that bids land away from PP corn. Modelling this decision to determine final planted acres with any accuracy is impossible. We will not know the final acres until October.
Regardless of the individual parameters, there is a market bid that gets them to plant.
Note: rumors have been circulating that Disaster Aid would increase the percentage paid for PP. That the PP payment would go from 55% to as high as 90%. Raising the PP bid, raises the bid required by the market to get minimum production. We could use more clarity from Washington; hmm, I am naïve.
The market is always rational and objective – NOT! The market portrays its actors – it is now emotional and irrational. Look at option volatility. It will overreact.
The role of the market now is to determine what price is required to provide enough production in the US without putting supplies into allocation mode. The market must determine the maximum number of PP acres to allow. What is that number? We think it is 8 million acres for corn. Lose 2 billion bushels of production and US end stocks in 19/20 can still be 1.5 billion bushels. If planters can get in the field this week, $4.50 corn incents enough planting. The market will have to increase the bid for every week planting is delayed. The going rate seems to be 30c per week for corn. The weekly rate will have to increase for later planting.
The market impact of the loss of corn production is then based on soybean planted acres. We can lose up to 400 million bushels (10MMT) without impacting the world carryout significantly. The indirect impact to corn comes as a result of the response by South America. If soybean supplies are adequate, South America will produce more corn to offset the loss in the US. The extra corn could be available
as early as March 2020. Double crop corn in Brazil is the great equalizer. The max allowable PP will shrink as planting is delayed because potential yields are decreasing. Incenting soybean planting
doesn’t require a high market bid. PP has a relatively low bid for soybeans due to the addition of an MFP payment based on total corn and soybean planted acres, and the lower soybean PP payment. If planters are allowed back in the field by June 20th and futures are near $9, it is likely soybean acres exceed 85 million – the estimate from the March intentions. November futures near $10 will keep soybean planters rolling past June 20. A rally in soybean futures this month could ultimately add to an incredibly bearish scenario.
The market is always rational and objective – NOT! The market portrays its actors – it is now emotional and irrational. Look at option volatility. It will overreact. Calling a market top will only be possible in hindsight. The change of fortunes in the market over the last 3 weeks has been astounding – >$10 billion on CME corn alone. We estimated spec funds had a $500 million – half a billion $ margin call – from corn and wheat in the first week of the rally. The price change has also impacted crops in inventory.
Much of the fortune has been offered to the US producer. The offer provided by the market always comes with a “catch” – take the offer provided today, or take what is behind the curtain? (Anyone under 50 google: Let’s Make a Deal). How producers manage the market offer over the next 60 days could impact their business the next three years. Everyone proceed with caution. Producers manage what the market could provide over $4.50 with options. For buyers – any buying should be Optionated .(tm) Supply side markets have a short shelf life. The current rally is much different than most supply side rallys. Most supply based rallys are responding to production losses. This rally is impacting production, by reducing the production loss.
Beware the risk when bidding for acres is closed.