Commodity Programs: Impact of Support Provisions on Selected Commodity
Prices (Letter Report, 02/21/97, GAO/RCED-97-45).
Pursuant to a congressional request, GAO reviewed the impact of support
provisions on selected commodity prices, focusing on: (1) whether
marketing loan provisions prevent loan rates from acting as price floors
and whether they allow U.S. prices to fall to levels closer to world
prices; (2) the effect lower loan rates would have on the relationship
between U.S. and world prices; (3) the affect of a lower loan rate on
step 2 payments for cotton exports and the impact of recent changes in
timing of payments on the program's effectiveness; and (4) the steps
that could be taken to make the peanut and sugar programs more
market-oriented.
GAO found that: (1) when alternative repayment rates, which are derived
from the U.S. Department of Agriculture's (USDA) proxies for world
prices, are near or below the loan rates, the marketing loan provisions
may prevent the loan rates from serving as price floors; (2) lowering
the loan rates has little if any effect on U.S. prices when alternative
repayment rates are above the loan rates; (3) however, when alternative
repayment rates are near or below the loan rates, the effect on U.S.
prices of lowering the loan rates differs by commodity; (4) for cotton
and rice, the availability of nonrecourse loans, in combination with
other program and market factors, keeps U.S. prices significantly higher
than adjusted world prices; (5) therefore, lowering the loan rates is
likely to allow U.S. prices to fall to levels that are closer to
adjusted world prices; (6) for wheat, feedgrains, and oilseeds, most
experts assert that the marketing loan provisions will work as intended
to overcome the price-supporting effects of the nonrecourse loans; (7)
for these crops, lowering the loan rates would have little if any impact
on U.S. prices; (8) to the extent that a lower loan rate results in
lower U.S. cotton prices, step 2 payments would be reduced but not
eliminated; (9) step 2 payments would continue to be made because the
marketing loan provisions have not been able to overcome the cotton
program's other features, such as government-paid storage, that help
keep U.S. cotton prices higher than adjusted world prices; (10) however,
because of recent changes in how USDA makes step 2 payments to
exporters, these payments may no longer directly offset higher U.S.
prices and therefore may be less effective in enhancing exports; (11)
further changes can be made to make the peanut and sugar programs more
market-oriented; (12) additional reductions in the quota support price
for peanuts will lower U.S. prices and increase economic efficiency;
(13) an increase in the tariff-rate import quota for sugar, allowing
more sugar to be imported at the lower tariff rate, or its elimination
entirely (no import restrictions), would result in lower U.S. prices;
and (14) once prices fall to the level of the loan rate, reductions in
the loan rate would be necessary to reduce prices further.
--------------------------- Indexing Terms -----------------------------
REPORTNUM: RCED-97-45
TITLE: Commodity Programs: Impact of Support Provisions on
Selected Commodity Prices
DATE: 02/21/97
SUBJECT: Agricultural policies
Price supports
Price regulation
Loan interest rates
Competition
International trade
Exporting
Commodity marketing
Loan repayments
Farm credit
IDENTIFIER: USDA Cotton Program
USDA Peanut Program
USDA Sugar Program
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Cover
================================================================ COVER
Report to the Chairman, Committee on the Budget, House of
Representatives
February 1997
COMMODITY PROGRAMS - IMPACT OF
SUPPORT PROVISIONS ON SELECTED
COMMODITY PRICES
GAO/RCED-97-45
Impact of Support Provisions on Selected Commodity Prices
(150920)
Abbreviations
=============================================================== ABBREV
ERS - Economic Research Agency
GAO - General Accounting Office
USDA - U.S. Department of Agriculture
Letter
=============================================================== LETTER
B-275856
February 21, 1997
The Honorable John R. Kasich
Chairman, Committee on the Budget
House of Representatives
Dear Mr. Chairman:
The momentum for change in U.S. agricultural policy began with the
passage of the 1985 farm act, when efforts were made to make federal
farm programs more market-oriented and to reduce the amount of
support that the government guarantees producers for their
commodities. The 1990 and 1996 farm acts continued to build on these
efforts and introduced additional changes.
However, the Congress retained a number of income- and price-support
provisions as a safety net for producers. In particular, nonrecourse
loans with marketing loan provisions continue to be available for a
number of commodities, including upland cotton (hereafter referred to
as cotton),\1 rice, wheat, feedgrains, and oilseeds. Through
nonrecourse loans, producers pledge their commodities as collateral
and upon forfeiture receive guaranteed minimum returns based on
prices known as loan rates. The marketing loan provisions, which
allow producers to repay their loans at alternative repayment rates
that are lower than the loan rates, were added to nonrecourse loans,
in part to prevent the loan rates from serving as price floors while
protecting producers' income from the effects of low market prices.
In addition, for cotton, peanuts, and sugar, other mechanisms are in
place to help support producers and related industries. Under the
cotton program, domestic mills and cotton exporters receive a
payment--known as the step 2 payment--to help defray the higher cost
of U.S. cotton and make it more competitive in world markets.
Similarly, the peanut and sugar programs have price-support features.
For example, the peanut program has domestic marketing restrictions
and the sugar program has a tariff-rate import quota.\2
Concerned about how these remaining support provisions affect U.S.
commodity prices in comparison with world prices, you asked the
following questions: (1) Do marketing loan provisions prevent loan
rates from acting as price floors and do they allow U.S. prices to
fall to levels that are closer to world prices? (2) What effect
would lower loan rates have on the relationship between U.S. and
world prices? (3) How would a lower loan rate affect step 2 payments
for cotton exports and what impact have recent changes in the timing
of payments had on the program's effectiveness? (4) What steps could
be taken to make the peanut and sugar programs more market-oriented?
--------------------
\1 Two major types of cotton are produced in the world: upland and
extra-long staple. About 98 percent of the cotton grown in the
United States is upland cotton.
\2 The tariff-rate import quota permits a limited level of imports at
a low tariff rate, set at 0.625 cent per pound. Any additional
imports beyond that level are assessed a higher tariff rate that
makes imports prohibitively expensive.
BACKGROUND
------------------------------------------------------------ Letter :1
Nonrecourse loans have long been the government's major price-support
instrument and provide operating capital to producers of commodities,
including cotton, rice, wheat, feedgrains, and oilseeds. Producers
store their commodities under loan until later in the marketing year,
when prices are usually higher than they are at harvest. Producers
have the option either to repay their loans with interest at any time
or, at the end of the loan period, to forfeit their commodities to
the government and have their interest payments forgiven. The
government has "no recourse" but to accept the commodities as
payment. In the past, when market conditions would have led to U.S.
prices falling below the loan rates, the loan rates supported U.S.
prices.\3 This happened because producers preferred to forfeit their
commodities to the government rather than sell them at lower market
prices that would have given them less than the face value of the
loans. Under these market conditions, U.S. prices were supported
and the government accumulated large and costly stocks.\4
For cotton, rice, wheat, feedgrains, and oilseeds, the Congress added
marketing loan provisions to nonrecourse loans\5 to eliminate the
price floors created by the loan rates while protecting producers'
income from the effects of low market prices. The intent was to
minimize loan forfeitures and the accumulation of government stocks
and to lower U.S. prices to levels closer to world prices. The
marketing loan provisions allow producers to pay back nonrecourse
loans at alternative repayment rates when these rates are lower than
the loan rates.
To establish alternative repayments rates, the U.S. Department of
Agriculture (USDA) first determines a proxy for the world price for
each commodity. These proxies for world prices are based on price
data obtained from international markets for cotton and rice and from
major U.S. terminal markets for wheat, feedgrains, and oilseeds.
Next, USDA adjusts the proxies for world prices (these proxies are
hereafter referred to as world prices) for quality differences and
for transportation costs\6 to arrive at the relevant alternative
repayment rates. For cotton and rice loans, the alternative
repayment rates are set weekly and are known as adjusted world
prices. For wheat, feedgrain, and soybean loans, the alternative
repayment rates are set daily and are known as posted county prices.
For minor oilseeds, (such as flaxseed, sunflower seed, and canola)
these rates are set weekly and are known as regionally calculated
prices.
When alternative repayment rates are below the loan rates, producers
can repay their nonrecourse loans at these lower rates. Because
producers keep the difference between the loan rate and the
alternative repayment rate, which is known as a "marketing loan
gain," they should be able to sell their commodities at market prices
and receive a total return--market price plus marketing loan
gain--that is at least equal to the loan rate.\7 Alternatively,
producers who do not take out loans may still receive government
payments equal to marketing loan gains. These amounts are called
loan deficiency payments. (See app. I for more information on how
program benefits are calculated.)
For some commodities, certain program factors have kept U.S. prices
higher than world prices. These factors vary by commodity program,
and we have reported on them for cotton, peanuts, and sugar.\8 For
example, several features of the cotton program, such as import
restrictions and the availability of government-paid storage when the
adjusted world price is below the loan rate, reduced producers'
incentives to sell cotton to the market and thereby kept U.S. prices
above world prices. High U.S. cotton prices, coupled with import
restrictions, adversely affected cotton exporters and domestic mills
that had to purchase higher-priced U.S. cotton. Consequently, the
1990 farm act included a provision for step 2 payments to be made to
exporters and domestic mills to offset higher U.S. prices. These
payments were continued in the 1996 farm act. USDA recently changed
its procedures for making step 2 payments. Under the new procedures,
exporters will receive the step 2 payment rate that is in effect
during the week the cotton is shipped instead of the week in which
cotton sales were contracted. For peanuts and sugar, the programs'
price-support features, such as domestic marketing restrictions for
peanuts and the tariff-rate import quota for sugar, have continued to
keep U.S. prices high. The Congress changed these programs in the
1996 farm act to help lower U.S. peanut and sugar prices, decrease
the government's costs, and reduce production and consumption
inefficiencies created by the programs' past features.
--------------------
\3 For this review, when we refer to U.S. prices, we mean the prices
that producers receive when selling their commodities in local cash
markets.
\4 Before the 1996 farm act, once commodities were forfeited to the
government, they typically remained off the market for a long time,
thereby supporting prices. The government was not allowed to sell
the commodities it had acquired unless U.S. prices rose to
statutorily established release prices. The 1996 farm act eliminated
the release-price restrictions on the sale of government-held
commodities, which could have the effect of limiting the
price-supporting ability of nonrecourse loans.
\5 Marketing loan provisions have been available for rice and cotton
since 1986, for oilseeds since 1991, and for wheat and feedgrains
since 1993.
\6 For cotton, world prices are adjusted for transportation costs
from a designated central location in the United States to Northern
Europe. For rice, world prices are adjusted for transportation costs
from the United States to selected Asian markets. For wheat,
feedgrains, and oilseeds, world prices are adjusted for
transportation costs from the county where the commodity is grown to
the terminal market.
\7 Producers' total return will be less than the loan rate only if
they sell at a market price that is below the alternative repayment
rate.
\8 Cotton Program: Costly and Complex Government Program Needs to Be
Reassessed (GAO/RCED-95-107, June 20, 1995). Peanut Program:
Changes Are Needed to Make the Program Responsive to Market Forces
(GAO/RCED-93-18, Feb. 8, 1993). Sugar Program: Changing Domestic
and International Conditions Require Program Changes (GAO/RCED-93-84,
Apr. 16, 1993).
RESULTS IN BRIEF
------------------------------------------------------------ Letter :2
When alternative repayment rates, which are derived from USDA's
proxies for world prices, are near or below the loan rates, the
marketing loan provisions may prevent the loan rates from serving as
price floors. For example, during the last 10 years, when marketing
loan provisions were in effect for rice, the price data suggest that
when the adjusted world price was substantially lower than the loan
rate, the marketing loan provisions prevented the loan rate from
serving as a price floor, and the U.S. price fell below the loan
rate. For cotton, the price data are inconclusive, and, therefore,
it is less certain whether the marketing loan provisions have
prevented the loan rates from acting as a price floor. For wheat,
feedgrains, and most oilseeds, since marketing loan provisions went
into effect, U.S. prices have generally been higher than the loan
rates. As a result, the price data needed to assess the
effectiveness of the marketing loan provisions are limited, which
makes it difficult to test whether the marketing loan provisions are
preventing the loan rates from serving as price floors. However,
even if the marketing loan provisions allow U.S. prices to fall
below the loan rates, U.S. prices will remain higher than adjusted
world prices for some commodities, such as cotton and rice. This is
because the marketing loan provisions cannot overcome the effects of
other program features and market factors that have kept U.S. prices
higher than adjusted world prices. In contrast, when U.S. and
adjusted world prices are above the loan rates, as they have been in
recent years, producers would not use marketing loan provisions, and
these provisions therefore would have no effect on U.S. prices.
According to USDA's 1996 forecast, these market conditions could
continue for some commodities over the 7-year duration of the 1996
farm act.
Lowering the loan rates has little if any effect on U.S. prices when
alternative repayment rates are above the loan rates. However, when
alternative repayment rates are near or below the loan rates, the
effect on U.S. prices of lowering the loan rates differs by
commodity. For cotton and rice, the availability of nonrecourse
loans, in combination with other program and market factors, keeps
U.S. prices significantly higher than adjusted world prices.
Therefore, lowering the loan rates is likely to allow U.S. prices to
fall to levels that are closer to adjusted world prices. For wheat,
feedgrains, and oilseeds, most experts assert that the marketing loan
provisions will work as intended to overcome the price-supporting
effects of the nonrecourse loans. For these crops, lowering the loan
rates would have little if any impact on U.S. prices. On the other
hand, a few experts assert that the marketing loan provisions may not
work as intended and U.S. prices will continue to be supported by
the loan rates. In this case, lowering the loan rates may have some
downward effect on U.S. prices.
To the extent that a lower loan rate results in lower U.S. cotton
prices, step 2 payments would be reduced but not eliminated. Step 2
payments would continue to be made because the marketing loan
provisions have not been able to overcome the cotton program's other
features--such as government-paid storage--that help keep U.S.
cotton prices higher than adjusted world prices. However, because of
recent changes in how USDA makes step 2 payments to exporters, these
payments may no longer directly offset higher U.S. prices and
therefore may be less effective in enhancing exports.
Further changes can be made to make the peanut and sugar programs
more market-oriented. While the 1996 farm act changed the peanut and
sugar programs to help make them more market-oriented, U.S. prices
will continue to be higher than world prices because some income- and
price-support features remain. Additional reductions in the quota
support price for peanuts will lower U.S. prices and increase
economic efficiency. An increase in the tariff-rate import quota for
sugar (allowing more sugar to be imported at the lower tariff rate),
or its elimination entirely (no import restrictions), would result in
lower U.S. prices. Once prices fall to the level of the loan rate,
reductions in the loan rate would be necessary to reduce prices
further.
MARKETING LOAN PROVISIONS MAY
ELIMINATE PRICE FLOORS, BUT
U.S. COTTON AND RICE PRICES
WILL REMAIN HIGHER THAN
ADJUSTED WORLD PRICES
------------------------------------------------------------ Letter :3
When alternative repayment rates are near or below the loan rates,
the marketing loan provisions may prevent the loan rates from serving
as price floors. In the past, these market conditions have occurred
for some commodities, and producers received marketing loan gains or
loan deficiency payments. Although the historical price data\9 were
inconclusive or limited for cotton, wheat, feedgrains, and oilseeds,
the data for rice suggest that the marketing loan provisions have
prevented the loan rate from serving as a price floor when the
adjusted world price was substantially lower than the loan rate.
(See app. II for our detailed analyses of the impact of the
marketing loan provisions on U.S. prices for each of these
commodities.)
For rice, during the last 10 years, when the marketing loan
provisions were in effect, the adjusted world price was below the
loan rate in 81 months.\10 During 21 of these 81 months, when the
adjusted world price was particularly low, the U.S. price was also
below the loan rate. This suggests that the provisions worked as
intended, and the loan rate did not act as a price floor for rice.
While USDA officials generally agreed that the historical price data
support this view, they stated that it is hard to separate out the
effects of other changes made to the rice program during this period
(such as the acreage reduction program) that may also have had an
impact on lowering U.S. prices.
For cotton, the price data are inconclusive on the effectiveness of
the marketing loan provisions in preventing the loan rate from
serving as a price floor because the adjusted world price has not
fallen significantly below the loan rate since the marketing loan
provisions went into effect. Until market conditions cause the
adjusted world price to drop significantly below the loan rate--low
enough to overcome the effects of other program features and market
factors that keep the U.S. price above the adjusted world price--it
cannot be conclusively determined whether the loan rate will still
act as a price floor for cotton under the marketing loan provisions.
In commenting on a draft of this report, USDA officials told us that
there is substantial evidence that the loan rate for cotton has not
served as a price floor since the marketing loan provisions went into
effect. They base their view on a comparison of loan forfeitures and
the accumulation of government stocks both before and after the
marketing loan provisions went into effect, for those times when the
U.S. price was only a few cents per pound above the loan rate. We
agree that the data on forfeitures and stock accumulation merit
consideration in determining whether the loan rate is serving as a
price floor, but we found that forfeitures have continued to occur in
some years, although the quantity forfeited is lower, since the
marketing loan provisions went into effect. Therefore, we believe
that it is necessary to observe what happens to U.S. prices during a
period when the adjusted world price falls significantly below the
loan rate in order to confirm that the marketing loan provisions
prevent the loan rate for cotton from serving as a price floor,
despite the effects of other program features and market factors that
keep the U.S. price above the adjusted world price.
For wheat, feedgrains, and oilseeds, the historical data are limited
because during the short time that these provisions have been in
effect, U.S. prices and alternative repayment rates have generally
been above the loan rates. Even if additional data were available,
they might be inconclusive because of the way in which the
alternative repayment rates are set. (This issue is discussed in
more detail in app. II.) Nevertheless, many USDA officials,
including agricultural economists, and other agricultural economists
we spoke to expect that the marketing loan provisions for wheat,
feedgrains, and oilseeds will prevent the loan rates from serving as
price floors when alternative repayment rates fall below the loan
rates. They base this position on both theoretical expectations of
producers' profit-maximizing behavior and experience with the generic
commodity certificate program in the past,\11 which was similar in
concept to the marketing loan provisions. However, a few
agricultural economists and commodity analysts offered several
reasons why the loan rates may at times provide some price support
for these commodities despite the marketing loan provisions. (See
app. II for additional details on these views.)
Even if the marketing loan provisions allow U.S. prices to fall
below the loan rates, some program features and market factors will
keep U.S. prices higher than adjusted world prices for some
commodities, such as cotton and rice. The program features include
(1) import restrictions that reduce foreign competition in the United
States, (2) the availability of the nonrecourse loan, and (3) for
cotton, government-paid storage that makes it easier for producers to
hold cotton off the market while waiting for prices to rise. The
market factors include quality, reliability, and transportation
advantages that allow U.S. producers to receive higher prices than
some foreign producers. To the extent that higher U.S. prices are
due to market factors that reflect the desirability of U.S. cotton
and rice, then higher U.S. prices do not necessarily impede the
marketability of these commodities. Therefore, adjusted world prices
will typically be less than U.S. prices because (1) the marketing
loan provisions cannot overcome the effect of all program features
that support prices and (2) in setting the adjusted world prices,
USDA does not fully account for all the market factors that result in
higher U.S. prices. (See app. II for a detailed discussion of
these factors.)
According to USDA's 1996 forecast, U.S. and world prices are
expected to remain above the loan rates for some commodities, as they
are now, for the 7-year duration of the 1996 farm act. This forecast
suggests that for these commodities the marketing loan provisions
will have no effect on U.S. prices or how they compare with world
prices. Under these conditions, producers would not use the
marketing loan provisions to repay their loans at the higher
alternative repayment rates. Instead, they would repay their loans
at the loan rates. However, some agricultural economists have
suggested that over the next several years U.S. and world prices
might be below those in USDA's 1996 forecast. If market conditions
change and alternative repayment rates fall below the loan rates,
producers may use the marketing loan provisions when redeeming their
loans.
--------------------
\9 We recognize that one limitation of using historical data is that
some programs (such as the farmer-owned reserve and acreage reduction
programs) that affected U.S. prices in the past have been eliminated
by the 1996 farm act.
\10 We did not include as part of our analysis the period from
January 1986 through October 1987 because over this period the
government was releasing excess rice stocks that it had accumulated
in previous years. This excess supply drove U.S. prices below the
loan rate. The 81 months occurred from November 1987 through July
1996.
\11 The 1985 farm act authorized USDA to issue generic commodity
certificates to make in-kind payments to producers participating in
government commodity programs. Producers receiving certificates
could exchange them at the posted county prices for commodities
placed under loan, exchange them for government-owned commodities, or
sell them for cash.
THE EFFECT OF LOWER LOAN RATES
ON U.S. PRICES WILL VARY BY
COMMODITY
------------------------------------------------------------ Letter :4
For all commodities, when U.S. prices and alternative repayment
rates are above the loan rates, lower loan rates will have little if
any effect on U.S. prices because producers can earn more by selling
their commodities on the market than by forfeiting them to the
government.\12 However, when alternative repayment rates are below
the loan rates, the effect of lowering the loan rates on U.S. prices
will vary by commodity.
For cotton and rice, when adjusted world prices are below the loan
rates, lower loan rates are likely to have some downward effect on
U.S. prices. This is because producers who use nonrecourse loans
with marketing loan provisions have the option to hold their
commodities under loan while waiting for prices to rise. This option
has a value, known as the option value of the loan, which varies
among producers at any given point in time and varies for any
individual producer over time. Unless producers are offered a
premium price that compensates them for giving up their option to
keep their commodity under loan, they have little incentive to take
the commodity out of loan. The option value is one of several
factors that cause U.S. cotton and rice prices to be higher than
adjusted world prices.\13 To the extent that a lower loan rate
reduces the option value of the loan because it reduces producers'
guaranteed minimum returns upon forfeiture, a lower loan rate will
have some downward effect on U.S. prices, thereby bringing them
closer to adjusted world prices. However, a lower loan rate will not
by itself eliminate the price premium paid for U.S. cotton and rice,
and U.S. prices will continue to remain higher than adjusted world
prices because of other program features and market factors. For
example, for cotton, a lower loan rate, combined with the elimination
of government-paid storage, would result in a larger downward effect
on U.S. cotton prices.
For wheat, feedgrains, and oilseeds, USDA officials, including
agricultural economists, and many other agricultural economists told
us that lower loan rates will have little if any impact on U.S.
prices when alternative repayment rates are below the loan rates.
According to these USDA officials and economists, when producers use
the marketing loan provisions and sell their commodities earlier in
the marketing year, they generally benefit by saving on storage
costs. The potential savings from avoiding storage costs are
relatively greater than the option value of the loan. Consequently,
these officials told us that lowering the loan rates will have little
if any effect on U.S. prices because marketing loan provisions will
keep the loan rates from supporting prices.
In contrast, a few other agricultural economists and commodity
analysts told us that the option value of the loan may be a
significant factor in producers' marketing decisions and that this
and other market factors may cause the loan rates to continue
providing price support despite the marketing loan provisions.
According to these experts, if the loan rates are supporting prices,
lowering the loan rates may have some downward effect on U.S.
prices. The degree to which prices will drop depends on how the
option value of the loan compares with the potential value of
avoiding storage costs while receiving marketing loan benefits.\14
In commenting on a draft of this report, USDA officials disagreed
that lower loan rates would reduce U.S. prices. Their detailed
comments and our response are presented at the end of this letter.
--------------------
\12 In the long run, lower loan rates may increase producers' risks
and decrease their expected returns, which could lead to reduced
production and higher domestic commodity prices.
\13 The 1996 farm act reduced the maximum time that producers could
keep their cotton under loan, thereby reducing the option value of
the loan in the future. (See app. II for additional discussion.)
\14 Transaction costs associated with using the marketing loan
provisions may also influence a producer's marketing decision.
LOWER LOAN RATE WOULD NOT
ELIMINATE THE USE OF STEP 2
PAYMENTS, AND RECENT CHANGES TO
THE TIMING OF STEP 2 PAYMENTS
MAY DIMINISH THEIR EFFECT ON
EXPORTS
------------------------------------------------------------ Letter :5
U.S. cotton prices have historically been higher than world prices,
in part because of import restrictions and other program features
that the marketing loan provisions have been unable to overcome.
Higher U.S. prices made U.S. cotton less competitive on the world
market, to which the United States exported its cotton as a residual
supplier when world supplies were low. To help keep U.S. cotton
competitively priced in world markets, the 1990 farm act added a
subsidy in the form of step 2 payments to exporters and domestic
mills. Exporters use the step 2 payment to reduce the price of U.S.
cotton offered to foreign buyers, and domestic mills use the step 2
payments to offset the cost of purchasing higher-priced U.S. cotton.
Step 2 payments are made when two conditions are met for 4
consecutive weeks: the (1) adjusted world price is less than or
equal to 130 percent of the loan rate and (2) U.S. price in Northern
Europe exceeds the average price in Northern Europe by more than
$0.0125 per pound. The payment per pound is equal to the difference
between the U.S. price in Northern Europe and the sum of the price
in Northern Europe (average across five countries) and $0.0125.
Figure 1 shows a hypothetical example of how the step 2 payment is
calculated.
Figure 1: Calculation of the
Step 2 Payment
(See figure in printed
edition.)
Note: Step 2 payments are not made during those times when special
import quotas are in effect.
USDA made a total of $701 million (in 1995 dollars) in step 2
payments from fiscal years 1992 through 1996. Currently, the
adjusted world price is sufficiently above the loan rate to preclude
the use of step 2 payments. If the adjusted world price drops to
within 130 percent of the loan rate in the future, step 2 payments
may be used again. As discussed previously, when the adjusted world
price is below the loan rate, a lower loan rate is most likely to
have some downward effect on U.S. prices. To the extent that U.S.
prices decrease because of a lower loan rate, step 2 payments will be
used less often and the payment rate will also be reduced. However,
since other program features (such as government paid-storage and
import restrictions) and market factors contribute to making U.S.
prices higher than world cotton prices, lowering the loan rate alone
will not eliminate the use of step 2 payments.\15
Recent changes in the timing of USDA's step 2 payments to exporters
may diminish this tool's effectiveness in enhancing exports. In the
past, exporters received the step 2 payment rate that was in effect
during the week they contracted for cotton sales.\16 As a result,
exporters could use step 2 payments to reduce the price of U.S.
cotton offered to foreign buyers. An unintended consequence of the
step 2 provision was that many contracts for future sales were made
during weeks with high payment rates. This practice was known as
"bunching," and many of these sales represented internal transactions
between U.S. firms and their foreign affiliates. Bunching increased
the cost of the step 2 provision to the government and placed
domestic mills and exporters without foreign affiliates at a price
disadvantage. To prevent bunching, USDA changed step 2 procedures so
that exporters receive the step 2 payment rate that applies during
the week the cotton is shipped instead of the week in which the sales
are contracted. Consequently, when exporters agree to a sale, they
do not know what step 2 payment rate, if any, will be in effect
during the week the cotton is shipped. Step 2 payments have not been
made since USDA changed its procedures. This change should reduce
the occurrence of bunching but could also make it more difficult for
exporters to reduce the higher price of U.S. cotton when it is
offered for sale to foreign buyers.
--------------------
\15 This conclusion assumes that the loan rate is not lowered so far
that the adjusted world price exceeds 130 percent of the loan rate.
\16 Domestic mills receive the step 2 payment rate in effect during
the week they open the bales of cotton.
PEANUT AND SUGAR PRICES WILL
REMAIN ABOVE WORLD PRICES
DESPITE RECENT PROGRAM CHANGES
------------------------------------------------------------ Letter :6
As we have reported in the past,\17 the peanut and sugar programs
have not been market-oriented because they have kept U.S. prices
higher than world prices and resulted in production and consumption
inefficiencies. As a result, these programs have cost users of
peanuts and sugar and the government hundreds of millions of dollars
annually. The Congress made a number of changes to both programs
through the 1996 farm act to reduce U.S. prices and some of the
economic inefficiencies in order to make the programs more
market-oriented. However, these changes did not eliminate the
difference between U.S. prices and lower world prices because the
domestic marketing quota for peanuts and the tariff-rate import quota
for sugar continue to restrict supply. As we recommended in the
past, greater market orientation could be achieved through (1)
further reductions in the support price for peanuts and (2) a
reduction in the loan rate for sugar and an increase in the
tariff-rate import quota. These changes would help lower U.S.
prices and increase economic efficiency, but one tradeoff would be a
potential reduction in producers' revenue.
--------------------
\17 Peanut Program: Changes Are Needed to Make the Program
Responsive to Market Forces (GAO/RCED-93-18, Feb. 8, 1993). Sugar
Program: Changing Domestic and International Conditions Require
Program Changes (GAO/RCED-93-84, Apr. 16, 1993).
PEANUTS
---------------------------------------------------------- Letter :6.1
The peanut program controls the domestic supply and protects
producers' income by (1) setting a national poundage quota that
determines the amount of peanuts that can be sold domestically and
(2) restricting imports. The national poundage quota is set at a
level based on the estimated quantity of edible peanuts used in the
United States at the support price. Prior to the 1996 farm act, the
quota could not fall below 1.35 million tons.\18 Generally, only
producers holding a portion of the assigned quota may sell these
"quota peanuts" domestically. Quota holders who choose not to grow
peanuts can sell or lease their quota within the county it was
assigned or return it to USDA for redistribution to other producers.
Producers without assigned quota and those who exceed their quota
cannot sell these peanuts in the domestic edible market except under
certain conditions,\19 but they may export them as "additional
peanuts."
The program protects producers' incomes through a two-tiered system
that sets minimum support prices for both quota and additional
peanuts. The support price for quota peanuts guarantees producers a
price in U.S. markets that is higher than world prices. Prior to
the 1996 farm act, the quota support price was adjusted upward
annually when the cost of production rose but was left unchanged when
the cost of production fell. (This adjustment was known as the
"escalator clause.") The support price for additional peanuts is
generally set lower than the world price and plays a limited role in
domestic peanut marketing.
Higher U.S. prices result in increased costs to consumers. The
world price for peanuts in 1995 averaged $415 per ton,\20 while the
support price for quota peanuts was $678 per ton. Therefore, U.S.
consumers paid more for items containing peanuts than they would have
if U.S. processors had purchased peanuts at the lower world price.
In addition, higher U.S. prices could create a consumption
inefficiency because the quantity of peanuts purchased at the higher
U.S. price is less than what would have been purchased at the lower
world price--the price that would have occurred if there were no
program.
The government also incurs costs when producers cannot sell their
peanuts at a price greater than or equal to the support price and
instead forfeit them to the government at the support price. The
government pays to have these peanuts crushed and sells them at a
price lower than the support price. To prevent forfeitures, USDA
strives to set the annual quota at a level that does not exceed the
expected quantity that would be demanded at the support price. If
USDA sets the quota too high, the government will incur costs from
forfeitures. For example, in fiscal years 1995 and 1996, the
government incurred costs of $124.7 million and $127.4 million,
respectively, because the legislatively set minimum quota of 1.35
million tons was greater than the quantity of peanuts demanded at the
support price in those years. On the other hand, if USDA sets the
quota too low, forfeitures will not occur, but U.S. prices will rise
because the supply marketed under the quota is not adequate to meet
the quantity demanded at the support price. In order to share
program costs with the government, producers and buyers of peanuts
pay a fee to the government, known as a marketing assessment, per ton
of peanuts sold.\21
The government also incurs indirect costs when it purchases
higher-priced peanuts and peanut-containing products for its food
assistance programs. In 1993, we reported that USDA paid the quota
support price, instead of the lower world price, for peanuts and
peanut-containing products that it purchased, leading it to incur
greater costs than without the peanut program.
The 1996 farm act made several changes to the peanut program to
reduce its costs and make the U.S. peanut industry more
market-oriented. One change in particular will help make U.S.
peanut prices somewhat closer to world prices--a lower quota support
price. Under the 1996 farm act, the peanut quota support price was
reduced from $678 to $610 per ton and fixed through the year
2002--the remainder of the life of the farm act. As a result of this
change, the quota support price is no longer linked to the cost of
producing peanuts and will not increase with inflation because the
escalator clause has been eliminated.
In addition to reducing the quota support price, the 1996 farm act
made other changes to the peanut program to increase economic
efficiency. These changes included eliminating the minimum level to
which the national poundage quota could fall, authorizing marketing
assessment increases, eliminating provisions allowing the carryover
of unfilled quota from year to year (undermarketings), redefining the
peanut quota to exclude seed peanuts, limiting disaster transfers
requested by quota holders whose commodity is damaged, and adding
marketing requirements to maintain program eligibility. These
changes should enable USDA to better control the quantity of peanuts
marketed at the quota support price, thus reducing government costs
associated with the program. Moreover, people who live outside of
the state in which the quota is allocated or who are not peanut
producers, as well as government entities, can no longer hold quota;
and the annual sale, lease, and transfer of quota is now permitted
across county lines within a state, up to specified amounts of quota.
These changes will improve the equity and economic efficiency of the
peanut program. (See app. III for additional details on these
changes.)
Although the lower quota support price of $610 will help reduce U.S.
peanut prices, it is still substantially above the average U.S. cost
of producing peanuts and world prices. In 1995, the average cost of
producing peanuts in the United States was $369 per ton and the world
price was $415 per ton,\22 while the support price was $678 per ton.
In 1993, we recommended that the quota support price be reduced so
that over time U.S. prices would more closely parallel the cost of
producing peanuts and world prices. Lowering and fixing the quota
support price at $610 per ton was a good first step. This price
could be reduced further, which would result in lower U.S. prices
that would be closer to world prices and would also result in
reductions in government costs. While USDA officials agreed that a
lower quota support price will lower U.S. prices and government
costs, they pointed out that it will also reduce producers' revenues.
--------------------
\18 In this report, tons refers to "short" tons. A short ton equals
2,000 pounds.
\19 Under a provision known as "buy-back," additional peanuts, which
are usually exported or crushed for oil and meal at prices lower than
the quota support price, can be purchased for use in the domestic
market if U.S. prices start to rise significantly. However, buyers
of these additional peanuts must, at a minimum, pay the higher quota
support price plus other mandated fees.
\20 The world price is derived from the price quoted for U.S.
peanuts in Rotterdam, adjusted for the cost of shelling and
transportation back to the United States.
\21 The 1996 farm act set the marketing assessments for peanuts at
1.15 percent of the loan rate for the 1996 crop and 1.2 percent of
the loan rate for the 1997-2002 crops.
\22 This estimate of the cost of production was derived from a USDA
estimate of variable production costs per acre. This estimate
however, does not include fixed costs of production, such as the cost
of land.
SUGAR
---------------------------------------------------------- Letter :6.2
The sugar program guarantees producers (growers and processors) a
minimum price for domestic sugar through the nonrecourse loan program
and controls the domestic supply of sugar through the use of a
tariff-rate import quota. The nonrecourse loan program sets a
guaranteed minimum price for domestic sugar through the loan rate.
However, the 1996 farm act restricts the availability of nonrecourse
loans to times when the tariff-rate import quota is at or above 1.5
million tons. USDA adjusts the tariff-rate import quota on the basis
of the (1) estimated domestic production and demand and (2) level of
supply needed to maintain domestic prices at levels high enough to
discourage forfeitures.\23 Prior to the 1996 farm act, under certain
market conditions, USDA could also limit the domestic marketing of
sugar by assigning marketing allotments to processors to maintain the
support price.\24 USDA assigned marketing allotments twice, in fiscal
years 1993 and 1995.
The 1996 farm act made the following changes to the sugar program to
reduce U.S. sugar prices and some economic inefficiencies of the
program:
-- Loans are to be recourse under certain circumstances. When the
tariff-rate import quota is established below 1.5 million tons
on the basis of estimated domestic production and demand, loans
are issued as recourse rather than nonrecourse to eliminate
potential forfeitures. If loans are recourse, then there is
effectively no price support and U.S. prices could fall below
the loan rate.
-- The loan rates were fixed. The loan rates were fixed for
refined beet sugar at the 1995 level of 22.9 cents per pound and
for raw cane sugar at 18 cents per pound. USDA has maintained
the loan rate for raw cane sugar at 18 cents per pound since
1981, although in the past it had the authority to raise the
rate. A fixed rate means that over time the real value of the
loan rate, and therefore the real value of government support,
will fall because of inflation.\25 If prices fall near the loan
rates, inflation-adjusted market prices may be lower.
-- The no-net-cost requirement was discontinued. In the past, the
sugar program was designed to operate at no net cost to the
government. The 1996 farm act did not renew the no-net-cost
provision of the program, and therefore this provision is no
longer operative. Without the no-net-cost provision, USDA could
in the future choose to set the tariff-rate import quota at a
higher level to allow greater imports, which would result in
lower U.S. sugar prices. However, it is not yet clear whether
USDA will choose to increase the tariff-rate import quota and
increase the chance of forfeitures under the nonrecourse loan
program.
-- Marketing allotments were eliminated. The 1996 farm act
eliminated USDA's authority to use marketing allotments, which
may result in a more efficient allocation of resources in the
sugar industry. More efficient producers will no longer have to
limit their level of production and marketings in favor of less
efficient and higher-cost producers. Any reductions in the
costs of production because of increased efficiency may be
passed on to users in the form of lower sugar prices.
-- Penalties were imposed on forfeitures. The 1996 farm act
required that sugar processors be assessed a 1-cent penalty on
every pound of raw cane sugar and a 1.07-cent penalty on every
pound of refined beet sugar forfeited to the government. This
penalty will reduce the effective guaranteed price that
processors receive from the government. Because of this
penalty, USDA can now support the price of sugar at a level that
is 1 cent lower than under the prior farm act without causing
processors to forfeit.
The 1996 farm act did not eliminate the tariff-rate import quota,
which continues to be the key mechanism by which total domestic
supply is restricted and U.S. sugar prices are supported. As long
as USDA continues to use the tariff-rate import quota as it has in
the past to restrict imports and support U.S. prices above the level
necessary to prevent forfeitures, the 1996 farm act's changes (such
as limits on the availability of nonrecourse loans) will have little
if any impact on U.S. prices. However, these changes could result
in lower U.S. prices if there are significant increases in domestic
supply (or similarly large decreases in domestic consumption) that
prevent USDA from maintaining a tariff-rate import quota of 1.5
million tons while supporting prices at their current level. In
commenting on a draft of this report, USDA officials pointed out that
such an increase in beet sugar production occurred in fiscal year
1995. If a similar increase in domestic supply occurred under the
1996 farm act, USDA could either (1) keep the tariff-rate import
quota at or above 1.5 million tons, which would result in lower sugar
prices because of increased supply, or (2) set the tariff-rate import
quota below 1.5 million tons, which would result in producers not
being eligible for nonrecourse loans, and which could result in lower
U.S. sugar prices.
If USDA's implementation of the sugar program continues to insulate
the U.S. sugar market from the world market, U.S. prices are likely
to remain higher than world prices.\26 For fiscal years 1991 through
1995, the average annual world price of raw cane sugar ranged from
9.22 to 13.86 cents per pound, and the average annual U.S. price
ranged from 21.39 to 22.76 cents per pound. In addition, according
to some sugar analysts who are familiar with trends in world sugar
prices, world prices are expected to decline in the short run and,
because of the sugar program, U.S. sugar users will continue to pay
premium prices. Finally, by supporting the price of U.S. sugar, the
sugar program also indirectly supports the prices of other
sweeteners, such as high-fructose corn syrup.
There is considerable controversy about the size of the premium paid
for U.S. sugar and, therefore, the total cost of the sugar program
to domestic sweetener users. The size of the premium is
controversial because it is not a simple difference between current
U.S. and world sugar prices. Instead, the size of the premium
depends in part on assumptions about how much the world price would
rise if the United States did not have a sugar program. The premium
could also be based on an estimate of what the world price would be
if all countries eliminated programs that support their sugar
industries. Nevertheless, as we and others have shown, higher U.S.
sugar prices result in increased costs of hundreds of millions of
dollars per year to U.S. sweetener users.\27 USDA has not officially
determined the size of the premium that users pay for U.S. sugar.
However, in a 1995 report,\28 USDA stated that for every
1-cent-per-pound premium paid for U.S. sugar, the cost to consumers
is $178 million (in 1995 dollars).
Higher U.S. sugar prices also result in a production
inefficiency--the cost of shifting resources from other economic
sectors to pay for more expensive domestic production instead of
importing lower-cost sugar. A consumption inefficiency also arises
when the quantity of sugar purchased at the higher U.S. price is
less than the quantity that would have been purchased at the lower
world price.
The government incurs indirect costs of millions of dollars a year as
a result of the sugar program when it purchases higher-priced sugar
and sweetener-containing products for its food assistance programs.
On the other hand, the government receives marketing assessments from
sugar processors on each pound of sugar that they market.\29
In order to reduce U.S. sugar prices, we recommended in our 1993
report that the loan rate be reduced gradually and the tariff-rate
import quota be adjusted accordingly. Changes made in the 1996 farm
act should help reduce U.S. prices if there are significant
increases in domestic supply or similar decreases in domestic
consumption. However, if domestic market conditions do not change,
reductions in U.S. prices could be achieved only by increasing the
tariff-rate import quota or eliminating it (no import restrictions).
Once increases in the tariff-rate import quota result in U.S. prices
dropping to the loan rate, reductions in the loan rate would be
necessary to reduce prices further. However, one tradeoff of an
increase in the tariff-rate import quota and a lower loan rate would
be a reduction in U.S. producers' revenues. Moreover, according to
an official of the American Sugar Alliance, making these changes
would adversely affect the long-term viability of the U.S. sugar
industry because U.S. sugar production would be replaced by
lower-priced imports, most of which receive some form of government
support, such as export subsidies. Other sugar industry officials
told us that further reductions in domestic sugar production will
result in the deterioration of the specialized
infrastructure--processing mills, machinery, seeds, and
chemicals--necessary to support a domestic sugar industry.
--------------------
\23 In the past, the sugar program was designed to operate at no net
cost to the government, which, according to USDA, meant no
forfeitures of sugar to the government. USDA adjusted the
tariff-rate import quota to prevent loan forfeitures. However, the
no-net-cost provision only applied to the direct costs of operating
the sugar program, not to other indirect costs incurred by the
government when it bought food products for its food assistance
programs.
\24 Under the 1990 farm act, foreign sugar producers and domestic
cane refiners were ensured that estimated imports of lower-priced
sugar would not fall below 1.25 million tons. If estimated imports
were less than 1.25 million tons for the fiscal year, USDA was
required to activate marketing allotments, which limit the domestic
marketing of sugar.
\25 To the extent that over time there are productivity gains in
sugar production, the real cost of producing sugar will also decline.
\26 In this report, the world price for sugar refers to the Number 11
contract price as traded on the New York Coffee, Sugar, and Cocoa
Exchange, (f.o.b. Caribbean) for raw cane sugar.
\27 While we recognize that the cost of the program varies from year
to year, we estimated in our 1993 report that the sugar program cost
domestic sweetener users an average of about $1.4 billion per year
(in 1991 dollars) between 1989 and 1991. This estimate was based on
an estimated long-run, free-market world price of 15 cents per pound
for raw cane sugar. Although USDA officials disagreed with our
methodology and assumptions, they told us that they used an
approximation of our methodology and estimated that the costs to
sweetener users averaged about $900 million annually (in 1991
dollars) for 1992-94. In addition, other studies using different
assumptions and methodologies have estimated that the sugar program
results in substantial costs to U.S. sugar or sweetener users.
\28 Lord, Ron. Sugar: Background for 1995 Farm Legislation
(USDA/ERS, Washington, D.C., Apr. 1995).
\29 The 1996 farm act increased marketing assessments on processed
raw cane sugar from 1.1 to 1.375 percent of the raw cane sugar loan
rate, and for refined beet sugar from 1.1794 to 1.47425 percent of
the raw cane sugar loan rate.
AGENCY COMMENTS
------------------------------------------------------------ Letter :7
We provided copies of a draft of this report to USDA for review and
comment. We met with officials of the Department, including USDA's
Deputy Chief Economist; the Farm Service Agency's Assistant Deputy
Administrator, Economic Policy Analysis Staff, and 10 other officials
representing various commodity divisions within this agency; and an
official representing the Commercial Agriculture Division of the
Economic Research Service. These officials expressed concern with
our findings in the following five areas:
-- USDA officials told us that in their opinion the marketing loan
provisions have prevented the loan rates from acting as price
floors in the past and will be similarly effective in the future
if market conditions warrant their use. They base this position
on (1) the strong theory behind the concept of the marketing
loan provisions; (2) USDA's past experience with the generic
certificate program, which they said was similar in concept to
the marketing loan provisions; and (3) the data that are
available for sunflower seeds and cotton. We disagree with USDA
that a conclusion about the effectiveness of the marketing loan
provisions for all commodities is warranted. While we agree
that the marketing loan provisions appear to have prevented the
rice loan rate from serving as a price floor, we believe that
the evidence is insufficient to reach similar conclusions for
the other commodities. For cotton, we disagree that the data on
forfeitures and stock accumulations, along with theoretical
expectations, are sufficient to reach a conclusion. For wheat,
feedgrains, and soybeans, the provisions remain largely untested
because U.S. prices and alternative repayment rates have
generally been higher than the loan rates; and for minor
oilseeds, the data necessary to analyze the provisions'
effectiveness are unavailable or, as USDA acknowledges,
"anecdotal." For cotton, wheat, feedgrains, and oilseeds, we
believe that more price data are needed to confirm that the
marketing loan provisions prevent the loan rates from serving as
price floors.
-- USDA officials were also concerned about our reliance on
historical data in analyzing the effectiveness of the marketing
loan provisions and projecting to the future, particularly when
major program changes were made in the 1996 farm act to increase
the market orientation of U.S. commodity programs. They stated
that in the future there will be a different combination of
domestic government commodity programs and a different mix of
international trade policies. Therefore, if the effectiveness
of the marketing loan provisions are analyzed using historical
data, these results should not be projected to the future. In
our report, we have added language to recognize that one
limitation of using historical data is that some programs that
affected U.S. prices in the past have been eliminated by the
1996 farm act. In addition, our report recognizes that
marketing loan provisions may prevent the loan rates from
serving as price floors in the future, only under certain market
conditions.
-- USDA officials were concerned that our draft report implied that
higher U.S. prices always meant that U.S. commodities were not
competitive on world markets. They said that price premiums are
justifiable if they reflect the desirability of U.S.
commodities over foreign commodities in world markets; they
acknowledged that price premiums deriving from program
provisions that keep U.S. prices artificially high and pose an
impediment to free trade are undesirable. We agree that some
price premiums resulting from market factors may be justifiable
and do not indicate a lack of competitiveness. Throughout the
report, where appropriate, we have changed any reference to
"making U.S. prices more competitive" to "lowering U.S. prices
to levels that are closer to" alternative repayment rates or
world prices.
-- USDA officials disagreed that lower loan rates would reduce U.S.
prices. They stated that lowering the loan rates would have
little if any effect on reducing U.S. prices when the marketing
loan provisions are available. While they did not disagree that
loans have an option value, they told us that if prices fall to
levels significantly below the loan rates, the option value of
the loans will have at best a marginal impact on U.S. prices.
The option value will only influence the seasonal variation of
prices, with no significant effect on annual average prices.
Furthermore, they told us that if producers obtained commercial
loans instead of government loans, producers would still be able
to keep their commodities off the market for some period of
time. Specifically, for cotton, officials told us that the
option value of the loan will be less of a factor in the future
because the 1996 farm act eliminated the 8-month loan extension,
which in the past allowed the loan to span 2 crop years. For
rice, officials stated that the level of the loan rate is
irrelevant to producers' decisions to plant; instead, the main
factor is the high cost of rice production. Because of this,
USDA officials stated that lowering the loan rate for rice will
have little if any impact on U.S. prices. For wheat,
feedgrains, and oilseeds, USDA officials hold the view that
marketing loan provisions will prevent the loan rates from
serving as price floors and therefore lower loan rates will have
little if any impact on U.S. prices.
Despite USDA's disagreement, we continue to believe that for cotton
and rice, when adjusted world prices are below the loan rates, lower
loan rates will likely have some downward effect on U.S. prices.
This is because the option value of the loan may be a significant
factor affecting U.S. cotton and rice prices. For cotton, while we
agree that eliminating the 8-month extension reduces the option value
of the loan, we believe that the availability of government-paid
storage and import restrictions continue to play a role in affecting
the option value of the loan and keeping U.S. cotton prices higher
than adjusted world prices. To the extent that lowering the loan
rate for cotton reduces the loan's option value, there will be some
downward effect on U.S. prices. For rice, although the price data
suggest that the marketing loan provisions have prevented the loan
rate from serving as a price floor, U.S. rice prices have remained
higher than adjusted world prices. To the extent that these higher
prices are caused by the availability of nonrecourse loans, we
believe that lowering the loan rate for rice will reduce the loan's
option value and will have some downward effect on U.S. prices.
For wheat, feedgrains, and oilseeds, we do not take a position on the
likely effect of lowering the loan rates on U.S. prices. The report
recognizes that most experts expect the marketing loan provisions to
work as intended and prevent loan rates from serving as price floors.
In this case, lower loan rates will have little if any impact on U.S.
prices. However, if marketing loan provisions do not prevent the
loan rates from supporting prices, as some others have suggested,
then lowering the loan rates may have some downward effect on U.S.
prices.
-- USDA officials expressed their strong disagreement with our
estimates of the cost of the sugar program to domestic sugar
users as reported in 1993 and cited in this report. This is in
contrast to USDA's official comments on our 1993 report, in
which USDA stated that our report was reasonable and had no
major data problems. At that time, USDA stated that the costs
and benefits derived using assumptions of hypothetical policy
alternatives were well within the range of most research.
However, in commenting on a draft of our current report, USDA
officials told us that since our 1993 report was issued, they
have changed their position and now strongly disagree with our
1993 estimate of the average annual cost to users of $1.4
billion. They stated that the 1993 report did not adequately
consider the complexities and dynamics of the U.S. and global
sugar markets. They said that the report overestimated the cost
of the sugar program to U.S. users, some data were used
incorrectly, and important sugar market issues were not
considered. Furthermore, they said that using our methodology,
different welfare cost impacts could be obtained by selecting
prices in different time periods. We continue to believe that
our 1993 report provided a reasonable estimate of the cost of
the sugar program to U.S. sugar users for the period analyzed.
More importantly, we believe that while the precise level of
price premium is subject to debate, the program and policy
problems that we identified in 1993 are still relevant.
USDA officials also suggested a number of technical revisions to our
draft. Where appropriate, we have incorporated these revisions into
the report.
---------------------------------------------------------- Letter :7.1
In conducting our review, we interviewed USDA officials from the
Commodity Credit Corporation, Economic Research Service, Farm Service
Agency, Foreign Agricultural Service, National Agriculture
Statistical Service, Office of the Chief Economist, and county
offices. We also spoke to officials of the World Bank, academic
experts, industry and trade representatives, and agricultural
commodity consultants. We also obtained data from USDA, and we
reviewed various economic and international trade studies conducted
by universities, management consulting groups, USDA, and
international agencies. We did not independently verify the data
used in this report. We conducted our review from July 1996 through
January 1997 in accordance with generally accepted government
auditing standards. A detailed discussion of our overall scope and
methodology is provided in appendix IV.
We are sending copies of this report to the Senate Committee on
Agriculture, Nutrition, and Forestry; the House Committee on
Agriculture; other interested congressional committees; the Secretary
of Agriculture; and other interested parties. We will also make
copies available to others on request.
If you or your staff have any questions about this report, please
contact me on (202) 512-5138. Major contributors to this report are
listed in appendix V.
Sincerely yours,
Robert A. Robinson
Director, Food
and Agriculture Issues
CALCULATING THE BENEFITS FROM
USING THE MARKETING LOAN
PROVISIONS
=========================================================== Appendix I
This appendix provides an (1) explanation of how to calculate the net
amount that producers receive from the government when they use
nonrecourse loans without marketing loan provisions, (2) analysis of
how the marketing loan provisions are intended to operate and prevent
the loan rates from acting as price floors,\1 and (3) illustration of
the differences in marketing loan benefits under various market
conditions and the relationship between the alternative repayment
rates and U.S. prices.
Throughout this appendix, we use prices and the loan rate for corn in
our examples to show how calculations are made. The specific
calculations for cotton, rice, wheat, feedgrains, and oilseeds may
vary to some extent. For example, for cotton and rice, the adjusted
world price would be used as the alternative repayment rate and not
the posted county price, and for cotton, storage costs would not be
included because the government pays storage costs when the adjusted
world price is below the loan rate. However, the overall process is
the same.
--------------------
\1 This analysis focuses on how the marketing loan provisions are
intended to operate. Therefore, it does not take into account
several reasons presented in appendix II on why the loan rate may at
times provide some price support despite the marketing loan
provisions. These reasons include the option value of the loan,
which may be large relative to the potential savings from storage
costs by using the marketing loan provisions.
CALCULATION OF NET AMOUNT
RECEIVED FROM NONRECOURSE LOANS
WITHOUT MARKETING LOAN
PROVISIONS
--------------------------------------------------------- Appendix I:1
Under the nonrecourse loan without marketing loan provisions,
producers who kept their commodity under loan for the full 9 months
would, upon forfeiture, receive the loan rate (less a service fee)
minus the storage costs they incurred. Producers were not required
to pay interest when they forfeited their commodities to the
government. However, if they repaid the loan, they had to pay
interest charges. The hypothetical example in table I.1 shows that
when the loan rate for corn was $1.89 per bushel, the net amount
producers received from the nonrecourse loan upon forfeiture at
maturity was $1.70 per bushel.
Table I.1
Calculation of Net Amount Received From
the Nonrecourse Loan When Forfeited at
Maturity Without Marketing Loan
Provisions
Benefits and
charges per bushel
Factors in calculating amount of corn
-------------------------------------------------- ------------------
Loan rate for corn $1.89
Less service fee 0.01\a
Effective loan rate 1.88
Less storage costs of 2 cents/month for 9 months\b 0.18
======================================================================
Total amount received $1.70
----------------------------------------------------------------------
\a The loan processing fee charged for taking out a loan may vary
from county to county. This fee is not an interest charge.
\b The relative value of storage costs may be higher if the
opportunity cost (in the form of interest foregone) is also included.
MARKETING LOAN PROVISIONS WERE
INTENDED TO ELIMINATE PRICE
FLOORS
--------------------------------------------------------- Appendix I:2
Before the marketing loan provisions were available, the loan rate
determined the effective level of price support, which increased
during the marketing year to reflect storage and interest costs that
producers incurred while holding the corn under loan. The forfeiture
option always allowed them to net $1.70 at the end of 9 months. To
be better off selling at any time during the 9-month loan period,
producers needed to receive an amount that made them at least as well
off as forfeiting at the end of the loan period. Producers had to
receive an amount that allowed them to repay the loan amount of $1.89
plus accrued interest, minus the amount of refunded prepaid storage
costs. (Producers who choose to keep their commodities under loan
are responsible for paying storage costs in advance for the full term
of the loan.) For example, after 3 months, producers would have had
to receive at least $1.80 ($1.89 plus 3 cents for interest minus 12
cents for refunded storage costs) to be better off selling rather
than leaving the commodity under loan for another 6 months and then
forfeiting it to the government. At 9 months, producers would have
had to receive at least $1.98 ($1.89 plus 9 cents in interest,
without any refund for storage) to be better off selling rather than
forfeiting the commodity to the government. In this example, when
prices fell below $1.98 at the end of the loan period, producers
forfeited their commodities and government stocks rose.
The marketing loan provisions were added in part to eliminate the
price floors created by the loan rates. When the alternative
repayment rate is below the loan rate at the time of harvest, the
marketing loan provisions provide a producer who holds a nonrecourse
loan with two options: (1) redeem the loan at any time at the
alternative repayment rate (for corn, this is the posted county
price) and sell the commodity at the market price or (2) forfeit the
commodity after 9 months at the loan rate. Under the first option,
the difference between the loan rate and the alternative repayment
rate represents a marketing loan gain to the producer. In addition,
producers who repay their loans at the alternative repayment rate do
not have to pay accrued interest on the loan. (Those producers who
choose to forego loans can receive government payments equal to the
marketing loan gains. These amounts are known as loan deficiency
payments.)
When the alternative repayment rate is below the loan rate, producers
are better off by choosing the first option because they can obtain
the full value of the loan rate without incurring the full 9 months
of storage costs associated with forfeitures and are relieved of the
interest costs on the loan. For example, if the alternative
repayment rate at the time of harvest is $1.60 per bushel, producers
are eligible for marketing loan benefits of 29 cents per bushel (the
difference between the loan rate of $1.89 and the posted county price
of $1.60). The producer sells the corn at $1.60 (this example
assumes that the posted county price remains unchanged and equals the
market price) and receives a total return of $1.89 (market price of
$1.60 plus the marketing loan benefit of 29 cents), which is the full
value of the loan. Because producers can receive the full value of
their loans even when marketing their commodities at prices below the
loan rates, the marketing loan provisions can prevent the loan rates
from serving as price floors. The longer producers hold their
commodities under loan, the more their benefit is reduced by storage
costs. Producers have an incentive to use the marketing loan
provisions early in the marketing year to avoid the greatest amount
of storage costs.
BENEFITS CAN DIFFER, DEPENDING
ON MARKET CONDITIONS
--------------------------------------------------------- Appendix I:3
The analysis in the previous section assumes that the posted county
price and the price offered to the producer (hereafter known as
market price) are the same. However, because the posted county price
is based on the previous day's terminal prices and lags behind the
market, it could be lower or higher than the market price. The total
benefit that a producer receives depends on the relationship between
the posted county price and the market price. As shown in table I.2,
producers benefit more when the posted county price is lower than or
equal to the market price than they do when the posted county price
is above the market price. According to USDA officials, marketing
loan gains are most likely to be made to producers when the posted
county price is lower than or equal to the market price. When the
posted county price is above the market price, producers would
generally be expected to wait until the U.S. price rose or the
posted county price fell before they redeemed their loans. However,
the amount of time producers are willing to wait for higher prices
will depend on the tradeoff between their expected price gains,
additional storage costs, and their expectations about future market
prices.
Table I.2
Total Returns That Producers Receive at
Harvestime Depend on the Relationship
Between the Market Price and the Posted
County Price
Posted county Posted county
Posted county price is lower price is higher
Factors in calculating the price is equal to than the market than the market
benefit the market price price price
----------------------------- ------------------ ------------------ ------------------
Loan rate for corn $1.89 $1.89 $1.89
Posted county price for corn 1.60 1.60 1.60
Market price for corn 1.60 1.65 1.55
Producer redeems the loan at 0.29 = (1.89 - 0.29 = (1.89 - 0.29 = (1.89 -
the posted county price and 1.60) 1.60) 1.60)
receives a marketing loan
gain of
Producer then sells the 1.60 1.65 1.55
commodity at the market
price and receives
=========================================================================================
Total returns $1.89 = (0.29 + $1.94 = (0.29 + $1.84 = (0.29 +
(marketing loan gain plus 1.60) 1.65) 1.55)
market price)
-----------------------------------------------------------------------------------------
DETAILED ANALYSES OF THE IMPACT OF
THE MARKETING LOAN PROVISIONS ON
U.S. PRICES FOR COTTON, RICE,
WHEAT, FEEDGRAINS, AND OILSEEDS
========================================================== Appendix II
This appendix provides our detailed analyses of the effects of the
marketing loan provisions on U.S. prices for cotton, rice, wheat,
feedgrains, and oilseeds.
COTTON
-------------------------------------------------------- Appendix II:1
Over the last 10 years, when the marketing loan provisions were in
effect, U.S. and world cotton prices were above the loan rate for
all but 35 months,\1 and producers did not use the marketing loan
provisions to redeem their loans. During the 35 months when the
adjusted world price was below the loan rate, producers received
about $2.6 billion in marketing loan gains and loan deficiency
payments. Figure II.1 shows the relationship between the adjusted
world price, the U.S. price, and the loan rate for this period.
Figure II.1: Relationship
Between the Adjusted World
Price, U.S. Price, and Loan
Rate for Cotton, 1986-95
(See figure in printed
edition.)
In 1995 cents per pound
Source: GAO's analysis of USDA's data.
As shown in figure II.1, U.S. prices fell below the loan rate for
only 5 of the 35 months that world cotton prices were below the loan
rate, and in only 2 of the 5 months was the U.S. price below the
loan rate by more than 1 cent per pound. These price data might
suggest that the marketing loan provisions were not working and that
the loan rate was creating a floor for U.S. prices. However, this
conclusion may be premature because during the last 10 years, several
other program features, some of which no longer exist, and market
factors contributed to keeping U.S. prices higher than adjusted
world prices and the loan rate. These program features include the
option value of the loan resulting from the availability of the loan
at a particular loan rate, the availability of government-paid
storage, quotas on imports, and, in the past, the availability of a
loan extension and restrictions on production. These features have
allowed producers to store their cotton under loan until either price
conditions become more favorable or they can forfeit the cotton to
the government. To overcome the disincentives created by the program
features and to get cotton out of storage and to the market, cotton
buyers (domestic textile mills and exporters) have had to pay premium
prices. These premiums have kept U.S. prices higher than the
adjusted world prices. In addition, U.S. cotton producers receive
premium prices because of a number of market factors, such as
confidence that the terms of the contract will be fulfilled (known as
contract sanctity/reliability), high-quality standards, and
transportation advantages. These program features and market factors
are discussed below.
-- Option value of the loan. The option to hold cotton under a
nonrecourse loan has a value known as the option value of the
loan. The loan rate guarantees producers a minimum price and
makes it easier for them to keep cotton off the market while
waiting for prices to rise. Therefore, unless producers are
offered a premium price that compensates them for giving up
their option to continue to keep cotton under loan, they have
little incentive to take cotton out of loan. Buyers are willing
to pay a premium price because when they acquire cotton, they
can continue to keep the cotton they acquire under loan,
retaining some of the option value.\2 The option value of the
loan increases at higher loan rates (or decreases at lower
rates) because the level of the loan rate determines the degree
of price protection.
-- Government-paid storage. For cotton alone, the government pays
storage costs when the adjusted world price nears or drops below
the loan rate. As a result, producers can keep cotton off the
market at no cost to them. This government-paid storage
increases the option value of the loan and therefore increases
the price that buyers will pay for cotton. In the past, the
government also paid storage costs for up to 60 days prior to
the time the cotton was placed under loan. However, beginning
with the 1996 crop year, the U.S. Department of Agriculture
(USDA) has changed its regulations so that government-paid
storage costs will be limited to the period of time when the
cotton is actually under loan. Producers will be responsible
for all storage charges that accrue prior to that time.
-- Import quotas and transportation costs. Import quotas and high
transportation costs largely inhibit domestic textile mills from
importing cotton. Therefore, except under certain conditions
when the U.S. price is significantly higher than the adjusted
world price, U.S. producers have a captive domestic market and
do not have to compete against foreign producers who are selling
cotton at lower world prices. For example, the step 3 provision
allows specified amounts of cotton imports when the U.S. price
is substantially above the adjusted world price for a
significant period of time.
-- Contract sanctity/reliability. USDA officials told us that
foreign buyers of U.S. cotton are willing to pay a premium
price because less risk is associated with this purchase.
Buyers can expect the terms of the contract to be fulfilled and
the product, as specified, to be delivered as promised.
-- High-quality standards. USDA officials told us that the
reliable quality of U.S. cotton is one of the market factors
that results in a premium price for U.S. cotton. High-quality
standards and strict grading procedures applied to U.S. cotton
reduce the buyer's risk that is frequently associated with
purchasing cotton in a foreign market.
-- Loan extension. The 1996 farm act eliminated the provision that
had allowed producers to extend their loans for an additional 8
months, which had provided a total loan period of 18 months.
The elimination of the extension will reduce the option value of
the loan in the future because producers will have less time to
keep their cotton under loan while waiting for prices to rise.
USDA officials told us that the elimination of the extension is
particularly important because the loan will no longer span 2
crop years.
-- Production restrictions. Prior to the 1996 farm act, production
restrictions--acreage set-asides and the 50/85/92 program\3
--reduced supply to some extent, and prices were higher because
less cotton was available on the market. The 1996 farm act
eliminated these production restrictions. This change should
have a downward effect on U.S. cotton prices in the future.
Furthermore, U.S. cotton prices are higher than the adjusted world
price because the adjusted world price is based on the cost of
transporting U.S. cotton to Northern Europe. USDA estimates the
world price for cotton from average prices quoted in Northern Europe,
adjusts the world price for U.S. quality differences, and subtracts
the cost of transporting cotton from the United States to
Europe--about 12 cents per pound--to arrive at an adjusted world
price. Domestic buyers incur only a 5-cents-per-pound cost of
transporting cotton to domestic mills. As a result, domestic buyers
gain a price advantage of 7 cents per pound on the value of the
cotton they purchase. This price advantage contributes to the price
premium that buyers offer to cotton producers to persuade them to
take cotton out of storage and sell it rather than hold it and
eventually forfeit it to the government.
In addition, because USDA sets the adjusted world price weekly and
U.S. prices change daily, buyers and producers can take advantage of
the fluctuating differences between the two prices and further
increase their returns from the program. Finally, because the
adjusted world price is a price based on a formula rather than a
market-determined price, cotton industry officials we spoke to stated
that it may not accurately reflect actual world cotton prices and
therefore may not be a good measure of U.S. competitiveness.
Because all the factors mentioned above result in premium prices for
U.S. cotton, it cannot be determined whether the loan rate will
still act as a price floor under the marketing loan provisions until
market conditions cause the adjusted world price to drop far enough
below the loan rate to overcome the price premium. During the last
10 years, for 33 of the 35 months when the adjusted world price was
below the loan rate by at least 1 cent, the adjusted world price
would probably have had to fall even further below the loan rate to
counter the effect of the premium and cause U.S. prices to fall
below the loan rate. It is not possible to predict whether market
conditions during the life of the 1996 farm act will result in the
use of the marketing loan provisions and whether the adjusted world
price will fall low enough to fully counter the premium and allow the
U.S. price to fall below the loan rate.\4
--------------------
\1 We did not include marketing year 1986 as part of our analysis
because during that period the government was releasing excess cotton
that it had accumulated in previous years. This excess supply drove
U.S. prices below the loan rate.
\2 Buyers retain less than the full option value of the loan because
they have to pay producers a premium to acquire the cotton that is
under loan.
\3 Under the 50/85/92 program, producers who planted at least 50
percent of the acres enrolled in the program (less acreage reduction
program and other program requirements) and devoted the rest to
conservation practices were allowed to receive payments on either 85
or 92 percent of their eligible acres.
\4 USDA does not publish forecast prices for cotton.
RICE
-------------------------------------------------------- Appendix II:2
During the last 10 years, when the marketing loan provisions were in
effect for rice, the adjusted world price was below the loan rate in
81 months.\5 During 21 of these 81 months, when the adjusted world
price was particularly low, the U.S. price fell below the loan rate.
Unlike the inconclusive cotton data, the data for rice suggest that
when market conditions result in an adjusted world price that is
substantially lower than the loan rate, the marketing loan provisions
prevent the loan rate from serving as a price floor. Figure II.2
shows the relationship between the adjusted world price, U.S. price,
and loan rate for rice for August 1986 through August 1996.
Figure II.2: Relationship
Between the Adjusted World
Price, U.S. Price, and Loan
Rate for Rice, August 1986
Through August 1996
(See figure in printed
edition.)
In 1995 cents per pound
Source: GAO's analysis of USDA's data.
Regardless of the availability of the marketing loan provisions, the
U.S. price will generally remain higher than the adjusted world
price because of several factors that cause buyers to pay a premium
for U.S. rice. In addition to the option value resulting from the
availability of the loan at a particular loan rate, other factors
that result in a premium price include contract sanctity/reliability,
high-quality standards, and significant tariffs and transportation
costs that limit imports. Moreover, the method used to calculate the
adjusted world price may contribute to keeping the U.S. price higher
than the adjusted world price. Each of these factors is discussed
below.
-- Option value of the loan. As in the case of cotton, the option
to hold rice under loan has a value because the loan rate
guarantees producers a minimum price, making it easier to keep
rice off the market. In addition, under the marketing loan
provisions, interest that has accrued on the loan is forgiven
when the loan is repaid at the adjusted world price. According
to one rice industry official, because the adjusted world price
for rice has been below the loan rate for long periods of time,
the loan has essentially become interest-free. Domestic rice
millers and exporters recognize the value of this "interest-free
loan" and are willing to pay premium prices to producers.
-- Contract sanctity/reliability. USDA officials and industry
representatives agree that U.S. rice buyers are willing to pay
a premium price for U.S. rice because less risk is associated
with this purchase. Buyers can expect the terms of the contract
to be fulfilled and the product, as specified, to be delivered
as promised. Sellers from other countries are generally not
able to back their products with the same level of contract
sanctity and reliability.
-- High-quality standards. High-quality standards and strict
grading procedures applied to U.S. rice reduce the buyer's risk
that is frequently associated with purchasing rice in a foreign
market. Industry officials told us that the quality of U.S.
rice is consistently better than the same type of rice produced
by any other country. This quality advantage is reflected in a
higher price for U.S. rice.
-- Import tariffs and transportation costs. Even though rice does
not have an import quota like cotton, it does have an import
tariff of up to 35 percent, depending on the country and/or
quality of rice. In addition, according to industry officials,
significant transportation costs are incurred when shipping rice
to the United States. Because of both the tariff and the
transportation costs, as well as concerns about quality and
reliability, only a small quantity of rice is imported into the
United States. Consequently, the lack of competition in the
U.S. market from lower-priced imports helps keep the U.S.
price higher than the adjusted world price. In commenting on a
draft of this report, USDA officials disagreed with the
importance of tariffs in protecting the U.S. rice market.
Currently, the rice that is imported is almost exclusively rice
varieties not grown in the United States. However, these
officials did not address the question of how much rice similar
to U.S.-grown rice might be imported if the tariff were not as
high.
As in the case of cotton, the adjusted world price may not
consistently reflect actual world prices. Since there is no readily
available source of world market prices for rice, USDA has to
calculate a world price for rice on the basis of actual transaction
prices in international rice markets. This world price is then
adjusted for transportation costs and some quality differences. Even
though the adjusted world price is based on market data, it is still
a formula-based price and may not represent actual world market
conditions. Moreover, the formula USDA uses to determine the world
price and adjusted world price for rice is not publicized, as it is
for cotton. According to one USDA official, the formula is not
publicized to prevent price manipulation by foreign competitors and
domestic producers. However, the formula's confidentiality has led
experts to question its validity. Some industry officials we spoke
to stated that the adjusted world price for rice is set too high,
while some agricultural economists stated that it is set too low.
Setting the adjusted world price too low would increase the premium
paid by domestic buyers for U.S. rice.
The forecasts of USDA and others indicate that while U.S. prices are
expected to remain above the loan rate for the 7-year duration of the
1996 farm act, world prices are predicted to be lower than the loan
rate in some of those years. If the adjusted world price falls far
enough below the loan rate, producers' use of marketing loan
provisions should allow U.S. prices to also fall below the loan
rate.
--------------------
\5 We did not include as part of our analysis the period from January
1986 through October 1987 because over this period the government was
releasing excess rice stocks that it had accumulated in previous
years. This excess supply drove U.S. prices below the loan rate.
The 81 months occurred from November 1987 through July 1996.
WHEAT, FEEDGRAINS, AND OILSEEDS
-------------------------------------------------------- Appendix II:3
For wheat, feedgrains, and oilseeds, the historical data needed to
assess the effect of the marketing loan provisions are limited.
Unlike the cotton and rice programs, which have over a decade of
experience with the marketing loan provisions, oilseeds have had
these provisions in effect only since 1991 and wheat and feedgrains
only since 1993. Moreover, since the marketing loans were authorized
for these commodities, U.S. prices have generally been above the
loan rates, and the federal government has spent only a limited
amount on marketing loan gains and loan deficiency payments. The
marketing loan provisions were used only in crop years 1993 and 1994
for wheat and feedgrains, and gains were realized on only a small
percentage of the total U.S. production of these commodities.
However, for oilseeds, these provisions were used for crop years 1991
through 1994. Table II.1 provides information on the total quantity
of wheat, feedgrains, and oilseeds produced in crop years 1993 and
1994; the percent of total production realizing marketing loan
benefits; and the average marketing loan gain or loan deficiency
payment received.
Table II.1
Marketing Loan Benefits (Marketing Loan
Gains and Loan Deficiency Payments) for
Wheat, Feedgrains, and Oilseeds, Crop
Years 1993-94
Percent of
total
production Average Average loan
receiving marketing loan deficiency
Yea Total quantity marketing loan gain per payment per
Commodity r\a produced benefits\b bushel or cwt. bushel or cwt.
---------------- --- ------------------ -------------- -------------- --------------
Wheat 199 2,396 mil. bu. 0.36 $0.12 $0.10
3
199 2,320 mil. bu. 0.005 0 0.12
4
Feedgrains
Corn 199 10,103 mil. bu. 1.020 0.02 0.04
4
Barley 199 398 mil. bu. 0.005 0 0.10
3
199 375 mil. bu. 0.004 0 0.10
4
Oats 199 230 mil. bu. 0.011 0 0.07
4
Sorghum 199 655 mil. bu. 0.055 0 0.03
4
Oilseeds
Flaxseed 199 3.480 mil. bu. 67.13 0.60 0.77
3
199 2.922 mil. bu. 23.99 0 0.11
4
Soybeans 199 1,871 mil. bu. 0.001 0.03 0
3
199 2,558 mil. bu. 0.001 0 0.02
4
Sunflowers 199 48,361,850 cwt. 1.55 0.14 0.15
4
Canola 199 2,524,500 cwt. 18.25 1.02 0.67
3
Rapeseed 199 74,420 cwt. 7.24 0 1.11
3
-----------------------------------------------------------------------------------------
Legend: bu.-- bushel
cwt. -- hundredweight
mil. -- million
Note: No benefits were realized for these commodities in crop year
1995 because U.S. prices and the alternative repayment rates were
above the loan rates.
\a For some commodities, payments were made only in a single year.
Therefore, for those commodities, information is provided for the
year when payments were made. \b Marketing loan benefits include
both marketing loan gains and loan deficiency payments made in any
given year.
Source: GAO's analysis of USDA's data.
Generally, marketing loan gains and loan deficiency payments were
made for a small share of the total production during crop years 1993
and 1994. For example, for corn, total marketing loan benefits
(marketing loan gains and loan deficiency payments) were realized on
1 percent of the total bushels produced in crop year 1994. Five
states (Illinois, Indiana, Michigan, Ohio, and Wisconsin) received
about 95 percent of the total loan deficiency payments made for corn
in crop year 1994. The average marketing loan gain for corn was
$0.02 per bushel in crop year 1994, and the average loan deficiency
payment was $0.04 per bushel. Furthermore, 50 percent of the loan
deficiency payments made to corn producers in crop year 1994 occurred
when the alternative repayment rate was no more than 3 cents below
the loan rate. With less than a 2-percent difference between the
repayment rate and the loan rate, it is difficult to determine
whether the loan rate was acting as a price floor for corn during
that year.
Even if additional data were available, particular aspects of each
commodity's program and market features make it difficult to reach
firm conclusions about the performance of the marketing loan
provisions in allowing U.S. market prices for wheat, feedgrains, and
oilseeds to drop below the loan rates.\6 For example:
-- For wheat, only one county loan rate applies to all five classes
of wheat, but there are five alternative repayment rates. The
average county loan rate may be set too high or too low for a
particular class of wheat. As a result, for some classes of
wheat, the fact that forfeitures occurred would not necessarily
indicate that the loan rate was supporting prices but rather
that the loan rate provided a price advantage not normally
supported by the market.
-- For wheat, corn, and other feedgrains, the market is becoming
more specialized because some buyers are willing to pay a
premium for certain quantities of grain with specific
characteristics. Such contractual arrangements result in
several U.S. prices existing simultaneously, some of which
could be above the loan rate because of price premiums. It is
therefore difficult to assess, at any given time, whether the
loan rates are supporting prices or whether the contractual
arrangements are keeping prices higher than the loan rates.
-- For oilseeds, since 1991, most payments under the marketing loan
provisions have been made for minor oilseeds.\7 However, little
price information exists for these commodities because many of
the minor oilseeds are grown under contract or are thinly
traded. For example, flaxseed received marketing loan benefits
on almost 70 percent of the total crop produced in crop years
1991 through 1993. But most of this crop was grown under
contract and little price information is available, according to
a USDA official. Moreover, because flaxseed is a thinly traded
commodity, determining its alternative repayment rates is also
difficult. Limited price data make it difficult to assess
whether the loan rate is acting as a price floor.
In addition, for wheat, feedgrains, and oilseeds, the method that
USDA uses to calculate the alternative repayment rates--posted county
prices--hinders an assessment of the marketing loan provisions'
effectiveness in allowing U.S. prices to drop below the loan rates.
USDA determines each county's posted county price, daily for wheat,
feedgrains, and soybeans, and weekly for minor oilseeds,\8 by using
the appropriate terminal price\9 from the previous day or week,
adjusted for transportation costs and other factors. Because the
terminal price may not reflect local county market conditions, the
posted county price is not always consistent with local prices.
Moreover, because posted county prices measure the previous day's or
week's terminal prices, they do not incorporate new information that
may affect prices on a particular day. As a result, in some
instances, the posted county price may be set below the loan rate
when actual market conditions warrant a posted county price above the
loan rate. In these cases, it may appear that the loan rate is
supporting the U.S. price, when in actuality the posted county price
may not be reflecting local county market conditions and prices.
(See app. I for more information on how the relationship between the
posted county price and the U.S. price affects the benefits
producers receive under the marketing loan provisions.)
Lacking conclusive data, USDA officials, agricultural economists, and
other commodity analysts disagree on the extent to which the
marketing loan provisions will prevent the loan rates from acting as
price floors for wheat, feedgrains, and oilseeds. Many USDA
officials and agricultural economists we spoke to expect that the
marketing loan provisions for wheat, feedgrains, and oilseeds will
work largely as intended if alternative repayment rates fall below
the loan rates. They expect these provisions to be most effective
when prices fall substantially below the loan rates and remain there
for a significant period of time. For example, one USDA official
told us that producers used the generic commodity certificate
program\10 during a period of low prices in the 1980s. Therefore, he
stated that it is likely that producers will use the marketing loan
provisions if the posted county prices fall substantially below the
loan rates in the future. Moreover, these experts stated that when
prices are below the loan rates, it will be to the producers'
advantage to use the marketing loan provisions because the producers
must pay for storage if they choose not to sell.\11 Producers would
usually gain from using the marketing loan provisions and selling
their crops instead of forfeiting them because they would not incur
the storage costs they would have had to pay if they had held their
commodity for the full term of the loan and then forfeited it. (See
app. 1 for further discussion on producers' marketing loan gains.)
These experts also stated that because producers would be willing to
accept lower prices for their commodities and use the marketing loan
provisions, loan rates would no longer act as price floors, and
forfeitures would be unlikely to occur.
However, a few agricultural economists and commodity analysts offer
several reasons why the loan rate may at times provide some price
support despite the marketing loan provisions. For example, some
told us that when U.S. prices and posted county prices are slightly
below loan rates, a temporary resistance prevents prices from falling
further below the loan rate. This happens because the gain from
using marketing loan provisions may not be enough to overcome the
transaction costs\12 associated with using the provisions. In this
case, producers may continue to hold their commodities under loan and
temporarily keep U.S. prices above or at the loan rates. These
experts stated that if supply and demand conditions warrant prices
falling further below loan rates, this resistance is most likely to
disappear. Some also stated that the loan rate may at times provide
price support because the option value of the loan is relatively
large compared with the potential savings from avoiding storage
costs. If so, producers may prefer to keep their commodities under
loan and forfeit them if prices remain low despite the marketing loan
provisions. In addition, the greater the option value of the loan,
the greater resistance loan rates will provide against falling
prices. Furthermore, because the posted county prices are sometimes
not consistent with local U.S. prices, some agricultural economists
told us that if posted county prices are higher than the local county
prices, producers may have little incentive to use the marketing loan
provisions and may choose to forfeit their commodities. The extent
to which this may occur depends on the actual differences between the
posted county prices and U.S. prices and the potential to avoid
storage costs by redeeming loans at the posted county prices.
According to 1996 forecasts by USDA and others, U.S. prices for
wheat, feedgrains, and soybeans are expected to be above the loan
rates for the next several years. Under these market conditions, the
marketing loan provisions will not be used. However, during 1996,
prices for wheat and feedgrains fell substantially. For example,
cash prices for corn fell from a high of $5.25 per bushel on July 11,
1996, to a low of $2.51 per bushel on November 5, 1996.\13 (Some of
this difference was due to seasonal variations.) If prices continue
to fall to levels near the loan rate of $1.89, then producers may use
the marketing loan provisions.
--------------------
\6 Other government programs, such as the Export Enhancement Program,
may also influence U.S. prices for wheat, feedgrains, and oilseeds.
\7 Minor oilseeds include sunflower seed, canola, rapeseed,
safflower, flaxseed, and mustard seed. Soybeans are not a minor
oilseed.
\8 For minor oilseeds, the alternative repayment rate is calculated
at a regional level instead of at the county level.
\9 A terminal price is derived from a terminal market, which is a
major U.S. market where commodity transactions occur. USDA assigns
two terminal markets to most counties and calculates a price
differential for each terminal that reflects transportation costs and
other factors that influence local prices. For each commodity, USDA
uses the assigned terminals' closing prices, applies the relevant
differentials, and then uses the higher of the two as the posted
county price.
\10 The 1985 farm act authorized USDA to issue generic commodity
certificates to make in-kind payments to producers participating in
government commodity programs. Producers receiving certificates
could exchange them at the posted county prices for commodities
placed under loan, exchange them for government-owned commodities, or
sell them for cash.
\11 Except for cotton, producers who place their commodity under loan
are responsible for paying all storage costs. Commodities may be
stored on the farm or at a warehouse; on-farm storage may cost less
than warehouse storage. Because USDA requires producers to pay
storage costs in advance for the 9-month loan term when placing a
commodity under loan, total storage costs to the producer include the
actual cost of storage as well as the interest foregone on the
advance payment.
\12 Producers incur transaction costs when they obtain a marketing
loan from USDA. These transaction costs include both measurable
costs, such as a loan service fee, as well as unmeasurable costs,
such as filling out paperwork and visiting the loan office.
\13 These corn prices represent central Illinois daily spot prices.
USDA calculates this price from the midpoint of the high and low
prices from a sample of 30 central Illinois elevators.
ADDITIONAL CHANGES MADE TO THE
PEANUT PROGRAM IN THE 1996 FARM
ACT AND THEIR IMPACT ON THE U.S.
PEANUT MARKET
========================================================= Appendix III
The 1996 farm act lowered the quota support price for peanuts to
reduce U.S. peanut prices and the cost of the peanut program to the
government. This appendix discusses additional changes made to the
peanut program and their effect on the U.S. peanut market. This
appendix also includes an economic analysis of the effect of the
reduced quota support price on the national poundage quota and on the
U.S. peanut market.
1996 FARM ACT CHANGES TO THE
PEANUT PROGRAM
------------------------------------------------------- Appendix III:1
In addition to the reduction in the quota support price, discussed on
page 15, other changes were made to the peanut program in the 1996
farm act: elimination of the legislatively set minimum national
poundage quota; authorization to increase marketing assessments;
elimination of provisions allowing the carryover of unfilled quota
from year to year (undermarketings); redefinition of the peanut quota
to exclude seed peanuts; limits on transfer payments (known as
disaster transfers) made to quota holders whose commodity is of
lesser quality; and added marketing requirements for maintaining
program eligibility. These changes should enable USDA to better
control the quantity of peanuts marketed at the quota support price,
thus reducing the government's costs associated with the program. In
addition, out-of-state nonfarmers and government entities can no
longer hold quota; and the annual sale, lease, and transfer of quota
is now permitted across county lines within a state, up to specified
amounts of quota. These changes will improve the equity and economic
efficiency of the peanut program. The following discusses these
changes in detail:
-- National poundage quota. The 1996 farm act eliminated the
minimum level for the national poundage quota, which refers to
the quantity of peanuts that can be marketed domestically at the
support price. The minimum quota is no longer fixed at 1.35
million tons by legislation. Instead, if conditions warrant,
the national poundage quota may fall to lower levels. For crop
year 1996, USDA set the quota at 1.1 million tons--0.25 million
tons less than the minimum set under the previous legislation.
This lower quota is intended to be more in line with the
estimated quantity of peanuts demanded at the $610 per ton
support price. If market conditions change in the future, USDA
now has the ability to match the quota to the changing quantity
demanded at the fixed support price. In addition, if the quota
is set to equal the quantity of peanuts demanded at the support
price, government costs for the program should be minimized.
This is because the government would not have to purchase
surplus peanuts to maintain the quota support price.
-- Marketing assessments. The 1996 farm act provides USDA with the
authority to increase future marketing assessments if marketing
assessments in the current year do not cover all losses incurred
from operating the peanut loan program. According to USDA
officials, this provision will help ensure that the peanut
program operates at no net cost to the Treasury.
-- Undermarketings. The 1996 farm act further enhanced USDA's
ability to set the quota by no longer allowing the carryover of
quota from year to year when producers are unable to produce
enough peanuts to meet their quota. The amount of peanuts
represented by the quota carried over to the next year was known
as undermarketings. Previously, these undermarketings were in
addition to the national poundage quota set for the year. By
eliminating undermarketings, the 1996 farm act improved USDA's
ability to control the quantity of peanuts marketed at the quota
support price.
-- Seed peanuts. For the 1996 through 2002 crop years, producers
will be allocated a temporary quota for peanuts to be used as
seed. Previously, producers had to purchase quota peanuts
rather than less expensive additional peanuts for seed. The new
quota for seed in effect reimburses producers for the extra
expense of using the quota peanuts. Under the previous
legislation, the national poundage quota was based on domestic
edible, seed, and related uses. Now the national poundage quota
will not include seed use. The quota for seeds will be in
addition to the national poundage quota. Also, the quota for
seeds will be temporary and will only apply to the seeds used in
the year the quota is issued. While the separate quota for
seeds may increase the total quantity of quota, it ensures that
the national poundage quota represents more closely only those
peanuts marketed for edible use.
-- Disaster transfers. Under the previous legislation, quota
peanut producers who harvested a crop but were unable to market
it commercially because it had been damaged by weather, insects,
or disease were protected from a loss in income by disaster
transfer payments. To qualify for the transfer payment,
producers placed their damaged peanuts into the government's
additional peanuts loan program and received the support price
established for additional peanuts. Furthermore, they received
the disaster transfer payment, which is the difference between
the higher quota support price and the support price for
additional peanuts. These transfer payments ensured that quota
holders received the quota support price regardless of the
quality of the peanuts they produced. Under the new
legislation, disaster transfers are limited to 25 percent of the
producer's quota and 70 percent of the quota support price.
-- Marketing requirements for maintaining program eligibility.
Producers who market 100 percent of their quota peanuts through
a marketing association loan for 2 consecutive years shall be
ineligible for price support the next crop year if during the
prior 2 years they received and did not accept a written offer
from a buyer for at least the quota support price.
-- Reallocation of peanut quota held by out-of-state nonproducers
or government entities. Effective with the 1998 crop year,
peanut quota may no longer be held by people who are not peanut
producers or whose primary residence and place of business is
located outside the state in which the quota is allocated. In
addition, peanut quota will be forfeited for farms owned or
controlled by municipalities, airport authorities, schools,
colleges, refuges, and other public entities. The forfeited
quota will be allocated to other eligible producers in the
state. The change made pursuant to the 1996 farm act will help
ensure that peanut producers, rather than peanut quota holders
who do not produce peanuts, are the beneficiaries of the peanut
program.
-- Transfer of peanut quota across county lines. The 1996 farm act
allows for the annual transfer of the peanut quota across county
lines within the same state for counties with less than 50 tons
of quota. For counties with more than 50 tons of quota, the
amount of transfer is limited to 40 percent of the quota in the
transferring county as of January 1, 1996. The cumulative
out-of-county transfers for any state, however, may not exceed
15 percent for 1996, 25 percent for 1997, 30 percent for 1998,
35 percent for 1999, and 40 percent for 2000. The previous
legislation allowed the transfer of quota freely across county
lines only in those states that had less than 10,000 tons of
quota and under certain conditions within contiguous counties in
the same state.
ECONOMIC ANALYSIS OF THE EFFECT
OF A REDUCED QUOTA SUPPORT
PRICE ON THE NATIONAL POUNDAGE
QUOTA AND ON THE U.S. MARKET
------------------------------------------------------- Appendix III:2
An economic analysis of the effect of the reduced quota support price
on the national poundage quota and on the U.S. market illustrates
that as a result of changes made under the 1996 farm act, more
peanuts will be available at a lower price than under the previous
legislation. Additional reductions in the quota support price may
further reduce the price of U.S. peanuts. The method by which the
support price and national poundage quota interact is shown in figure
III.1.\1
Figure III.1: Effect of the
Peanut Program on the Market
(See figure in printed
edition.)
This figure is a simplified economic representation of how the peanut
market operates. The supply curve shows the different quantities of
peanuts that producers will offer at each price. The demand curve
shows the different quantities of peanuts that buyers will purchase
at each price.
Prior to the 1996 farm act, the support price was set at a level
represented in the figure by P1, and the minimum national poundage
quota was set at a quantity represented by Q1. In recent years,
domestic use of peanuts has fallen short of the minimum national
poundage quota set by legislation. This decline in use is attributed
to changes in consumers' tastes because of concern about fat in the
diet and is represented by a shift in the demand curve from D1 to D2.
Although demand for peanuts declined and only Q3 quantity of peanuts
would be purchased on the domestic market at the quota support price
P1, the national poundage quota was fixed by legislation at Q1.
Therefore, USDA could not reduce the quota and had to buy Q1 minus Q3
quantity of surplus peanuts, increasing the costs associated with the
program. To reduce these costs while maintaining a support price of
P1, USDA would have had to reduce the quota to Q3 quantity of
peanuts--the quantity that would have been purchased at the quota
support price P1.
Under the 1996 farm act, the legislatively set minimum national
poundage quota was eliminated and the poundage quota was reduced.
The quota did not need to be reduced to Q3, however, because the
quota support price was also reduced--from P1 to P2. The new quota
was set at Q2, the quantity that would be purchased by the market at
the lower support price, P2. These changes reduce the possibility
that the government will have to purchase surplus peanuts. Under
this scenario, buyers purchase a larger quantity of peanuts at a
lower price than under prior legislation, even though the quota has
been lowered. If there were no program, however, the quantity
purchased would be even greater--Qe--and the price even lower--Pe.
For this reason, further reductions in the quota support price for
peanuts, if made, may lower U.S. prices.
--------------------
\1 The following article contributed to this analysis: Martin, Laura
L. and A. Blake Brown. "Economic Impacts in North Carolina of a
Peanut Support Price and Quota Reduction," Journal of Agribusiness.
14-1 (Spring 1996): 95-108.
SCOPE AND METHODOLOGY
========================================================== Appendix IV
At the request of the Chairman of the House Committee on the Budget,
we reviewed seven commodity programs--cotton, rice, wheat,
feedgrains, oilseeds, peanuts, and sugar--to determine how certain
support provisions that remain operative under the 1996 farm act
affect U.S. commodity prices in comparison with world prices. The
world price must be analyzed on a commodity-by-commodity basis
because currently there are only proxies for world prices. For this
review, we used USDA's proxies for the world price for cotton, rice,
wheat, feedgrains, and oilseeds. The world price for peanuts is
derived from the price quoted for U.S. peanuts in Rotterdam,
adjusted for the cost of shelling and transportation back to the
United States. The world price for sugar is the Number 11 contract
price as traded on the New York Coffee, Sugar, and Cocoa Exchange,
(f.o.b. Caribbean) for raw cane sugar. For this review, when
analyzing U.S. prices, we used prices that producers receive for
cotton, rice, wheat, feedgrains, and oilseeds.
In conducting our review, we obtained data from USDA on payments made
under the programs for cotton, rice, wheat, feedgrains, and oilseeds,
as well as information on how the alternative repayment rates are
calculated. We also spoke with representatives of USDA's Commodity
Credit Corporation, Economic Research Service, Farm Service Agency,
Foreign Agricultural Service, National Agriculture Statistical
Service, Office of Chief Economist, and county offices. We also
spoke to officials from the World Bank, academic experts, industry
and trade representatives, and agricultural commodity consultants.
We reviewed various economic and international trade studies
conducted by universities, management consulting groups, USDA, and
international agencies.
We conducted the following analyses to determine if the marketing
loan provisions prevent loan rates from acting as price floors and
allow U.S. prices to fall to levels that are closer to adjusted
world prices. For cotton and rice, we analyzed USDA's proxies for
weekly world prices for crop years 1986 through 1995 and the way in
which these prices were converted to the adjusted world prices used
for the marketing loan provisions. To understand how the conversions
were made, we spoke to officials at the Farm Service Agency. We also
analyzed weekly spot market prices for cotton and producer prices for
rice for the same period to understand the relationship between the
adjusted world price and U.S. prices. To adjust prices for
inflation, we used the gross domestic product implicit price
deflator, which is the generally accepted method for determining real
prices. We also identified other program and market factors that
affect U.S. prices for cotton and rice.
To make the same determination for wheat, feedgrains, and oilseeds,
we obtained data on marketing loan benefits from USDA's Kansas City
Management Office to determine the level and general distribution of
payments for crop years 1993 through 1995. For corn, we also
analyzed posted county prices, loan rates, and market price
information to understand the relationship between these prices for
crop year 1994. We selected corn for our detailed analysis because
this was the only commodity of this grouping for which meaningful
price data were available.
We recognize that our analysis of historical price data to determine
the effectiveness of the marketing loan provisions may be limited in
its applicability to the future. This is because the 1996 farm act
has either eliminated or changed many of the program provisions that
were in place in the past.
To determine the effect of lower loan rates on the relationship
between U.S. and world prices, we spoke with USDA officials,
including agricultural economists, and other agricultural economists
who are specialists in each of the commodities we reviewed. We also
reviewed the literature on this question.
To determine the effect of a lower loan rate on step 2 payments, we
interviewed and obtained documents from USDA officials and spoke to
officials from the National Cotton Council and the International
Cotton Advisory Committee, and to a cotton industry official. To
determine the impacts of the recent changes in the timing of step 2
payments on the program's effectiveness, we reviewed regulations and
reports from USDA and others and spoke to officials at USDA, the
National Cotton Council, and the International Cotton Advisory
Committee, and to a cotton industry official.
To identify additional changes that could be made to make the peanuts
and sugar programs more market-oriented, we reviewed legislation and
regulations, as well as reports from USDA. We also interviewed
officials at USDA, in academia, commodity consulting groups, the
American Sugar Alliance, and representatives of sugar grower and
processor associations.
We did not independently verify the data used in this report. We
conducted our review from July 1996 through January 1997 in
accordance with generally accepted government auditing standards.
MAJOR CONTRIBUTORS TO THIS REPORT
=========================================================== Appendix V
RESOURCES, COMMUNITY, AND ECONOMIC
DEVELOPMENT DIVISION
Juliann M. Gerkens, Assistant Director
Jay R. Cherlow, Assistant Director for Economic Analysis
Carol E. Bray, Senior Economist
Barbara J. El Osta, Senior Economist
Anu K. Mittal, Senior Evaluator
Karla J. Springer, Senior Evaluator
*** End of document. ***