Academic journal article Journal of Agricultural and Applied Economics

Risk-Adjusted Comparison of Conservation Reserve Program Payments versus Production Payments for a Corn-Soybean Farmer

Academic journal article Journal of Agricultural and Applied Economics

Risk-Adjusted Comparison of Conservation Reserve Program Payments versus Production Payments for a Corn-Soybean Farmer

Article excerpt

Conservation reserve program (CRP) payments amount to several billion dollars annually. Payments are allocated to both remove land from production and to help farmers pay for conservation improvements. However, research examining whether farmers increase their utility with CRPs is limited. This paper uses simulation analysis and certainty equivalents to compare farming income to payments under the CRP. Farming income is a combination of crop production and government payments as specified in the 2002 Farm Bill. This analysis focuses on farms in three different counties in Kentucky. Results indicate that CRPs are good choices for many farmers.

Key Words: certainty equivalents, conservation, CRP, government payments, risk, simulation

JEL Classifications: Q15, Q18, Q16, C15

The 2002 Farm Bill presented farmers with many choices. Most discussion and analysis focused on which Farm Service Agency (FSA) option farmers should choose. FSA offered farmers five basic options with one of the options having three suboptions. The choice of an FSA option helps determine government payments over the life of the Farm Bill. However, just focusing on the five FSA options implies that farmers will keep farming their land.

The 2002 Farm Bill also allocated money to Conservation Reserve Programs (CRP). For many farmers, the first decision should actually be between continuing to farm or putting the land into a conservation program. Only if continuing to farm is the best option should farmers then decide among the various FSA options. However, to choose between farming and CRP payments, producers need to estimate their returns from continuing to farm.

The choices are difficult to compare because they are so different. Farmers are comparing a sure payment every year with CRP to one that will vary from year to year by continuing to farm. The farming option has variability not only from yields and prices, but also from government payments. This farming option is also complicated by the FSA option choice. Farmers need to find their optimal FSA option, estimate the payments, and then combine the government payments with the variable production income.

The objective of this study is to compare the utility from CRP payments to the utility from picking an optimal FSA option and continuing to farm. These comparisons are analyzed in three Kentucky counties.

The utility from the CRP choice is a straightforward calculation. Farmers know how much they will receive ahead of time, provided their offer is accepted. Therefore, farmers can plan for at least 10 years of payments. These payments do not vary, so there is no risk. The only downside is what happens after 10 years. There is some probability that land may not be rolled over into a new CRP contract. In addition, land that has been in CRP for 10 years may require some maintenance work before it can be used as cropland again.

The utility calculation for continuing to farm is much more complicated. From the production side, farmers face three major areas that contribute to net income variability. First is yield variability. Weather obviously is a major contributor to yields each year. However, despite this variability, yields have trended upward as new seed varieties continue to push the yield envelope. Yield histories exist in all counties so it is fairly easy to estimate the trend for yield and to calculate a yield variance.

Expense variability also contributes to income variability. Expenses may or may not exhibit a yearly trend. Some expenses like labor clearly show an increase from year to year. For other expenses, a simple mean may be a good predictor of next year's expense. Like the yields, data exist for historical expenses so any expense trends, means, and variances can be calculated.

Grain prices are the most difficult calculation in the production estimation of income variability. Prices probably do not follow a trend, but is the mean a good estimate of future prices? …

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