The National Agricultural Statistics Service (NASS) of the USDA will release the first yield and production forecasts for the 2012 U.S. corn and soybean crops on August 10. The first forecasts of the season are always highly anticipated, but none more than this year as widespread drought conditions have resulted in a wide range of yield and production expectations.

It might be useful to briefly review the NASS methodology for making corn and soybean yield and production forecasts. Data for the forecasts are collected in two separate surveys conducted roughly in the last week of July and the first week of August for the August report. The Agricultural Yield Survey (AYS) queries farm operators in 32 states for corn and 29 states for soybeans asking operators to identify the number of acres to be harvested and to forecast the final average yield. The sample of operators is based on a sophisticated sample design to achieve the desired sample size and each state is expected to achieve a minimum response rate of 80 percent. In 2011, approximately 27,000 operators were surveyed for all crops for the August report. Each operator is surveyed in subsequent months to obtain new forecasts of acreage and yield. Historical relationships indicate that respondents tend to be conservative in early forecasts of final yields (underestimate yield potential), particularly in drought years. This tendency is quantified and factored into official yield forecasts.

The second survey is the Objective Yield Survey (OYS) and is based on an area frame sample of cultivated land in 10 principal states for corn and 11 states for soybeans. Based on the June acreage survey, a random sample of fields is drawn in each state and enumerators visit these fields to take measurements needed to forecast yields in pre-determined segments of the fields. In 2011 these measurements were taken in 1,920 corn fields and 1,835 soybean fields. For corn, the number of plants and number of ears per segment are counted and the size of the ears is measured. For soybeans, enumerators measure row width and count the number of plants, number of main nodes, lateral branches, dried flowers and pods, and pods with beans in each segment. The data are used to forecast grain weight (yield) per acre. Each segment is visited in September, October, and November (if not yet harvested) to take new measurements and counts to form new yield forecasts. Just before the operator harvests the field, each segment is hand harvested and weighed. The data from the two surveys are combined to forecast average yield and production. For a fuller description of this process see our publication here and the complete NASS publication here.

USDA makes new yield and production forecasts in September, October, and November with final estimates released in January. Because yield forecasts are limited by crop maturity and are influenced by subsequent weather, the August yield forecasts tend to have the largest deviation from the final estimates released in January. For the period 1970 through 2010, the August yield forecast for corn ranged from an overestimate of 18.3 percent to an underestimate of 10.1 percent. The middle 50 percent of the forecast errors ranged from an over-estimate of 1.3 percent to an under-estimate of 5.1 percent. For soybeans, the August yield forecast ranged from an overestimate of 16.2 percent to an underestimate of 10.2 percent. The middle 50 percent of the forecast errors ranged from an over-estimate of 3.0 percent to an under-estimate of 4.5 percent. For a more complete analysis of the historical yield forecast deviations in August, September, October, and November see the post here.

While the USDA's August forecast will provide a benchmark for the size of the 2012 corn and soybean crops, the market will continue to form yield expectations beyond the release of the report. Analysts use a combination of techniques to judge yield potential, including crop condition ratings, crop weather models, satellite imagery, and analogue years. In the case of analogue years, there were six previous years since 1960 when the U.S. average corn yield was more than 10 percent below the unconditional trend yield. The shortfall in those years ranged from 10.4 percent to 25.6 percent and averaged 17.5 percent. A U.S. average yield 17.5 percent below trend would result in a 2012 average yield of 131 bushels, while a yield 25.6 percent below trend would result in an average yield of 118 bushels. There were also six previous years since 1960 when the U.S. average soybean yield was more than 10 percent below the unconditional trend yield. The shortfall in those years ranged from 11.8 percent to 19.3 percent and averaged 14.9 percent. A U.S. average yield 14.9 percent below trend would result in a 2012 average yield of 36.7 bushels, while a yield 19.3 percent below trend would result in an average yield of 34.8 bushels.

In addition to yield, the size of the 2012 crops will be influenced by the magnitude of harvested acreage. Harvested acreage, particularly for corn grain, may be unusually small in relation to planted acreage, further reducing production potential. The corn and soybean markets continue to trade smaller and smaller crops, but prices may not yet reflect the full extent of production shortfalls.

Here are summary points from a news release from Gary Schnitkey, with an additional point from the Logan Co. FSA Office:

Notification of Drought Loss

Producers who think they have a crop loss need to:

1. Notify their agent within 72 hours of the discovery of damage. A notice of loss can be made by phone or in person. Although drought loss is not immediate, producers should contact their agent as soon as they feel a loss is present.
2. Continue to care for the crop and protect it from further damage, if possible.
3. Get permission from the company before destroying or putting any of the crop to an alternative use.

4. Contact your FSA office to fill out FSA-576 Notice of Loss form before destroying. Notice of Loss will be denied if crop has been destroyed with no RMA documentation

The 2012 corn crop will be much smaller than anticipated earlier in the year when producers planted near-record acreage in a very timely fashion. Prospects then were for an above-trend average U.S. yield and a record large crop in excess of 14.5 billion bushels. A crop of that size would have allowed for an increase in consumption and some build-up in inventories and resulted in much lower prices than experienced over the past year. In May, for example, the USDA saw prospects for U.S. corn stocks to grow from 850 million bushels at the end of the current marketing year to 1.88 billion by the end of the 2012-13 marketing year. The average farm price was expected to decline from $6.15 this year to $4.20 to $5.00 next year.

Weather conditions since the crop was planted have been generally unfavorable over large areas so that crop conditions have deteriorated and yield prospects have declined sharply. In the first report of the year the USDA's Crop Progress report indicated that 72 percent of the crop was in good or excellent condition. By July 8, only 40 percent of the crop was in good or excellent condition. The USDA's May WASDE report indicated potential for a national average yield of 166 bushels. Just two months later the July report indicated potential for a yield of 146 bushels. The USDA's July supply and demand projections for the 2012-13 corn marketing year are presented in the first column of Table 1. Despite the drop in yield these projections result in year ending stocks in excess of beginning stocks. The mid-point of the expected average farm price for 2012-13 is $5.95, $0.35 below the average now expected for 2011-12.

A continuation of widespread stressful weather suggests that the average U.S. corn yield could be lower, perhaps much lower, than 146 bushels. At the same time, the price of December 2012 corn futures has increased about $2.00 since mid-June as production prospects continued to deteriorate, putting prices well above the average currently projected by USDA. A key question in the market outlook is whether the current level of prices is high enough to ration usage in light of substantially diminished expectations about supply. Further questions about the price level are raised by the prospect of even smaller production if weather conditions do not take a turn for the better.

We provide estimates in Table 1 of how the corn crop would be allocated to various uses and the implications for price under several alternative yield scenarios. We consider scenarios where U.S. average yields range from 140 bushels to 125 bushels, in 5 bushel increments. Please note that the yield scenarios reflect what we believe is a plausible range of yield outcomes for this "what if" analysis, but we do not take a position on the likelihood of any particular scenario at the present time.

The projections of total production, total consumption, and consumption by category for each scenario are based on several key assumptions:

1) Acreage planted but not harvested for grain totals 9 million acres rather than 7.55 million estimated in the USDA's June Acreage report. This is similar to the acreage not harvested in previous drought years like 1988 and 2002.

2) Minimum year-ending stocks are equal to 5 percent of consumption. While there is not a clear consensus on the minimum level of "pipeline" stocks needed to bridge the period between the end of a marketing year and the next harvest, we believe the experience of recent years indicates this is a reasonable estimate.

3) Export demand is likely stronger than that implied by USDA's July balance sheet due to production problems in other parts of the world, notably Argentina. This is reflected in an initial projection of 1.7 billion bushels rather than the 1.6 billion used by the USDA.

4) Export demand is relatively price inelastic, so that exports decline modestly with smaller supplies and higher prices.

5) Domestic processing demand is also relatively price inelastic, so that non-ethanol processing uses decline modestly with smaller supplies and higher prices.

6) Feed demand is relatively more price elastic than export or domestic processing demand so that feed and residual consumption declines with smaller supplies and higher prices. We impose the assumption of a 3 percent decline in feed and residual use for each incremental decline in yield. However, we also assume that for each bushel decline in corn consumed for ethanol, there is a one-third bushel increase in corn feeding to offset the reduction of distiller's grain production. This is a simplifying assumption since some distiller's grain is exported and the reduction in output would not impact domestic supplies one-for-one. Some of the decline in distiller's production might instead boost corn exports.

7) The projection of ethanol use of corn is calculated as a residual, which means we assume that ethanol use is the most price elastic component of corn usage.

It is widely argued that ethanol use is perfectly price inelastic up to the quantity mandated under the Renewable Fuel Standard (RFS). But this ignores the feature of the RFS that allows fuel blenders to accumulate carryover stocks of RINS credits that can be used to meet the mandate in lieu of blending actual gallons of ethanol. Previous estimates of the stock of RINS found in this earlier farmdoc daily post by Nick Paulson indicate that blenders probably hold at least 2 billion gallons of RINS that could be used to partially meet the RFS mandate during the 2012-13 marketing year. Technically, we assume that ethanol use is the most price elastic category up to the point where the available stock of RINS is used up. Without policy changes ethanol use after the stock of RINS is used up would become perfectly price inelastic. One additional topic deserves mention. Fuel blenders also have the option to defer up to 20% of the RFS mandate in a given year but this "borrowing" has to be made up in the following year. This could make the breakpoint where ethanol use becomes perfectly inelastic even lower. However, we do not believe it is reasonable to project substantial usage of the borrowing provision because the additional quantities would push ethanol blending above the 10% blend wall in the following year. See our earlier post here for a discussion of ethanol blend wall issues.

8) The projected average farm price for each scenario uses the USDA projection as a starting point and applies an estimate of the total price flexibility coefficient reported in a recent article by Mike Adjemian and Aaron Smith found here. We use their flexibility estimates for the current era of large ethanol use. Specifically, we use an estimate of -3, which, in order to be conservative, is approximately equal to the upper end of the 95% confidence limit (smallest in absolute value) of their flexibility estimates for the current time period. This estimate implies that for each 1 percent total supply declines price is projected to increase 3%.

The projections based on the previous assumptions are found in Columns 2 through 5 of Table 1. Note the very modest declines in feed and residual use of corn with lower yields and higher prices, which seems to be a contradiction of assumption (6). However, total corn-based feed consumption would decline much more rapidly than implied by the corn feed and residual projection. This is due to the decline in feeding of distiller's grain, which is driven by the more rapid pace of decline in ethanol use (and production). Progressively more liquidation of livestock numbers would be required with each 5 bushel decline in the average corn yield through this implied distiller's grain pathway.

The projections also imply that ethanol production would eventually drop below the mandated level of blending. We calculate the mandated level for the 2012-13 corn marketing year at 13.6 billion gallons, which would require processing of about 4.9 billion bushels of corn. However, as noted in the discussion of assumption (7) part of that the mandate can be satisfied by accumulated RINS from production that exceeded the mandate the past two years. We estimate that maximizing the use of those RINS suggests that a minimum of about 3.92 billion bushels of corn would be required to meet the mandate. Under the demand assumptions in this analysis, an average yield much below 130 bushels would not provide adequate corn supplies to meet the mandate even making full use of the available stock of RINS credits. Such a situation would require more severe reductions in consumption in other categories (likely in feed use) or some partial waiver of the mandate. Nonetheless, it is still noteworthy how low the U.S. average corn yield can sink before the RFS mandate becomes binding and much more drastic adjustments are forced on other categories of use. This highlights the key role that the RINS credits are likely to play in the upcoming marketing year.

Implications for Price

What about the question posed at the beginning of this post? Is the current level of prices high enough to ration usage in light of substantially diminished expectations about supply? In central Illinois, the current forward bid for harvest delivery of corn is about $7.20. This is consistent with the scenarios where yield is between 135 and 140 bushels. If yield turns out to be above 140 then current prices would appear to be sufficient, and perhaps more than sufficient, to ration usage. An average yield of 135 bushels or less would require substantial further rationing, resulting in record high average prices. Under such a scenario, history suggests that prices may go well above the expected average price in order to initiate the additional rationing process. Prices have probably not yet gone high enough to accomplish the necessary rationing if the average yield is below 135 bushels.

In closing, it is important to emphasize that our analysis should be viewed for what it is–a simple, first take on what might happen under alternative corn yield scenarios. How actual market dynamics will be worked out is fraught with complexities. In particular, we are in uncharted territory regarding the interaction of the corn, ethanol, and gasoline markets in a major drought. This adds even more uncertainty to what is already an extremely volatile market situation.

Issued by Darrel Good and Scott Irwin
Department of Agricultural and Consumer Economics
University of Illinois

The House Agriculture Committee released a discussion draft of the 2012 Farm Bill, which is further described here. This draft includes a target price program called Price Loss Coverage (PLC), a different approach from revenue options in the Senate Farm Bill. If the House Discussion Bill becomes law, farmers will be able to choose between PLC and Revenue Loss Coverage, essentially a county revenue program similar to the ARC program in the Senate Farm Bill. Herein PLC is described. Parameters of the House Bill cause estimated payments from PLC to be higher for wheat, rice, and peanuts than for corn and soybeans, potentially impacting acreage decisions.

Price Loss Coverage (PLC)

As defined in the House Discussion Bill, PLC makes payments when midseason price is below the effective price. The midseason price is the average of the national price during the first five months of the marketing year. For corn and soybeans, this would be prices during the months from September through January.

In the House Discussion Bill, effective prices equal $3.70 per bushel for corn, $8.40 per bushel for soybeans, $5.50 per bushel for wheat, $14 per hundredweight for rice, and $535 per ton for peanuts (see Table 1). When the midseason price is below the effective price, the payment rate equals the effective price minus the higher of the midseason price or the loan rate. Loan rates are $1.95 per bushel for corn, $5.00 per bushel for soybeans, $2.94 per bushel for wheat, $6.50 per hundredweight for rice and $355 per ton for peanuts.

Per acre payments for a planted acre equals:

payment rate x payment yield x .85.

Farmers will receive payments on prevented planted acres at a rate of .3 rather than the .85 for planted acres. Payment yield equals the current farm's counter-cyclical yields or updated yields based on the average yield from 2008 through 2012 times .9. The producer has a crop by crop choice to update the payment yield. On a farm, payment acres, which equals .85 times planted acres plus .3 times prevented planted acres, cannot exceed base acres.
As an example of PLC payments, take corn with an effective price of 3.70 per bushel. If the midseason price is $3.50, the payment rate is $.20 per bushel ($3.70 effective price - $3.50 midseason price). A farm with a 155 bushel payment yield, representative of payment yields for central Illinois, receives a payment of $26 per acre ($.20 payment rate x 155 bushel yield x .85).

PLC differs from previous target price programs in that PLC makes payments on planted acres. Target price programs in previous Farm Bills use historical base acres, not planted acres, when determining payments. Base acres are set for a farm based on historical plantings and are not impacted by planting decisions in the current year. Because payments are much more directly tied to planted acres, the PLC program has higher potential to influence acreage decision than does previous target price programs as well as the direct payment program. Payment acres for the current direct payment program are either determined using planted acres from 1981 through 1985 or from 1998 through 2001, depending on the farmers choice regarding update options provided in the 2002 Farm Bill.

Effective Prices Relative to Projected Prices

Effective prices in the House Discussion Bill vary relative to projected long-run prices. To illustrate, effective prices are compared to long-run prices used by Congressional Budget Office (CBO) in projecting governmental expenditures from 2013 through 2022. In the authors' opinion, CBO prices represent reasonable price projections into the future, with the caveat that projecting agricultural prices is error prone. The average of yearly prices from 2012 to 2022 is $4.72 per bushel for corn, $10.86 for soybeans, $5.94 per bushel for wheat, $13.13 per hundredweight for rice, and $505.24 for peanuts. Relative to the projected price, corn's effective price is 78% of the CBO projected price (see Table 1). Soybean's effective price is 77% percent of the effective price. The other crops have higher percentages of 93% for wheat, 107% for rice, and 106% for peanuts (see Table 1).

Crops with lower percentages likely will receive PLC payments less often than crops with higher percentages. To illustrate, chance of payments, payment rates, and per acre payments are estimated using CBO long-run prices and historical price variability from 1972 through 2011. Using these parameters, corn and soybean have a 10% yearly chance of receiving a PLC payment (see Table 1). The remaining crops have a higher percent chance of payment: wheat has a 35% yearly chance, rice a 68% chance, and peanuts a 58% chance. Rice and peanuts have a higher than a 50% chance of receiving payments because the effective prices for these crops are above the CBO projected prices.

Per planted acre payments will vary across crops as well. On a national level, PLC payments for an acre are expected to be $4.74 per acre for corn and $3.86 per acre for soybeans (see Table 1). The remaining crops have higher per acre payments: wheat has a $9.98 per acre payment, rice a $93.84 per acre payment, and peanuts a $77.11 per acre payment.

Per acre payments as a percent of crop revenue also vary across the crops. For each crop, expected crop revenue is estimated as the average of national yields from 2008 through 2011 times the CBO projected price. For corn, crop revenue is estimated at $732 per acre and expected PLC payments represent 1% of crop revenue (1% = $4.74 PLC payment / $732 crop revenue). In other words, PLC payments will increase revenue for corn by 1%. Expected PLC payments as a percent of crop revenue are 1% for corn and soybeans, 4% for wheat, 8% for peanuts, and 10% for rice (see Table 1).

Impact on Planting Decisions and Commentary

Varying PLC payments as a percent of crop revenue across crops has the potential to impact acreage decisions. The PLC Program relatively favors crops in the following order: rice (10% PLC payment as a percent of crop revenue), peanuts (8%), wheat (4%), and corn and soybeans (1%). For example, a farmer with a choice of growing wheat or soybeans would likely consider the PLC payment in their decision making. This could switch acreage to wheat from soybeans because wheat has a higher expected PLC payment than soybeans.

Rice and peanuts have much higher direct payments relative to corn, soybeans, and wheat. Direct payments per acre are $96 per acre for rice and $46 for peanuts. This compares to $24 per acre for corn, $17 for soybeans, and $15 for wheat. A strong relationship exists between the current direct payments and the estimated PLC payments across the five crops examined in this article (see Figure 1). This similarity raises a question for discussion: is part of the reason for setting effective price levels at their proposed levels an attempt to replicate direct payment levels with the PLC program?

If replication of the direct payment program is indeed the objective, this could be problematic because PLC is impacted by current plantings while the direct payment program is not, as discussed above. Moreover, in the past, distortionary impacts of setting prices too high relative to the market could be managed by increasing the acreage set aside required for the crop with support prices that were set too high relative to the market. But, acreage set asides were eliminated in the 1996 Farm Bill. Given the lack of set asides and the size of the differential payments across crops, attempts to preserve the relative order of payments in the direct payment program likely should not be tied to current planting decisions.

Acreage decisions also will depend on how many farmers choose PLC over Revenue Loss Coverage (RLC), the county revenue option. RLC will have differing impacts on acreage decisions than PLC. Hence, the extent to which farmers choose RLC could mute the impacts described above.

Issued by Gary Schnitkey
Department of Agricultural and Consumer Economics
University of Illinois

and

Carl Zulauf
Department of Agricultural, Environmental and Development Economics
The Ohio State University

The USDA's World Agricultural Outlook Board (WAOB) released the monthly WASDE report this morning. Several changes were made in supply and consumption projections for corn and soybeans. By far the most important changes were the drops in yield projections. Following is a brief summary and implications of the report.

Corn

In a major surprise the projection of U.S. corn yield for 2012 was reduced 20 bushels, from 166 to 146 bushels per acre. For some perspective on the size of the decline, the largest June to July drop in non-survey projections before this year was three bushels (in 2005). Total projected production declined from 14.79 billion bushels to 12.97 billion, a drop of 12.3%. This large decline in production naturally led to a sharp decline in projected use for 2012/13. Beginning stocks for the marketing year were increased 52 million bushels, reflecting a softening of exports late in the current marketing year, but this had a very small impact relative to the drop in production. Total available supplies for the 2012/13 marketing year were forecast at 13.903 billion bushels compared to 15.656 billion just one month ago. The main adjustment in use was to lower feed and residual use 650 million bushels to 4.8 billion. Exports were dropped 300 million bushels to 1.6 billion and ethanol use was dropped 100 million bushels to 4.9 billion. Total use was projected at 12.720 billion leaving 1.183 billion in ending stocks. Not surprisingly, the mid-point of the projected range of prices for the marketing year was boosted from $4.60 to $5.90.

One important point regarding the changes to corn usage for the upcoming marketing year pertains to feed and residual use. The 650 million bushel drop (12%) in feed and residual use would seem to imply a very large liquidation in U.S. livestock herds. However, one should keep in the mind that the June estimate of 2012/13 feed and residual use, 5.450 billion bushels, was very large relative to the estimate for the current marketing year, 4.550 billion bushels, and also large relative to livestock numbers. A "pre-drought" starting point for 2012/13 feed and residual use closer to 5 billion bushels is more reasonable and implies a much smaller decline in feed use and animal numbers.

Another point of debate is the 300 million drop in the forecast of exports for 2012/13. This is mainly due to a projected decline in Chinese imports. Since the domestic corn production estimate for China did not change the decline in exports appears to be a reaction to higher prices. Whether these declines actually materialize will be an important development to monitor as we proceed through the upcoming marketing year.

Soybeans

Like corn, the major surprise in soybeans was the reduced yield projection. The USDA lowered its projection from 43.9 bushels to 40.5 bushels. The largest previous drop in June to July non-survey projections was one bushel in 1993. Total production for 2012 is now forecast at 3.050 billion bushels, down from 3.205 billion in June. The decline in production caused domestic crush to be adjusted downward by 35 million bushels and exports to drop by 115 million bushels. The net effect of the changes was to drop ending stocks by 10 million bushels to 130 million. This is very near the minimum "pipeline" level of ending stocks and any further declines in U.S. production will necessitate further reductions in use. The mid-point of the season average price range for 2012/13 was increased from $13 to $14.

Implications

Major uncertainty still surrounds both the supply and demand sides of the 2012/13 corn and soybean balance sheets. The drought conditions currently afflicting much of the Corn Belt may result in further reductions in the U.S corn and soybean yield. A turn in the weather to cooler temperatures and more precipitation would be especially beneficial to soybeans, which have more capacity than corn to recover from the recent damaging weather conditions. The dramatic turn in production prospects the last few weeks may also prompt adjustments in U.S. polices, such as a partial waiver of the Renewable Fuels Standard (RFS) for convention biofuels in 2013.

Issued by Scott Irwin and Darrel Good

Low corn and soybean yields are increasingly likely as hot, dry weather is forecast to continue over much of the corn-belt during the critical corn pollination period. Lower yields then lead to questions about grain farm incomes in 2012. Grain farm incomes likely will be above projections made in winter of 2012, assuming that crop prices increase if crop yields are below trend-line levels. However, some farms will suffer losses. Farms that did not purchase crop insurance could face losses. Also, grain farms that have hedged a great deal of expected production could have lower incomes than those farms that have not pre-harvest hedged as much grain.

Income Projections

These conclusions are reached by simulating 2012 net farm income under drought conditions for a farm typical of northern and central Illinois. This farm has 1,200 tillable acres, with 10 percent of the acres owned, 60% cash rented, and 30% share rent. Cash rent is $295 per acre. The farm has non-land costs of $514 per acre for corn and $306 per acre for soybeans. Debt level is $480,000. The farm purchases Revenue Protection (RP) crop insurance at an 80% coverage level for both corn and soybeans. The Trend Adjusted Actual Production History (TA-APH) yield is 180 bushels per acre for corn and 50 bushels per acre for soybeans.

Net farm incomes under drought conditions are compared to two base cases.

1. 2012 winter expectations of net incomes. During winter, 2012 income for the farm was simulated using a corn yield of 185 bushels per acre and a soybean yield of 58 bushels for soybeans, the expected yields for this farm. These expected yields likely would have led to a reduction of corn prices from 2011 levels. Prices of $5.00 per bushel for corn and $11.00 per bushel for soybeans were used for winter projections. In May when yield prospects were favorable, forward bids for fall delivery of corn reached $5.00, suggesting that the winter projected prices were reasonable given that trend line yields occur. The winter yields and price result in net income of $167,200 (see Table 1).

2. Incomes given long-run prices. Below trend yields for corn in 2010 and 2011, severally reduced wheat yields in Russia in 2010, and low soybean yields in South America in 2011 have led to prices above long-run projections in recent years. Estimates of long-run prices are $4.50 per bushel corn price and a $10.50 per bushel soybean price in projections. These prices result in $94,500 of net farm income, below the $167,200 income in the base case (see Table 1).

Drought Scenarios

Scenarios include a mild drought (165 bushels per acre corn yield), a moderate drought (150 bushels per acre corn yield), and a severe drought (135 bushels per acre corn yield). Because of the widespread nature of the dry weather, prices are assumed to increase as yields decrease. The mild drought scenario has a corn price of $5.80 per bushel, the moderate drought a 6.20 price, and the severe drought has a $7.50 price.

The mild drought scenario represents continuing dry weather, but eventually a return to more normal weather that includes some rains during the growing season. Net income under this scenario is forecast at $219,900; above the income given winter expectations (see Table 1). While yields under the mild drought case are lower than winter expectations, higher prices offset yield declines.

A moderate drought has 150 bushels per acre corn yield and 53 bushels per acre soybean yield. Expected prices are increased to $6.20 per bushel for corn and $14.50 per bushel for soybeans. Net income is projected at $190,400, below the income projected for the mild drought and above the income given winter expectations.

A severe drought has a corn yield of 135 bushels per acre and a soybean yield of 40 bushels per acre. Widespread yields at these levels likely would result in dramatic increases in corn and soybean prices. A $7.50 corn price and a $17.25 soybean price are used in this scenario. Given these prices, income under a severe drought is projected at $292,100, up considerably from winter expectations. Crop insurance payments are occurring under this scenario. As a result, further yield declines would not have much of an impact on incomes because lower crop revenue is offset by higher crop insurance proceeds.

Caveats

The above scenarios suggest that many farmers would not have lower incomes due to lower yields. There are three important cases in which incomes could decline:

• Farms that have no crop insurance or crop insurance at low coverage levels would have lower incomes, particularly at very low yield levels.

• Farms that hedged a large portion of expected production could face income losses. By hedging, farmers would not benefit from assumed price increases. Take, for example, the case in which 50% of expected production is hedged at average price available in the spring 2012: 92 bushels of corn hedged at $5.40 per bushel and 29 bushels of soybeans hedged at $13.00 per bushel. Under severe drought, this farm would have $126,000 of net farm income, considerably below the $292,100 income with no pre-harvest hedging.

• The above scenarios presume that prices increase as a result of lower yields. If price responses do not occur, incomes would be much lower than presented here.

Summary

Grain farm incomes may not be adversely impacted on many farms if there are higher prices associated with lower yields, a reasonable assumption given the widespread nature of dry weather this year. Somewhat ironically, lower yields this year may postpone the return to lower prices, as another supply disruption will keep grain stocks at low levels. This could then lead to 2013 price expectations above long-run levels and higher than would be the case had trend-line yields occurred in 2012. This conclusion, however, is based on the assumption that no long-run reductions in consumption occur, which could be the case if very high prices occur in 2012. Reduced consumption would then result in lower incomes in 2012 than presented above. It could also lead to lower grain farm incomes in future years.