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Is this ACRE green?

Imagine this: You're at a hotel for the winter meeting of your favorite farm group. A fire alarm sounds. You have two choices for escape. Open your room window and jump 10 stories to a tiny net held by firefighters. Or, dash down the hall into a newfangled, insulated elevator designed to let you down slowly.

That's the essence of a decision facing commodity growers. We've all been on the upper floors of the High Price Hotel. If a fire sale turns high prices to smoke, the 2008 farm bill offers you a one-time choice. Rely on the old safety net to protect you if prices fall below target prices. (That's $2.63 a bushel for corn). Or jump into the Average Crop Revenue Election (ACRE) program, starting as early as sign-up for the 2009 crop.

ACRE is like an elevator. It's not a solid floor. Instead of countercyclical payments tied to a fixed target price, it offers payments for specific crops tied to a state-level revenue guarantee. The guarantee moves up or down with the market because it's hooked to several rolling averages.

ACRE's state revenue guarantee is based on a two-year average of the U.S. crop year cash price multiplied by an Olympic average of your state's five most recent crop year yields. (That's an average that tosses out the high and low years.) If a state's revenue falls below 90% of that per-acre guarantee, payments start to kick in. But you'll never get more than 25% of that guarantee. The guarantee is for 83.3% of your planted crop acres (85% in 2012).

There's a second trigger, too. Your farm has to have a loss. That happens when your farm's income (actual yields times the U.S. market year-average price) is below on-farm expected revenue. That's calculated using a five-year Olympic average of your yields and the two-year rolling average of national prices. (Crop insurance premiums are added back in to the on-farm benchmark.)

The reason why all of this works something like an elevator is that the farm law limits changes in the state-level ACRE guarantee to 10% a year, going up or down. So your guarantee can't fall too fast.

Because any benefits of ACRE depend on where prices go through 2012, no one can predict with absolute certainty whether ACRE will be better than sticking with the old safety net. But Carl Zulauf, an economist at Ohio State University, understands it as well as anyone. He designed a program similar to ACRE for American Farmland Trust during the farm bill debate.

ACRE, Zulauf says, can help you "adjust to systemic risk from price and state yield declines." And he adds, "it has the ability to help farmers when there’s a period of rapidly increasing cost of production."

If things get bad, ACRE could kick in sooner and help you a lot more than the old safety net. But not forever, because ACRE is based on averages that could keep falling.

ACRE has a cost. You give up 20% of your direct payments if you opt in. For corn, that's a U.S. average of $4.87 an acre. There's a second potential cost if prices really fall. Anyone in ACRE is still in the marketing loan program. But your loan rates drop by 30%. The national loan rate for corn stays at $1.95 in the 2008 farm bill. Under ACRE it is $1.65 1/2.

Is ACRE worth that? Art Barnaby, Kansas State University economist, calls ACRE "a put option on expected state revenue, and the premium is 20% of your direct payment."

With relatively high prices in 2007 and 2008, economists at Iowa State University see the potential payout from this federally subsidized put option as substantial.

An analysis by Iowa State's Center for Agricultural and Rural Development (CARD) shows two scenarios where payments start either when corn prices fall below $5.60 a bushel or when they fall below $4.40. The payments top out at $216.90 an acre. (See the graph below).

This shows that if prices fall enough, you don't need some statewide disaster to trigger payments.

As the economists point out, "Significant declines in market prices can generate substantial payments for all farmers of a crop. Thus, a situation in which the ACRE guarantee builds to a high level through a series of high prices followed by significantly falling prices will generate substantial payments."

If you look at the same chart, you'll see that payments start to rise under the old countercyclical program when corn hits the effective target price of $2.35 (the target price minus your direct payment). If the chart went farther to the left, toward even lower prices, would the lines for the old program intersect with the ACRE graph? Would the old program ever pay better than ACRE?

"In the cases we looked at, we didn't find one," says Chad Hart, one of the economists who crunched the numbers on ACRE. "For the current program to win out, it's pretty much the high-price case when ACRE doesn't pay," he says.

So if prices keep going up from the averages of 2007 and 2008, you'd leave about $5 an acre on the table (your 20% direct payment cut) in the case of corn and get nothing.

That may be a small price to pay for a form of risk management.

Zulauf points out that early this summer, in-the-money put options for 2009 corn at about $7 a bushel cost about $1 a bushel. To protect the income from 160 bushels an acre would cost $160, making your $5 premium for ACRE look cheap.

"In a sense, ACRE is like buying insurance. In my mind, I hope that I don't collect on insurance," he says.

As good as ACRE looks on paper right now, there are other things to consider. ACRE will not offer advanced payments, Hart points out. And because the USDA will need time to calculate national average market prices, your earliest payment on 2009 crop revenue shortfalls would be in late 2010.

And don't expect $200-an-acre payments. That's a scenario that's possible, but it's not a prediction.

Zulauf went to great lengths to put together the breakeven chart on this page, including crunching five-year Olympic yield averages for 26 states going back to 1974. After calculating price and yield variation and projecting trendline yields, he came up with the breakevens you see. With prices above them, you're likely to do better with ACRE, even after giving up 20% of direct payments. Yet, if prices stay high, you won't get ACRE payments.

"The breakeven price analysis is about expected payments, not actual payments," he says. "You will not know your actual payments from ACRE until 2013."

Imagine this: You're at a hotel for the winter meeting of your favorite farm group. A fire alarm sounds. You have two choices for escape. Open your room window and jump 10 stories to a tiny net held by firefighters. Or, dash down the hall into a newfangled, insulated elevator designed to let you down slowly.

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