Issue Paper 96-3
October 1996

The Federal Agriculture Improvement and Reform Act of 1996 (FAIR Act) made several significant changes from previous farm program legislation. While the changes impact all program commodities (e.g., wheat, feed grains, cotton and rice), they have prompted considerable concern for the future of the rice industry in Texas. The major changes are:

• The program lasts seven years, from 1996 to 2002, with decoupled government payments declining in amount over time. The program is a significant departure from past legislation due to the decoupling of contract payments from prices and crop acreages planted. The payments are based on a farm's historical crop acreage base and farm program yields. Therefore, the contract payment is not impacted by current or future prices and, with the exception of limitations on fruits and vegetables, there is virtual full flexibility in what can be produced on the farm. Eligible producers or the landowners, or in some cases both, were required to enroll farms (designated by their FSA farm numbers) in a seven-year production flexibility contract (PFC) with the Farm Service Agency (FSA) to gain access to the contract payments. The deadline for signing a production flexibility contract was August 1st for all land except that which becomes available from an expiring conservation reserve program (CRP) contract. An important clarification is that enrolling a particular FSA farm number qualifies the land for contract payments, not the current operators and/or landowner -- the individuals designated to receive the contract payments may change over time.

• The total rice contract payments that will be paid to producers and/or landowners with rice base are summarized in Table 1. Total payments to all U.S. rice producers and landowners decrease from a high of $491 million in 1998 to $339 million by 2002. In Texas, 99.9 percent or 594,720 acres of the eligible 595,479 rice acres were enrolled in a production flexibility contract. The number of contract acres is multiplied times its associated farm program yield to determine total payment quantity (roughly 170.6 million cwts). The annual contract payment rate per cwt can then be calculated by dividing the allocated rice payments by payment quantity (Table 1).

To estimate an individual's contract payment, multiply the farm's contract acres times the farm program yield times the payment rate times 85 percent as indicated by the formula:

Estimated Annual
Contract Payment = Contract acres * Farm Program Yield * Contract Payment Rate * 0.85

The 0.85 factor indicates that only 85 percent of historical production is eligible for contract payments. In a share lease situation, multiply the estimated annual contract payment by the designated share agreed upon and reported annually to FSA on form CCC 478.

• In the absence of a multi-year written lease, both landowner and tenant must agree annually on how the contract payments will be divided. FSA will accept amendments to the production flexibility contract beginning in October of each year through the close of the fiscal year or September 30th. The landowner and/or the tenant may request a 50 percent advance to be received either December 15th or January 15th, then a change after these dates will only apply to the 50 percent portion of contract payments that are remaining.

• Producers and landowners have been given, with the exception of fruits and vegetables, basically unlimited flexibility to produce any crop they want and still maintain eligibility to receive a rice contract payment. In the past, producers had to grow rice to receive a rice payment. The land can be planted to any alternative crop including hay (other than fruits and vegetables), grazed, or left idled in conserving use and still receive the contract payment as long as conserving-use regulations are met.

• One of the most contentious changes associated with the 1996 Farm Bill is the distribution of contract payments and what are the landowner/tenant rights to contract payments under the legislation. The legislation required USDA to protect the interests of tenants to share contract payments on a fair and equitable basis. It also made it clear that the implementation of the 1996 Farm Bill would not preempt state tenancy laws. Therefore, as long as proper notification and due process is followed, landowners can change tenants and renegotiate lease arrangements without being in violation of the fairness language stipulated in the legislation relative to tenants. FSA indicates that the following general rules apply to the division of payments among producers on contract cropland.

  If the entire farm is cash leased, the landowner is not entitled to any contract payments; that is, they accrue to the tenant operator. This distribution arrangement is based on the fact that under cash leases, tenant operators incur all production and price risk.

  If the farm is share leased, the contract payments must be shared. According to FSA, this does not mean that the contract payment share has to be the same as the crop shares, but it needs to be within the normal range of shares in the area. FSA indicates, however, if the producers and the landowner can agree on how the contract payments are shared, then the contract can be approved. If they can not agree, then the funds will be held in escrow until such agreement is reached, provided both parties have signed the contract by September 30th of the program year.

  When a share lease expires, the division of payments between tenant(s) and landowner(s) can be renegotiated or the owner(s) can assume total control of the land and receive all the payments if the farm is planted, hayed, grazed or maintained in conserving use as required by FSA.

  If the farm is sold, the new owner(s) could elect to receive contract payments and/or decide how the payments are divided with tenants as long as the new owner(s) meet the other terms of the contract. The original owners and tenants have no right to the contract payments after the farm is sold; however, if the original tenants continue to operate the farm, they may still qualify to receive contract payments depending on their lease agreement.

Historically, Texas rice producers have been heavily dependent on government program payments to supplement market income. Even with substantial government support, the number of rice acres in Texas has been generally declining. Under the new program, average rice contract payments per acre are large when compared to other program crop payments (Table 2). Using the state average farm program yields, rice payments per acre are nearly 4 times as high as those for the next highest commodity (cotton).

Low prices in previous years have prompted many producers to consider the feasibility of alternative enterprises. Although 1996 rice yields and current market prices are enabling many producers and landowners to realize profitable returns, there is uncertainty as to the level of future rice returns. In general, rice contract payments per acre are considerably higher than either current cash rents ($40 to $75 per planted acre) or the cash equivalent for many of the prevailing share agreements given recent year's market prices. As indicated earlier, in a cash rent situation, the operator receives the entire contract payment. Given the high contract payment levels relative to rents associated with many existing rental arrangements, there has been increased interest on the part of some landowners to either renegotiate or end their rental arrangements with their tenants.

The relatively risk-free nature of the contract payments, albeit only for the seven-year period (1996-2002), may encourage such renegotiations with some landowners seeking the greater security of the known fixed payment levels rather than the more variable share rents associated with fluctuating rice yields and prices. Landowners may wish to increase cash rents, change the share arrangement, or in some cases, end the lease relationship completely and keep the contract payments for themselves. It is the differences between current rental agreement rates and the per acre contract payments that is contributing to considerable discussion in regard to restructuring landowner-tenant relationships in the rice industry. This means that landowners will likely be asking for a larger share or higher cash lease amount. For example, a landowner who currently receives $70 per acre on a cash lease may see the estimated $116 per acre contract payment to be paid to the tenant as reason for wanting to renegotiate the lease agreement. The differences between rental rates and contract payments per acre are not as large for other program commodities. As a result, landowner-tenant relationships have not become an issue elsewhere as they have in the Texas Rice Belt.

Due to the farm program changes, landowners and tenants may wish to evaluate whether changes in the rental arrangements are warranted. This negotiation should be based on economic and financial considerations, not what the neighbor is doing, what is read in the newspaper, or being discussed at the local coffee shops. Tenants should prepare a rice enterprise budget, which can be used in the negotiations to show how alternative arrangements would impact their projected income and expenses as well as the amounts that landowners could expect to receive. A software program has been developed specifically for this purpose in the Department of Agricultural Economics at Texas A&M University. The software can be used to quickly evaluate the economic impact on both the landowner and tenant for alternative lease arrangements. The software includes several common share lease and cash rent tenure arrangements which may be used in evaluating returns accruing to landowners and tenants over the 1997 to 2002 period for a range of expected rice yields and market prices. The program is flexible so that users can customize lease arrangements and use their own enterprise budgets for evaluation. Anyone interested can contact their local County Extension Agent for information about how to obtain a copy.

With rice enterprise production budgets it is fairly easy to estimate the economic returns to the landowner and the tenant given various rental arrangements and alternative enterprise possibilities for the next year. However, producers, landowners, lenders and other agribusinesses need to examine their economic options based on their longer-term expectations for alternative crop and livestock prices and costs of production. Some farmers whose land is suitable for other enterprises have viable options in crop production. However, it should not be assumed that this past year's prices are representative of those that will exist in the future.

There are important long-run implications associated with a shift out of rice production. The Texas rice industry is served by a highly specialized infrastructure, especially in terms of water delivery, and rice drying, storage, and processing. Recent declines in Texas rice acreage has placed this infrastructure in a very fragile position. A key question that is not easily answered is how much reduction in Texas rice acreage can the industry sustain before the infrastructure goes out of business?

If the rice industry infrastructure collapses, then what might have been a sound economic decision in the short-term could prove hazardous down the road. In the event rice production becomes more attractive to landowners in the post FAIR Act period, they run the risk that a viable infrastructure to support rice production will not be available in the future. And, a historically important cropping alternative for their land will have been lost. Similarly, there may not be a supply of tenant operators available to farm rice on rental acreage.

Previous attempts at identifying economically viable cropping alternatives to rice production have been futile for many of the soil and climatic situations. For these producers, their only option may be cattle production which is subject to wide cyclical price swings.

In some cases, after reviewing the situation, the landowner and tenant may not come to agreement and either may chose to terminate the lease relationship. As indicated earlier, when a lease expires, as long as the landowner properly notifies the tenant, it is well within his/her property rights to end the lease relationship and assume total control of the land. The landowner would then receive all contract payments up to the $40,000 per "person" payment limitation. By consulting with an experienced attorney, it may be possible to receive payments for more than a single "person" on a farm operation. To receive the payments, the landowner would then need to either farm the land, establish a new rental agreement with a different tenant, or at least maintain weed and erosion control as required by USDA-FSA. The following considerations should be kept in mind:

• If landowners decide to begin farming their land, then they will receive all the contract payments and can plant almost anything on the land other than fruits and vegetables. There will, however, be costs (e.g., weed control) incurred even if the land is left in idled, conserving-use status.

• If a new rental agreement is developed, under a strict cash lease, the landowner would not receive any contract payments. Under a share lease, however, the shares going to the landowner and tenant are almost unrestricted as long as both parties agree. The only restriction is that the landowner can not receive 100 percent of the contract payment under a share lease agreement.

• If the decision is made to leave the land idle from crop production, it is in the landowners' best interest to visit their local FSA office to be certain that they fully understand the implications. The land must be maintained in a agricultural-related status to receive contract payments. It might also be wise to check with the local appraisal district to confirm that the land left idled in conserving-use status will continue to be eligible for agricultural-use tax status.

Renegotiation of land leases is a common phenomenon throughout agricultural history. Lease arrangements are largely predicated on tradition and the supply and demand of the local rental market. The specifics of tenure arrangements tend to be private (between the parties involved) and fairly rigid over time, subject to change only in the event of rather major changes in economic conditions.

As an example, the Midwest corn/soybean complex routinely experiences rising and falling cash rental rates, keeping pace with the level of net returns associated with these two crops. The prominent role of farm management consultants representing landowners contributes, perhaps in large part, to the seemingly continual fluctuation of rental rates in this region. In contrast, the much more static-to-declining nature of rental rates in the Texas Rice Belt accentuates the shock of the current situation. Historical returns occurring in Texas rice production in combination with few feasible enterprise alternatives have allowed tenants to basically determine rental rates. Tenure arrangements have also been driven by considerations of large landowners and operators in managing the effects of payment limitations. For the most part, however, supply forces have dominated demand, leading to a tendency towards lower returns to landowners.

The FAIR Act of 1996 allows landowners to reverse these market forces, at least in the short run, and many appear interested in these opportunities. Such actions have dire consequences for affected tenants in the short run, with potentially negative long-run effects for the total Texas rice industry.

Due to the importance of decisions made with regard to tenure arrangements, it is important to obtain and analyze good information before making any decisions. This will enable landowners and tenants to negotiate with a good understanding of the economic implications for both parties.