The U.S. cotton industry has shown significant growth since the implementation of the marketing loan provisions from the 1985 Farm Bill in 1986. Where the use of cotton totaled roughly 12.0 million bales in the decade before 1985, usage increased to the 18.0 million bale level by 1995. Most of the 6.0 million bale increase was due to growth in domestic mill use. Farm price, however, has averaged near 60.0 cents per pound during the decade before and after the 1985 cotton program. This, improved yields and a 30 percent increase in acreage has produced enough cotton to meet the 50 percent increase in usage at essentially the same price.
Much of the expansion in cotton acreage has been in the Southeast states of Alabama, Georgia, North Carolina, South Carolina, Virginia, and Florida (Figure 1). In 1995, acreage in these states totaled 3,460,000 acres, compared with only 761,000 in 1986. The rapid growth in production has stimulated substantial investments and economic activity in the agribusiness community that provide production inputs, harvesting equipment, gins and warehouses. The Delta states of Arkansas, Louisiana, Mississippi, Missouri, and Tennessee nearly doubled acreage to 4,877,000 during the last decade. Acreage in the Southwestern states of Texas and Oklahoma increased by 1,532,800 to 6,783,000. In the West, Arizona, California, and New Mexico acreage has been more stable, gaining less than 300,000 acres to 1,596,000.
The shift in cotton from West to East is clearly emphasized by changes in regional production shares since 1986. In 1995 the Southeast produced 22 percent of the crop, a sharp gain from 8 percent in 1986; the 1995 Delta share was 34 percent, a small increase from 32 percent in 1986; the Southwest contributed 26 percent of production in 1995, down from 29 percent in 1986; and the West dropped from 31 percent in 1986 to an 18 percent share of production in 1995.
Therefore, the largest impact of the new farm program on cotton will likely be felt in the Southeastern and Delta states. However, in 1995 Texas farmers planted about 38 percent of the total U.S. cotton acreage while its production share was 26 percent.
For a global perspective, cotton growers in the United States produced about 20 percent of the world's 88 million bale crop in 1995. American textile mills, however, used only 13 percent of the 86 million bale disappearance.
Upland cotton provisions of the 1996 Farm Bill are summarized in Table 1. The target price/deficiency income support program is replaced by fixed, annual transition payments. Upland cotton's share of the fixed payments equals 11.63 percent based on expected share of deficiency payments that would have been paid during 1996-2002 under an extension of the current program as projected by the Congressional Budget Office (CBO). Aggregate payments reach $675 million in FY 1998 before declining to $466 million by FY 2002.
Individual contract payments would be based on 85 percent of the eligible contract acreage multiplied by the 1995 farm program yield multiplied by the per unit distribution of the aggregate allocation. To be eligible the farm must have established at a 1996 crop acreage base in at least one of the target price program crops. Conservation compliance regulations must be met to qualify for the production flexibility contracts.
The nonrecourse loan program is calculated as under current legislation with the exception that it is capped at $0.5192/lb. The minimum loan floor of $0.50/lb is retained. Extension of the nonrecourse loan beyond the original 10 month period, however, is eliminated. The marketing loan provisions are maintained as currently implemented with the exception that Step 2 upland cotton payments are limited to $701 million over the FY 96-2002 period.
The 1996 Farm Bill significantly increases production flexibility. Eligible producers can plant any program crop they choose on their cropland acreage. They can also hay and graze their land or they may decide not to plant anything if they properly maintain the land in an agricultural related activity. Fruits and vegetables generally are not allowed on contract acres. There are exceptions, however, that would allow fruits and vegetables to be planted.
Annual authority to require acreage reduction in order to be in compliance with the farm program is eliminated. Under the 1990 Farm Bill the Secretary was instructed to utilize acreage reduction programs in order to maintain projected stocks-to-use targets of 29 percent.
Enrollment in the CRP program is capped at 36.4 million acres. Producers would be allowed to exit the program without penalty after giving a 60 day written notice. Through the first 12 sign-ups, approximately 1,434,000 acres of cotton base were idled in the CRP program. Approximately 84 percent of that base is in Texas.
The 50/85 program that allowed producers to plant as little as 50 percent of their payment acreage and receive deficiency payments on 85 of their payment acreage is eliminated. The flexibility provision of the 1996 Farm Bill effectively grant producers a 0/100 program since they would not be required to plant anything in order to receive their eligible transition payment.
Transition payments under all flexibility contracts are limited to $40,000 per person. Marketing loan gains continue to be capped at $75,000 per person. There is a separate $50,000 per person limit on additional contract payments that result from the repayment of unearned 1995 crop advanced deficiency payments. The three entity rule is maintained, thus total annual payments are capped at $230,000 per person, down from the current $250,000 limit. The $50,000 limit on contract payments resulting from the repayment of unearned 1995 deficiency payments is not annual but a one time limit for the life of the contract.
National. Assuming normal yields, FAPRI estimates that cotton prices under the 1996 Farm Bill would fall from the mid-seventy cent per pound level currently being received for the 1995 crop to the $0.63 to $0.64/lb level through most of the 1996-2002 study period. Couple declining market prices with a 12 percent increase in variable cost of production and per acre returns above variable cost falls by 4 percent from 1996 to 2002. A seven percent increase in projected yields from 1996 to 2002 somewhat offsets the cost price squeeze induced by moderate reductions in average farm price and a 12 percent increase in variable costs. The decoupled transition payments, however, will more than offset this decline in market returns on a dollar basis. However, from a cash flow standpoint if one compared market returns above variable cost plus transition payments in 1996 with comparable expected returns for the year 2002 the cash flow surplus would have declined by 11 percent.
The relative decline in returns above variable cost, whether measured with or without the decoupled transition payment results in a 17 percent reduction in planted cotton acreage from the 16.72 million acres planted in 1995 to 13.95 million acres in 2002.
Farm Level. AFPC maintains data to simulate the impacts of farm policy on 72 representative crop and livestock farms nationally. Of these, 10 are dependent on cotton production for a majority of their income (Figure 2).
Six of the ten cotton farms are located in Texas, two in the Mississippi Delta and two in the Southern San Joaquin Valley of California. County location and characteristics of the representative panel farms are included in Appendix Table A1.
Six of the panel farms are the size considered to be representative of the majority of full-time commercial farming operations in the study area. In four of the regions, Texas Southern and Rolling Plains, Mississippi Delta and California Southern San Joaquin Valley, a second farm roughly two to three times larger than the moderate scale operation is monitored as an indication of economies of size. Detailed data describing the financial impacts of the 1996 Farm Bill over the 1996-2002 period as projected by FAPRI/AFPC are included in Appendix Table 2.
All six Texas cotton farms are able to maintain real net worth over the study period (Figure 3). While five of the six Texas farms experience real growth between 17-35 percent, the large Southern Plains operation grows by 76 percent.
While these results on average appear moderately optimistic for the region, there are some concerns. Increased production flexibility and relatively tight U.S. stocks will likely result in increased price volatility. If net cash farm income (NCFI) declines by as little as 7 percent of gross receipts, then four of the six Texas farms experience a loss in real net worth (Figure 3). The Texas Southern Plains farms could sustain a NCFI decline equal to 12-16 percent of their gross receipts before losing real equity during the seven year period.
Four of the six Texas farms will have to draw on cash reserves and/or refinance operating debt as early as 1998. Only the Texas Souther Plains farms appear capable of making it through the study period without cash flow problems.
The Southern Plains farms have improved their economic viability significantly over the last 2-3 years by placing a portion of their acreage under irrigation growing both cotton and peanuts. Since this is a growing trend in the Southern Plains region, a question for the future is will the water table remain sufficient or decline beyond economic levels?
The large California and both Mississippi operations lose real equity over the 1996-2002 study period, ranging from 8 percent on the large California operation to 23 percent on the moderate Mississippi farm. A three percent improvement in NCFI relative to gross receipts, however, would allow the large California and large Mississippi operation to maintain equity, while roughly 7 percent would be needed on the moderate scale Mississippi farm. As a rule of thumb, AFPC believes that if equity can be maintained with NCFI increases of 8 percent of total receipts, then the farm has a good chance of sustaining equity. This could easily be the case on the large California and Mississippi cotton farm where decoupling of production from payments could result in cost restructuring that was not achievable under the current payment limit and production relationships of the current program.
As with most of the Texas farms, cash flow problems become apparent as early as 1997 as prices decline, transition payments are reduced and costs increase.
The analysis presented in this paper raises several issues which will have to be addressed by the cotton industry as well as other sectors of U.S. agriculture. These include:
Producers and other agribusinesses in the cotton sector will seek alternative means of reducing the increased risk exposure. Market power issues will likely become more prevalent as those with the potential to pass on risk will likely do so. Producers who have in the past specialized in production, while somewhat insulated from downside price risk with the help of government payments, will be increasingly exposed to price swings. Improved marketing decisions will bring considerable premiums to those adept at managing price risk. The positive impacts, however, will not be universally achievable.
Many producers and agribusinesses will not have either the managerial capability or the inclination to compete in this more risky environment. Others will continue to specialized in production and turn the marketing over to a third party. Operating entities of sufficient size to specialize effectively in both production and marketing will do so. Many, however, are likely to turn to group marketing or cooperative efforts as a means of managing price risk.
Farmers, as well as the agribusinesses that supply them inputs and market their products, have become increasingly concentrated throughout this century. This trend will likely be enhanced under the 1996 Farm Bill environment. As mentioned previously, decreased price and income stability will result in firms seeking to reach economies of size sufficient to internalize maximum efficiency associated with price risk reduction or vertically integrating through group activities. The bottom line is a more concentrated agriculture.
Increased flexibility at the regional level will place pressure on firms dependent on volume from a specific crop such as cotton. Shifts to grains, oilseeds or other alterative crops that prove more profitable in a single year could play havoc on agribusiness with market areas defined at regional levels, especially if single crop dependent. Cotton gins, for example, are of little use in processing and storing grains or oilseeds. Conversely elevators do not lend themselves to cotton processing in years where cotton is the markets commodity of choice.
Will there be investments in gins and elevators in this uncertain environment? The answer is yes. Will the firms likely be larger and capable of serving a larger geographical region? Again the answer is yes as a means of geographical insurance. The results of this pressure is increased concentration in agribusiness. A similar story could apply to lending, input supplies, and other value-added processors as they seek to reduce the regional volume uncertainty inherent in full flexibility.
The panel farm discussion pointed out some areas of concern relative to regional competitiveness. The panel farm process, however, was never intended to be extrapolated to all cotton farms in the region. Therefore, regional competitiveness and flexibility opportunities are likely better addressed using ERS costs of production by region, adjusted for FAPRI/AFPC out-year estimates on revenues and cost inflation. (See previous paper by Knutson et al).
When net returns are measured relative to the variable input cost required to produce the crop, the Southern Plains and Southeast appear most competitive among the southern cotton producing regions. A similar story was revealed in the panel farm analysis for those regions analyzed.
The flexibility issue is an interesting one for producers, lenders, other agribusinesses and economists. What will be produced in these regions if producers are given increased ability to respond to markets? At first blush analysts look at returns per acre in whole farm systems and may conclude that the farm will plant the crop that returns the most to the fixed inputs, management and risk given production constraints. Utilizing net returns per acre, cotton appears competitive with major alternative crops in the Southern Plains, Delta and Southeast. However, when returns are denominated by their cost of production, cotton falls to the bottom in each region. Low variable input crops such as wheat and soybeans prevail when per acre returns are compared to the cost of production that must be put at risk to achieve these returns. Although crude, this simplistic analysis may suggest greater movement out of cotton in the major production regions than might otherwise be anticipated. Certainly the mix within each region will likely become more volatile each year given price expectations. This further supports the stability issues addressed earlier in the paper.
With a seven year contract as a requirement for receiving transition payments, landlords, and tenants find themselves in unfamiliar territory relative to past negotiations. The issue centers around how the transition payment is to be distributed. Current language instructs USDA to be fair and equitable in protecting both landlords and tenants.
Since the majority of leased land in the U.S. is contracted based on single year verbal agreements, they rely on the good faith of the parties involved. The multi-year nature of the transition payment could change this tradition depending again on the degree to which the USDA/FSA allows landowners/tenants to negotiate transition payment shares.
In any event, the decoupling of transition payments, expected decline in market prices, and increased income risk will likely place downward pressure on the price of farmland. As a result, traditional rental agreements may need to be revised under conditions of the 1996 Farm Bill.
No doubt, the provisions of the 1996 Farm Bill will increase the flexibility of producers to respond to market signals. However, the financial risk will increase because of production and price uncertainties. The alternative grain and soybean crops will gain increased attention in evaluating production and price risk. The infrastructure of agribusiness and rural communities will need to adjust to cope with greater economic instability. The pressure to manage market risk internally will encourage more integration of production and marketing activities. The result will lead to a greater concentration in agricultural businesses and a possible change in the market structure for cotton. A multi-year contract on transition payments from the government will likely cause a considerable realignment in the traditional landlord/tenant relationships. Further, land values will likely weaken as farm earnings are squeezed between increasing production costs and highly variable and uncertain cotton prices.
Cotton producers in the United States have the capability to increase production substantially. But, the economic incentive must be favorable to offset the large capital outlays and risk in cotton production. Past farm programs have assisted in providing income stability and rigorous price competition against man-made fibers and to maintain exports. With higher cotton prices, synthetic fibers could become more price competitive. Furthermore, foreign growers with various levels of state support and low labor costs might increase their share of the international market.
AFPC, "Representative Farms Economic Outlook: FAPRI/AFPC April 1996 Baseline," AFPC working Paper 96-1, Texas A&M University System, April 1996.
FAPRI, Summary of the FAPRI Baseline, FAPRI, University of Missouri and Iowa State University, April 1996.
| TXSP1682 | A 1,682-acre Texas Southern High Plains (Dawson County) moderate size cotton farm. The farm plants 961 acres of cotton (886 dryland and 75 irrigated), 95 acres of peanuts, and has 183 acres in CRP. The farm generates 80 percent of its receipts from cotton. The farm has been updated for 1996. |
| TXSP3697 | A 3,697-acre Texas Southern High Plains (Dawson County) large cotton farm. The farm plants 2,822 acres of cotton (2,094 dryland and 728 irrigated), 128 acres of peanuts and has 214 acres in CRP. Cotton generates 92 percent of this farms receipts. The farm has been updated for 1996. |
| TXRP1700 | A 1,700-acre Texas Rolling Plains (Jones County) moderate size cotton farm that plants 1,070 acres of cotton and 200 acres of wheat. Cotton accounts for 88 percent of the farms receipts. The farm has been updated for 1993. |
| TXRP2500 | A 2,500-acre Texas Rolling Plains (Jones County) large cotton farm that plants 1,633 acres of cotton, and 300 acres of wheat. About 89 percent of this farms receipts are derived from cotton. The farm has been updated for 1993. |
| TXBL1200 | A 1,200-acre Texas Blacklands (Williamson County) moderate size cotton and grain farm with 820 acres of cotton and 360 acres of sorghum. Cotton generates 80 percent of the farms receipts. The farm has been updated for 1993. |
| TXCB1700 | A 1,700-acre Texas Coastal Bend (San Patricio County) cotton farm with 1,190 acres of cotton and 510 acres of grain sorghum. About 84 percent of this farm's receipts are cotton receipts. The farm has been updated for 1993. |
| CAC900 | A 900-acre Southern San Joaquin Valley California(Kern County) moderate size cotton farm that plants 640 acres of cotton and 225 acres of alfalfa. The farm generates 78 percent of its gross income from cotton. The farm has been updated for 1993. |
| CAC3150 | A 3150-acre Southern San Joaquin Valley California (Kern County) large cotton farm harvesting 2,000 acres of cotton and 1,002 acres of alfalfa. Cotton generates about 80 percent of this farm's receipts. The farm has been updated for 1993. |
| MSC1635 | A 1,635-acre Mississippi Delta (Washington County) moderate size cotton farm that plants 925 acres of cotton and 640 acres of soybeans. The farm generates 87 percent of its receipts from cotton. The farm has been updated for 1993. |
| MSC3620 | A 3,620-acre Mississippi Delta (Washington County) large cotton farm that plants 1,700 acres of cotton and 1,620 acres of soybeans. About 92 percent of the farm's receipts are derived from cotton. The farm has been updated for 1993. |