Producers face new pricing decisions Editor's note: With low prices prevailing for cotton and other loan-eligible commodities, producers can expect to receive government assistance again this season in the form of marketing loan gains or loan deficiency payments (LDP). The National Cotton Council prepared this summary of the marketing options available to producers and key rules and procedures of the marketing loan program and the LDP.
THE FREEDOM to Farm Act places a $75,000 per person limitation on marketing loan gains or LDPs on loan-eligible commodities produced in the 2000 crop year. The limit on LDP/marketing loan gains is distinct from the $40,000 per person limit on Agriculture Market Transition Act (AMTA) payments.
Because sizable marketing loan gains are possible, the $75,000 per person loan gain or LDP limit could impact producers. The limit can influence the way a producer markets the 2000 crop. Producers should consider their available options, understand the impact of the payment limit and consult with FSA offices regarding loan or LDP eligibility. (Producers who market through cooperatives do not escape the impact of payment limits. You should discuss payment limit issues with coop personnel to learn how you can be affected.)
Producers can receive marketing loan benefits as follows:
1 Bypassing the loan and receiving LDP payments on loan eligible commodities.
2 Putting commodities under CCC loan and redeeming with cash at an adjusted world price (AWP) below the prevailing loan rate.
3 Redeeming loan commodities using marketing certificates.
Options 1 and 2 may be exercised up to a producer's cumulative $75,000 limit on marketing loan gains. Redemption of a loan commodity using marketing certificates (option 3) will not count against a producer's marketing loan gain payment limit.
Government programs Cotton produced on farms enrolled in a production flexibility contract with the Farm Service Agency is eligible for marketing assistance loans (or, alternatively, LDPs). You may choose between a loan and an LDP on a bale-by-bale basis. For the 2000 crop, producers who are not enrolled in a production flexibility contract will be eligible for an LDP (but not a marketing assistance loan).
Marketing loan and LDP The base loan rate for upland cotton is 51.92 cents per pound. When the AWP is less than the loan rate, a producer may redeem the upland cotton loan at the AWP. The spread between the loan and the AWP in the following example (5.92 cents per pound) is the marketing loan gain and counts against the producer's marketing loan payment limit.
- Cotton placed into loan at loan rate 51.92 cents.
- Loan repaid at the AWP 46.00 cents.
- Marketing Loan Gain (equivalent to LDP) 5.92 cents
Storage and interest are not charged upon redemption when the AWP is below loan. This amount may be a net gain to the producer but would not count toward the payment limit.
Instead of placing cotton in the loan, you may receive the same 5.92-cent gain by applying for an LDP on the cotton. Once the producer receives the LDP, the cotton is no longer loan eligible.
Impact of payment limit Producers who reach their $75,000 marketing loan gain payment limit may redeem their commodity with cash at the original loan principal or forfeit the commodity without incurring additional government charges.
They cannot redeem loans with cash at the adjusted world price. Revenue to the producer on the forfeited commodities is only equivalent to the loan value which has already been received.
Similarly, producers who have received up to $75,000 in LDPs, but who still have loan eligible commodities, may place those commodities in the CCC loan and receive the loan rate. However, they cannot redeem with cash at the AWP because they have reached the payment limit.
Fortunately, producers may use marketing certificates in lieu of cash in both of the above instances to redeem their loans at the AWP.
Use Of Commodity Certificates for Redemption of Upland Cotton
Producers may use commodity certificates to redeem loan eligible commodities. The Commodity Credit Corp. announced procedures that will allow FSA offices to issue certificates in the exact dollar value needed to redeem the producer's loan and function as an immediate exchange. In other words, there will be no actual issuance of a certificate, or generic certificate, that could be used at a later date.
For individual producers, FSA will complete this process upon execution of form CCC-681-1A. If someone acts as the producer's agent, i.e. the producer has an option-to-purchase contract, then a CCC 605 superscript * must also be on file (forms CCC 605-1 or CCC 605-2 may also be available, ask the FSA office).
Marketing certificates allow cotton that has been placed under CCC loan to be redeemed at the AWP without counting towards a producer's marketing loan gain payment limit. The important point is that certificates are only useful for the redemption of cotton that is under CCC loan. This procedure does not apply to CCC-owned inventory.
Marketing of loan cotton Producers can sell an "option to purchase" their cotton and simultaneously authorize the option purchaser to redeem cotton that had been placed under CCC loan (commonly referred to as an "equity" sale). The value of the option ("equity") is often reflective of the relevant contract on New York, costs to tender cotton on New York minus the cost to redeem the loan. The purchaser of the "equity" acquires certain redemption rights that can vary in value over the remaining life of the loan as contract values on the New York Board of Trade and the world price of cotton respond to changing market conditions.
In addition, the possibility of storage and interest charges being waived or reduced, depending on the value of the AWP1, also can contribute to the value of the option.
Be aware that "option-to-purchase" contracts generally stipulate that the purchaser is offering a particular price on the condition that the cotton can be redeemed at the prevailing AWP. If the purchaser could not redeem the cotton at the AWP because the producer had reached the payment limit, the purchase price will be adjusted and the producer could face additional charges. The availability of marketing certificates to redeem at the AWP should enable producers and merchants to avoid such additional charges. Receiving and other carrying charges that accrue prior to cotton being placed into the loan also are for the account of the producer.
Marketing cotton, receiving LDP A producer who has forward contracted cotton or decides to sell his cotton without use of the loan may be eligible for an LDP. However, you must understand the rules governing LDP eligibility when forward contracting cotton. The type of contract entered into can affect eligibility. Generally, there are two types of delivery specified in a forward contract: 1) a "gin-direct sale," or 2) delivery sometime after ginning.
Important LDP rules To be eligible to receive an LDP (or a loan), the producer must have beneficial interest in the cotton when applying for the LDP. Beneficial interest means having title to the cotton, control of the cotton and risk of loss.
Contact your local FSA office to ensure that any forms and contracts regarding determination of the LDP are consistent with your intended marketing practices. Examine sales contracts to ensure the producer maintains beneficial interest until application is made for the LDP.
If a forward sale of cotton does not specify that the cotton is transferred as of ginning, but rather contemplates a transfer of title at some future date - upon invoicing, upon loading or upon delivery of warehouse receipts, for example - the producer may maintain beneficial interest until the cotton is actually transferred. In such case, the producer likely would be eligible for an LDP until the later date.
TO RECEIVE an LDP on such cotton, the producer would need to file the CCC-Cotton AA LDP with FSA before he loses beneficial interest.
A "gin direct" sale normally specifies that title to the cotton passes from the producer to the buyer upon ginning. For such cotton to be eligible for an LDP, you must have a CCC-709 in place for such cotton prior to ginning. The CCC-709 can be limited to production from a specific farm if necessary.
Form 709 establishes the LDP at the value in effect at the time of ginning and should be used for gin-direct contracts or when there is reason to be concerned that the producer will be unable to apply for the LDP before beneficial interest is lost.
RECEIVING AN advance payment on a forward contract - except for option to purchase type agreements - could make the producer's cotton ineligible for an LDP or the CCC loan. Conversely, delivery of cotton to the buyer will cause the producer to lose beneficial interest even though no money has yet been received for the cotton.
Locking in an LDP rate Producers may lock-in an LDP rate (by locking in an AWP) on upland cotton stored in ricks, modules or trailers. Consult your local FSA office for specific procedures. When locking in the rate, you must provide a module number supplied by a cooperating gin.
You must then submit production evidence identifying the specific bales produced from the specific module. The LDP will be paid using bale-specific production evidence and at the rate determined using the locked-in AWP.
Fixed Price and Basis Contracts
There are normally two types of sales: "fixed price" or "basis." In a fixed price sale, the buyer offers a set price for specified delivery. In a basis sale (also known as "on-call" sale), the grower fixes the basis for a specified New York Cotton Exchange Futures contract with the right to fix the respective contract value at some point in the future. The basis sale could provide for fixing the contract value well after delivery of the cotton.
Basis is the difference between the value of a specific New York futures contract for a commodity and the cash value of the commodity at a specific location and time. A wide range of factors, including location, shipping differentials, relative tightness or availability of various cotton styles for immediate shipment and movement of New York cotton futures values, influence basis.
The fact that a contract is a fixed price or basis contract likely will have little impact on the question of beneficial interest. There are other considerations. You can lose beneficial interest (by delivery of the cotton, for example) even though the contract value under a basis contract has not been fixed.
The following table covers only a few of the marketing options available and the associated result of a particular option. Neither this table nor this paper is intended to encourage or endorse one marketing option over another, but is designed to help ensure producers are aware of the inter-relationship between some marketing decisions and government programs.