& Policy Update. October 28, 2017 Volume 17, Issue 10 FEATURED ARTICLES PROSPECTS FOR WINTER BACKGROUNDING IN 2017

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1 Graphic owner: UKZN SAEES: school website & Policy Update October 28, 2017 Volume 17, Issue 10 Edited by Will Snell and Phyllis Mattox FEATURED ARTICLES Prospects for Winter Backgrounding in Kenny Burdine - Greg Halich Soybean Delivery App Now Available - Jordan Shockley - Joseph Dvorak - Ricky Mason - Samuel McNeill Ky Ag Exports Remain Stable - Will Snell Farm Optional Method for Paying Self-Employment - Suzy Martin Farm Bill Update - Will Snell PROSPECTS FOR WINTER BACKGROUNDING IN 2017 Seasonally, calf prices tend to decrease in the fall as more calves move through markets and grass growth halts. However, excellent fall pasture growth and relatively inexpensive feed prices have supported calf markets thus far and we have not seen the usual drop. In reality, winter backgrounding profitability has a significant impact on calf prices as those winter backgrounders are competing with feedlots to purchase calves. Winter backgrounders had an excellent year in 2016 as they purchased calves in the fall on a severely depressed market and sold feeders this spring on a market upswing. The purpose of this article is to examine potential returns to backgrounding programs for the upcoming winter. At the time of this writing (October 27, 2017), March 2018 feeder cattle futures were trading around $153 per 100 wt. As winter backgrounders consider purchasing calves this fall, these late winter futures prices provide market expectations for feeder cattle sale prices. A futures price of $153 suggests a likely Kentucky price for 850 lb. steers in the mid-$140 s in March As an example, with spring feeder cattle futures at $153, and a -$8 basis, an 850 lb. feeder steer in Kentucky would be expected to bring around $1,233 $1.45 per lb.) in March. Of course, actual basis is heavily impacted by local market conditions, lot size, cattle quality, location, and numerous other factors. The -$8 basis discussed previously is based on an expected basis for 800 lb. steers at $5 under the board and an additional $3 for the price slide from 800 to 850 lbs. We assumed selling in potload sized groups. Producers considering winter backgrounding should make some estimate of a late winter sale price as they start to consider what can be paid for calves this fall. An excellent reference for predicting sale prices based on futures is AEC , Using the Futures Market to Predict Prices and Calculate Breakevens for Feeder Cattle which can be found on the Agricultural Economics website at The Kentucky Livestock and Grain Market Report for the week ending on October 20 th reported a state average price for lb. steers of $150 and a state average price for lb. steers of $145. However, futures prices have increased significantly since last week and we would expect calf prices to reflect these changes. Given this market increase, we would expect 550 lb. steer calves to bring around $160 per cwt or something close to $880 per head. Larger groups of high quality calves would certainly sell for more than this, so individuals are encouraged to apply this process to the type of calves they typically buy. We also need cost estimates on wintering those calves and selling them in the spring. While we provide an estimate for a specific winter program, costs will vary greatly based on local conditions and the specific backgrounding program. Feed is the major cost and producers should consider all potential feeding options including commodity feeds, corn, and corn silage. For this scenario, we will consider a single program where calves are fed 1.5% of their body weight per day of a 50/50 corn gluten/soy hull mix and another 1.5% of their body weight per day of grass hay. While performance will vary, we will assume a rate of gain of approximately 2.3 lbs. per day, which would put on 300 lbs. in approximately 130 days. In terms of costs, we will value the corn gluten/soyhulls at $160 per ton and value the grass hay at $75 per ton. Health costs are assumed to be $25 per head, selling/marketing expenses are set at $18 per head, and transportation is set at $10 per head. An interest charge of 5% is included and death loss is assumed to be PAGE 2%. These 2 costs will vary by location and operation, so readers are encouraged to come up with their own estimates. Continued on Page 2

2 PAGE 2 Several of these cost estimates are worth careful consideration. For example, we have assumed selling/marketing expenses of roughly $18 per head. Since we are assuming that winter backgrounders are moving cattle in load lot quantities, this is likely very close. However, many producers will be selling in smaller groups and likely paying higher commission rates on a per head basis. Vet and medicine costs are also important. We have assumed $25 per head, which is likely sufficient to include mass medication of all calves. However, this is a decision that the individual producer should make. Finally, we would point out that our analysis largely assumes that calves are being purchased. If this was done for a cow-calf operator who was considering backgrounding their own calves, several costs would change. First, it is likely that vet, medicine, and death loss for raised calves would all be lower. Secondly, transportation and commission would be paid on the calves if they were sold after weaning, so the relevant costs become the difference in commission and transportation paid on the heavy feeder versus the calves, rather than the total costs. With these caveats in mind, the following table shows expected returns to the program described above. Table 1: Winter Backgrounding Budget Estimate Revenues # units unit price / unit total Feeder 849 lbs $1.45 $1,231 Expenses Stocker Calf 550 lbs $1.60 $880 Hay 1,365 lbs $0.04 $51 Hulls / Gluten 1,365 lbs $0.08 $109 Mineral 0.25 lbs / day $0.40 $13 Vet / Med 1 head $25.00 $25 Selling/Marketing 1 head $18.00 $18 Hauling 1 head $10.00 $10 Other 1 head $10.00 $10 Interest 5% rate $19 Death loss 2% $18 Total Expenses $1,154 Return to Land, Capital and Mgt $77 As can be seen in table 1, projected returns are $77 per head this winter, based on the assumptions discussed previously. Producers are strongly encouraged to modify these assumptions for their individual programs to better reflect calf values and expected spring basis, as well as cost estimates and feed prices for their area. It is also worth noting that labor, depreciation, and interest on owned capital are not included in the budget, so the return shown is a return to land, capital, and management. Producers should ask themselves if that return adequately compensates them for their time, capital investment, management, and risk. The two key assumptions made in Table 1 include the cost of the calves being placed and the expected sale value in the spring. Changes in calf placement costs will greatly impact winter backgrounding returns. For every $5 per cwt decrease in the purchase price of the calves, the return to land, capital, and management increases by $27.50 per head. The second assumption, the sale price for the feeder steer won t be known with certainty until spring. Note that the assumed spring sale price in the analysis is $145 per cwt and the projected return is $77 per head. A $9 per cwt decrease in sale price would result in actual returns falling to $0. While feed price does not have as large an impact on profit as sale price, a $25/ton decrease in price in corn-gluten/soyhulls would increase expected profit by $17 and vice versa. Given the assumptions of the analysis in Table 1, expected returns to winter backgrounding are moderate given the late- October s calf market and late winter CME Feeder Cattle Futures. However, given the importance of expected sale price on returns, winter backgrounders are encouraged to explore opportunities to manage downside price risk through contracting, futures and options, LRP insurance, and other strategies. Continued on Page 3

3 PAGE 3 The figure below depicts March CME Feeder Cattle Futures from DTN over the last six months. Note that the March CME Feeder Cattle Futures contract is up nearly $20 per cwt from where it was in the spring. While it does appear that the market is offering some opportunity for winter backgrounding, the last few months, as well as the last few years have provided a reminder as to how unpredictable these markets are. Therefore, some additional effort should be applied to manage downside price risk. Winter backgrounders should carefully calculate their breakeven purchase prices for calves and be opportunistic as they approach this fall. Figure 1. March 2018 CME Feeder Cattle Futures from DTN (close 10/26/17)

4 PAGE 4 SOYBEAN DELIVERY APP NOW AVAILABLE The Best Bean Buyer app is now available for download in the App Store for Apple and Google Play for Android users. In partnership with the Kentucky Soybean Board, this app helps soybean producers determine and compare the best price received by elevators when considering delivery costs and high moisture discounts. This app helps answer the question, should I sell my soybeans to the closest elevator or should I haul them a further distance to receive a price premium? By incorporating critical factors such as cash price, discount schedules, and hauling elements, a soybean producer can estimate and compare net prices at various elevators in real-time. The balance between maximizing the price per bushel received and minimizing hauling costs could be the difference in turning a profit given the current margins for soybeans. So act now and download the free app in time for soybean harvest. A short YouTube tutorial on how to use the app is at the following link:

5 PAGE 5 KENTUCKY AG EXPORTS REMAIN STABLE Last week USDA released official data on state agricultural exports for CY USDA allocates U.S. ag exports by state based on the state s market share of U.S. cash receipts for each exported commodity. Thus, Kentucky receives export value for tobacco produced in Kentucky, but processed and exported out of Virginia as well as Kentucky-grown soybeans exported from the Gulf or a Kentucky born and backgrounded steer finished in Nebraska and exported to Japan. Kentucky agricultural exports remained relatively stable in 2016 at $2.1 billion, nearly 40% of the state s ag cash receipts. Soybeans and related byproducts (e.g. meal/oil) remained the state s top ag exports representing nearly 1/3 of Kentucky s ag exports, followed by live animals, primarily horses (18%), and tobacco (11%). National trade data indicate that U.S. ag exports may increase this fiscal year in response to improving global economies, abundant U.S. supplies, and a weaker U.S. dollar. USDA is forecasting U.S. ag exports to total $139 billion in FY 2017, up from $129.6 billion in FY 2016, but still 9% below FY 2014 record high of $152.3 billion. Entering 2017, many analysts had expected the U.S. dollar to strengthen amidst anticipated higher U.S. interest rates. But inflation in the United States has remained limited so far in 2017, resulting in the Federal Reserve keeping interest rates remaining relatively low. Plus, improved economic outlooks in Europe and Japan have also contributed to the weakness in the U.S. dollar in The U.S. dollar has declined by around 8% since the first of the year compared to our major trading partners. Soybean exports are estimated to increase to record levels (up 10% in FY 2017) thanks to continued strong demand in China, but corn exports will likely be lower in response to strong competition from South America. Livestock exports are forecast to increase by approximately 15% this fiscal year on the heels of strong beef, pork, poultry and dairy product exports. China remains our number one export customer for U.S. agriculture, followed by our other two major export customers Canada and Mexico Collectively, these three markets comprise 45% of U.S. agricultural exports. Of course, most of the ag trade attention of late has centered on the renegotiation of the North Atlantic Free Trade Agreement (NAFTA). Trade negotiations on NAFTA 2.0 have begun with a lot of focus on agriculture as well as automobile manufacturing (another huge issue for Kentucky). Prior to the passage of NAFTA in the early 1990s, Canada and Mexico accounted for around 20% of U.S agricultural trade compared to nearly 30% of our export sales today. Despite concerns over Mexican and Canadian buyers looking to other markets to replace U.S. agricultural imports amidst their frustration over NAFTA politics, U.S. trade with our NAFTA partners has remained fairly strong so far this year. USDA is projecting that the U.S. will send $40 billion of ag commodity/products to Canada and Mexico in FY 2017 (up $2 billion from last year), compared to $8.9 billion in 1993 the year prior to the implementation of NAFTA. However, a collapse of NAFTA could have significant long-term trade repercussions for U.S. and Kentucky agriculture. Collectively, Mexico and Canada are the largest buyers of U.S. corn, wheat, beef, pork and poultry.

6 PAGE 6 FARM OPTIONAL METHOD OF PAYING SELF-EMPLOYMENT During years of low net taxable farm incomes, the Internal Revenue Service (IRS) allows farmers to optionally pay selfemployment (SE) tax. One might ask why anyone would voluntarily pay a tax; however, there are several benefits to paying SE tax. These include retirement benefits, eligibility for disability payments, and survivor benefits. Some may argue about the longevity of the retirement benefit part of paying into the system, particularly for young taxpayers. The biggest benefits for young producers to paying SE tax are to remain current and eligible for disability payments and survivor benefits in the event of life changing circumstances. Benefits are earned by building up credits. You can earn a maximum of four credits each year. For 2017, you must have earnings of at least $1,300 to get one credit. Earnings of at least $5,200 will result in the maximum of four credits for the year. According to the Social Security Administration (SSA) website, to receive disability benefits, you must have accumulated at least 20 credits in the 10 years immediately before you became disabled if you are 31 or older. For those younger than that, the requirement is to have worked half the time between the age of 21 and the time you become disabled. The number of credits needed for survivor benefits depends on the age of the taxpayer when they die. The younger you are, the fewer credits you need, but nobody needs more than 40 credits (10 years of work). There is a special rule that allows children to receive benefits if there were at least six credits (1.5 year s work) in the three years before the death. Keep in mind that tax returns can only be amended for three years following the due date of the original return, so the ability to go back and create credits is limited. In years that farmers have low to negative taxable farm incomes, the IRS allows them to use the farm optional method to calculate the SE earnings. Generally, you can use the farm optional method if your 2017 gross farm income is $8,444 or less, OR your net farm profits are less than $5,630. If you meet either of the requirements, you can calculate your SE earnings as two-thirds of your gross farm income up to $5,200. In addition to the benefits mentioned previously, optionally paying SE tax could have a positive impact on tax credits such as the child or dependent care credit, the earned income credit and/or the additional child tax credit. If the taxpayer has an offfarm job with taxes reported on a Form W-2, then it is likely they have already earned enough to build up the credits for the year. As always, it is important to consult your tax preparer, as everyone s situation is different. KENTUCKY FARM BUSINESS MANAGEMENT

7 PAGE 7 P PAGE 5AGE 5 PAGE 5 FARM BILL UPDATE The 2014 Farm Bill is scheduled to expire September 30, Consequently, policymakers, farm organizations, conservationists, and other interested parties have been debating the issues throughout this past year. The Senate and House Ag Committees have held a series of hearings in 2017 with the goal of completing a farm bill in a timely manner. The last farm bill was signed by the President on February 7, 2014, nearly two years after the expiration of the 2008 farm bill. Congress has not passed a Farm Bill on time since 1990, resulting in a series of short-term farm bill extensions to avoid the adoption of costly permanent legislative parameters evolving from the 1949 and 1938 farm bills. Budgetary issues continue to be a challenge as farm/commodity organizations attempt to strengthen the safety net for U.S. agriculture amidst a depressed agricultural economy, while other groups, such as hunger advocates, and conservationists attempt to protect their programs. Baseline funding for the 2018 farm bill will likely be lower as expenditures on food assistance programs have declined in recent years in response to a modestly improved U.S. general economy increasing employment and incomes. Despite the intense battle over funds to support farm versus food assistance programs, most farm organizations and policy makers from ag-dependent states/districts support maintaining farm and nutrition programs remaining together in farm bill legislation. Unlike farm bills in recent history, it appears that the structure of the 2018 farm bill may not vary considerably from the previous farm bill with the primary crop income safety net programs, Average Risk Coverage (ARC) and the Price Loss Coverage (PLC), remaining intact. Early in the debate, farmers growing in multiple counties expressed frustration over ARC payment methodology resulting in considerable variance of payment levels across county boundaries, but this issue has not received much attention of late. However, for farmers renting ground in multiple counties, a bill was introduced last week to require USDA to calculate the ARC county payments based on the ARC payment rate for the county in which the land is located rather than the rate for the FSA administrative county used by the farmer. In addition, this legislation called for modifying yield calculations in determining ARC payments by using Risk Management Agency (RMA) data versus National Agricultural Statistics Service (NASS) data. In addition, there has been some discussion on using a simple 10-year timeframe to determine the price and yield data used in calculating baseline revenues instead of the 5-year Olympic averages required under the 2014 Farm Bill. Giving expected payments for the ARC program diminishing, most analysts anticipate that a large number of corn and wheat farmers will likely switch from ARC to the PLC program under the 2018 Farm Bill. Some farm/commodity organizations are calling for PLC reference prices to be increased to more closely align with the variable cost of production and to reexamine equity of PLC levels across crops. In addition, cotton would like to be included as a PLC crop, while dairy is calling for greater protection under the Margin Protection Program (MPP). Some growers are calling for annual flexibility in selecting safety net options (ARC vs PLC) and the ability to adjust or reallocate base acres and update yields. However, budget constraints are complicating discussion on all these modification options. Commodity groups are placing greater emphasis on maintaining the federal crop insurance program as the primary risk management tool in the 2018 Farm Bill, with potentially new products for livestock enterprises. While very supportive among farmers, the federal crop insurance program is facing a lot of scrutiny in the 2018 farm bill deliberations. Similar to the 2014 Farm Bill, expect debate over producer subsidy levels, producer caps on premium subsidies, maintaining the harvest price option, and potentially means testing of crop insurance payments. In addition, financial incentives for crop insurers will also be revisited. Some conservation groups are requesting an increase in acres enrolled under the Conservation Reserve Program (CRP) while trade, energy, and research supporters are also requesting additional funding to support existing programs. Concerns over the aging farm population are elevating policy options to improve access to capital for young or beginning farmers. In addition, there are dozens of programs (e.g., Value Added Producer Grant Program) that will expire with no baseline funding. Similar to the debate over commodity programs, additional funds will not likely be available for these requests unless dollars are secured from other areas of the farm bill. Congressional leaders in both chambers have expressed a goal of passing the 2018 Farm Bill early possibly in However, this could be an optimistic timeframe given a host of issues confronting the 115th Congress including tax and health care reform, trade, immigration, infrastructure, and budget-related matters.

8 PAGE 8 College of Agriculture, Food and Environment Department of Agricultural Economics 315 Charles E. Barnhart Bldg. Lexington, KY Phone: Fax: Economic & Policy Update View all issues online at Educational programs of Kentucky Cooperative Extension serve all people regardless of race, color, age, sex, religion, disability, or national origin. UNIVERSITY OF KENTUCKY, KENTUCKY STATE UNIVERSITY, U.S. DEPARTMENT OF AGRICULTURE & KENTUCKY COUNTIES COOPERATING.