AGRICULTURAL OUTLOOK                                        February 23, 1999
March 1999, ERS-AO-259
               Approved by the World Agricultural Outlook Board
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CONTENTS

In Brief

Briefs
Livestock, Dairy, & Poultry: Lower Output to Revive Hog Prices in 1999
Trade Policy: U.S. Export Programs Target Weak Global Demand

Commodity Spotlight
Coffee Exporters Counting on Improved Earnings in 1999/2000

World Agriculture & Trade
Brazil's Financial Crisis & the Potential Aftershocks

Risk Management
Farmers Sharpen Tools to Confront Business Risks

Special Article
Value-Enhanced Crops: Biotechnology's Next Stage
Testing May Facilitate Marketing of Value-Enhanced Crops

IN BRIEF

Lower Output to Revive Hog Prices in 1999    

In 1998, hog prices tumbled to the lowest annual average since 1972, $31.67
per cwt; the average for December was $14 per cwt, the lowest December monthly
average since 1963.  Responding to the run of low returns in 1998, U.S.
producers reduced their breeding herds late in the year.  Based on market hog
inventory, pig crops, and farrowing intentions reported in the December Hogs
and Pigs report, pork production in 1999 is expected to total about 18.9
billion pounds, down from last year overall (less than 1 percent), with a
sharp decline in the final quarter.  With receding slaughter levels, lower
production, and continued increases in net exports, hog prices are expected to
rebound from the extreme lows in late 1998, rising throughout 1999 from the
mid-$20's to near $40 per cwt, and averaging in the mid-$30's per cwt for the
year. 

Brazil's Financial Crisis & Potential Aftershocks

The intensifying financial crisis in Brazil, marked by a sharp devaluation of
its currency in mid-January, has renewed concerns about the consequences of
the crisis for U.S. agriculture.  Latin America and Asia together bought about
60 percent of U.S. agricultural exports last fiscal year, and Brazil's
currency devaluation is already having repercussions in other countries in
Latin America.  In the short run, Brazil's devaluation will have relatively
little impact on U.S. agricultural trade with Brazil, though an expected
reduction in U.S. agricultural exports and an increase in agricultural imports
will likely widen the U.S. agricultural trade deficit with Brazil ($684
million in fiscal year 1998).  In the longer run, the potential for effects on
U.S. agricultural trade is greater, particularly if Brazil is unable to regain
financial control and if the continuing crisis forces other Latin American
countries to take measures to stay competitive, such as devaluing currencies
or raising import tariffs. 

Coffee Exporters Count on Higher Earnings

Brazil and other coffee exporting countries are expecting a smaller 1999/2000
Brazilian crop to draw down world supplies and reverse the 1998/99 downturn in
prices and foreign exchange earnings.  Prices for arabica coffee, milder in
taste than robusta (and the type most widely consumed in the U.S.) have been
lower since last summer due to sharply higher 1998/99 production, particularly
in Brazil, which accounts for about one-third of world output.  

The fortunes of coffee exporters depend increasingly on supply management by
producers, because importers have become less willing to hold stocks to buffer
the price volatility.  Traditionally, U.S., European, and Japanese importers
reacted to declining coffee prices by building up stocks.  In recent years,
however, U.S. and other importers and roasters have moved toward just-in-time
inventory to avoid carrying costs.  Because of this, prices will vary more
than in the past. 

Value-Enhanced Crops: Biotechnology's Next Stage 

Biotechnology's next quest, to provide field crops with value-enhanced
qualities for end-users (output traits) is underway.  Biotechnology's first
stage featured crops with improved agronomic qualities(input traits) valued by
farmers, such as resistance to pests.  The industry now visualizes a system in
which farmers grow crops designed for the specific needs of end-users in food
manufacturing, the livestock sector, and even the pharmaceutical industry. 
Breaking with agriculture's traditional supply-side orientation may not be
easy, however.  Whether biotechnology's second stage is a wave or a modest
ripple will hinge on several economic and technical factors.

Farmers Sharpen Tools to Confront Business Risks  

Risk management involves finding the combination of strategies most likely to
achieve a desired level of return at an acceptable level of risk.  Three risks
that concern farmers most, according to USDA's 1996 Agricultural Resource
Management Study, are uncertainty regarding commodity prices, declines in crop
yields or livestock production, and changes in government law and regulation. 
     

Farmers have a variety of tools for cutting risk, such as diversification of
production across multiple enterprises, entering into production and/or
marketing contracts, and keeping extra cash on hand for emergencies.  Other
strategies include crop or revenue insurance, futures market trading, and
off-farm employment.  When individual efforts to deal with financial stress
fail and large numbers of farms face significant financial loss, the Federal
government has stepped in to assist farmers with direct payments, loans, and
other types of support.  Most recently, the 1999 Agricultural Appropriations
Act provided for $2.375 billion of emergency financial aid to farmers.  Since
farm business characteristics vary widely and operators' risk preferences
differ, there can be no "one size fits all" approach to risk management. 


BRIEFS

Livestock, Dairy, & Poultry
Lower Output to Revive Hog Prices in 1999

In 1998, hog prices tumbled to the lowest annual average since 1972, $31.66
per cwt; the monthly average for December was $14 per cwt, the lowest December
monthly average since 1963. Although feed costs were sharply below a year
earlier, the extremely low prices slashed producers' returns. 

The steep decline began in late 1997. Earlier in the year, producers had been
anticipating sharply increased export demand from Asia following the outbreak
of foot-and-mouth disease in Taiwan in March 1997 (AO March 1998). At that
point, hog supplies were relatively tight, well below estimated slaughter
capacity, and feed costs were declining. In response, producers took steps to
expand production, increasing their breeding herds and setting in motion a
process that would reach fruition beginning in late 1997 to early 1998, at the
end of the approximately 10-month biological cycle (from breeding until the
pigs produced reach slaughter weight). By July, prices had reached a monthly
high of $59 per cwt. 

In late 1997, however, the effects of the deepening Asian financial crisis had
begun to affect export demand. Although exports continued to increase in 1998,
rising an estimated 20 percent for the year, they were concentrated in lower
value cuts. Meanwhile, the expanded production began to increase the supply of
hogs substantially by September 1998, there were 63.5 million hogs on U.S.
farms, the highest number since 1980. Productivity increases in pigs per
litter and litters per sow, as well as in weight of slaughtered animals, added
to the magnitude of expansion, as did recent increases in the number of hog
operations with 2,000 or more head, which have seen the greatest productivity
gains.

The unusually large increase in hog supplies strained the capacities of hog
slaughter plants; weekly slaughter in the fourth quarter of 1998 frequently
reached 2.2 million head, compared with a weekly level of only about 1.65
million head in mid-1997. As slaughter plants exceeded their capacity, packers
turned to overtime labor to handle the huge supply, pushing up costs.
Increased slaughter costs for packers, who were tied to contracts or
purchasing arrangements for a large share of their supply, were quickly
reflected in lower bid prices for hogs offered on the spot, or cash, market.

Adding further stress to an already strained system, increased shipments of
Canadian hogs began to flow to U.S. packers just as the U.S. hog supply had
outstripped plant capacity. The strong U.S. dollar, increased production and
low prices in Canada, and labor problems at some Canadian packing plants led
to an increase of nearly 1 million head in hog imports in 1998 compared with
1997.

Responding to the run of low returns in 1998, U.S. producers reduced their
breeding herds late in the year. USDA's December Hogs and Pigs report
indicated a December 1 breeding inventory 4 percent below a year earlier, the
first reduction in the quarterly year-over-year breeding inventory since March
1997. The reduction points to a smaller first-half 1999 pig crop and lower
pork production in the second half of 1999. 

Based on market hog inventory, pig crops, and farrowing intentions reported in
the December Hogs and Pigs report, pork production in 1999 is expected to
total about 18.9 billion pounds, down less than 1 percent from last year
overall. Although production is expected to increase about 5 percent in
first-half 1999, it will decline in the remainder of the year; fourth-quarter
1999 production is expected to be about 10 percent below a year earlier. 

With receding slaughter levels, lower production, and continued increases in
net exports, hog prices are expected to rebound from the extreme lows of
$19.48 per cwt of late 1998, rising throughout 1999 from the mid-$20's to near
$40 per cwt, and averaging in the mid-$30's per cwt for the year. Although
poultry production is expected to rise 5-6 percent, beef production is
expected to drop 2-3 percent in second-half 1999, reducing competition for
pork. With a continuing decline in feed costs expected, producers' returns may
rise above breakeven late in the year. The severe financial distress hog
producers experienced in 1998, however, may slow their response to favorable
returns it may take longer than the typical 3-6 months of positive returns
before producers resume herd expansion.

In contrast to the historical drop of 38 percent for hog prices on the market
in 1998, retail pork prices declined less than 5 percent. Farmers' share of
retail prices fell to 22 percent for the year, and was only 10 percent in
December as the farm-to-retail spread widened to more than $2 a pound. A low
farm share of retail value with a lengthy adjustment period is typical when
livestock prices drop sharply, although the drop to 10 percent that occurred
in December was unusually steep. Retail prices in 1999 are expected to
continue a downward adjustment to the lower hog prices, declining another 2-4
percent, with the sharper drops expected early in the year. As hog prices rise
in 1999, retail declines will taper off with a 1-percent decline in
fourth-quarter 1999. 

Retailers contend that the retail prices used in the farm-to-retail price
spreads, which include data from the Consumer Price Index, do not accurately
reflect large volumes of pork moving at sale prices. In their view, if these
lower priced sales were included in the calculation, the spread would not
appear as wide. At the same time, retail pricing responds to consumer demand
for pork, not to the supply of hogs. Consumer incomes are strong, and demand
for pork has held steady without the need for significant price reductions. As
preferences for pork increase in response to higher quality, improved
consistency, and larger cut size, pork supplies have not outstripped rising
retail demand at current prices.

Continuing moderate domestic pork prices will help support U.S. exports in
1999. U.S. pork exports are expected to increase 10 percent in 1999, compared
with  a likely 20-percent rise in 1998. The 1998 increase was the result of
lower U.S. pork prices and a volume increase of lower valued products; in
1999, as supplies stabilize, increased exports will bid up prices. A
double-digit increase, however, will be contingent on successful delivery of
food aid to Russia. Japan, Russia, Mexico, and Canada have accounted for
three-fourths of all U.S. pork exports in 1998, and Japan, Mexico, and Canada
will likely account for most of U.S. pork exports in 1999. 

Japan's imports in 1999 are expected to increase moderately in line with a
stronger yen. While double-digit economic growth rates seen earlier in the
decade are not likely in 1999, the U.S. share of Japanese pork imports is
expected to remain near 30 percent. The U.S. provides more than 70 percent of
the fresh pork and more than 15 percent of frozen pork imported by Japan.
Denmark is the major U.S. competitor for frozen pork imports to Japan,
supplying more than 33 percent of the frozen market. After the outbreak of
foot-and-mouth disease in Taiwan in 1997, Japan compensated for the loss of
imports from Taiwan by diversifying its imports of fresh pork, adding cuts
from Canada and South Korea. Canada is likely to provide the U.S. strong
long-term competition for Japan's fresh pork market.

The moderation of economic growth in Mexico, together with continued recovery
of its pork production industry, could slow Mexican demand for U.S. pork
products in 1999. While export growth to Mexico may not meet the recent 2-year
average growth rate of 60 percent, U.S. shipments to Mexico in 1999 are likely
to continue increasing at a double-digit rate.

Exports to Canada in 1999 are likely to continue at the high levels reached
following the dramatic increases of 1996-97. Strong Canadian demand for U.S.
products reflects, in part, Canadian consumer demand for cuts that Canadian
processors have been exporting in order to develop markets in Asia. As
restructuring and expansion of the Canadian pork industry continues, demand
for U.S. products could trend downward. On the import side, shipments of
Canadian hogs could moderate in 1999, as slaughter capacity increases in
Manitoba and as Ontario hogs increasingly move to plants in Quebec under
buying contracts.

Leland Southard (202) 694-5187
southard@econ.ag.gov  

BRIEFS

Trade Policy
U.S. Export Programs Target Weak Global Demand

The U.S. government operates several types of programs to encourage U.S.
agricultural exports and to feed needy people in foreign countries. Export
credit guarantees, export price subsidies, and market promotion programs have
facilitated commercial exports during this decade. U.S. food assistance
programs donate agricultural products directly to individual countries with
food aid needs or through the United Nations (UN) World Food Program, and
permit long-term credit sales of agricultural commodities to countries on a
government-to-government basis and to nongovernmental organizations in
recipient countries. 

U.S. agricultural exports rose steadily through the 1990's, reaching $59.9
billion in fiscal year 1996. But as financial problems in Asian countries and
in the former Soviet republics weakened world demand and as global commodity
supplies increased in response to high prices in the mid-1990's, U.S. exports
slipped to $53.7 billion in fiscal 1998. Weak global demand is expected to
continue in the short term and, coupled with large world commodity supplies
and a strong U.S. dollar, is expected to lower U.S. agricultural exports to a
forecast $49 billion in fiscal 1999. 

Export credit guarantees facilitate exports to buyers in countries where
credit is necessary to maintain or increase U.S. sales, but where financing
may not be available without U.S. government guarantees. The Export Credit
Guarantee Program (GSM-102), the largest of the group, guarantees loans of
more than 6 months to 3 years, and the much smaller Intermediate Export
Credit Guarantee Program (GSM-103) guarantees loans of more than 3 years up
to 7 years. Smaller credit guarantee programs, the Supplier Credit Guarantee
and Facilities Guarantee Programs, were implemented only recently. USDA's
Commodity Credit Corporation (CCC) approvals of export credit guarantees slid
to $2.9 billion in 1997, down from a peak of $5.7 billion in fiscal year
1992, but rose again in 1998 to $4 billion as importers, particularly in
Asia, sought government-guaranteed commercial loans to purchase U.S.
products. Export credit guarantee shipments accounted for 6 percent of U.S.
agricultural exports in 1998, down from 13 percent in 1992 when the export
level was much lower.

The chief importers using U.S. export credit guarantee programs in 1998 were
the Republic of South Korea, Mexico and, to a lesser extent, Turkey, Pakistan
and Indonesia. Mexico has been one of the largest users of the credit
guarantee programs throughout the past decade, but South Korea had reduced
its program imports in the 1990's, and other major importers of the early
1990's such as Algeria, Iraq and the former Soviet Union sharply reduced
their program purchases or no longer participate in the U.S. export credit
guarantee programs. 

USDA's export market promotion programs, the Market Access Program (MAP) and
the Foreign Market Development (Cooperator) Program, currently are funded at
about $120 million, a drop of over $100 million from their peak 1993 program
level. Both programs, partnerships between USDA and private sector
organizations, help develop markets for U.S. agricultural exports.
Historically, 80 percent of MAP funding has helped build global markets for
high-value products. 

USDA runs two export subsidy programs, the Export Enhancement Program (EEP)
and the Dairy Export Incentive Program (DEIP). The EEP, initiated in May
1985, awards cash payments on a bid basis to exporters, enabling them to sell
certain commodities to specified countries at competitive prices. From 1986
through June of 1995, the EEP was associated with over half of U.S. wheat
exports and, to a lesser extent, barley, wheat flour, and other commodity
exports. Since July 1995, EEP has assisted only a few sales of barley and
frozen poultry. The DEIP, the most active export subsidy program today,
awarded $110 million in export bonuses (direct export subsidies) to U.S.
exporters in 1998 for sales of selected dairy products: butter, butter oil,
cheese, and milk powder. 

The Uruguay Round Agreement on Agriculture (URAA), completed in 1994, imposed
meaningful disciplines on agricultural export subsidies for the first time.
In the 1996 Farm Act, Congress further reduced funding for the EEP, but
supported funding for the DEIP at levels allowed under the URAA for U.S.
dairy export subsidies. Reduced U.S. export subsidy spending from 1996
through 1999 also reflects minimal program activity following high world
grain prices in 1996 and 1997.

The U.S. provides food assistance to needy populations overseas through
Public Law 480 (Food for Peace) Titles I, II and III and through section
416(b) of the Agricultural Act of 1949, as amended, and the Food for Progress
Program. Title I of P.L. 480 finances sales of commodities under long-term
credit arrangements (up to 30 years) to developing countries with
insufficient foreign exchange. Donations for emergency food relief and
nonemergency humanitarian assistance are provided under Title II to
international organizations such as the UN's World Food Program and to
recipient governments. Title III grants food assistance to support
development programs in least developed countries. Section 416(b) provides
for donations of CCC-owned surplus commodities to developing countries, and
Food for Progress authorizes the donation or sale of food aid commodities to
assist developing countries that are implementing market-oriented policy
reform. 

Funding for the chief U.S. food assistance programs under Public Law 480
declined in the mid-1990's due to budget considerations, but allocations
turned up slightly in 1998 to $1.14 billion. The President announced a
separate food aid initiative for wheat in July 1998 as global food aid needs
rose and supplies of U.S. wheat and other commodities mounted. Under this
initiative, 5 million metric tons of wheat and wheat products will be made
available for donation overseas. The wheat and wheat products are being
purchased by the CCC under its surplus removal authority and donated under
section 416(b). 

As of January 26, 1999, 4.8 million tons of wheat had been allocated under
section 416(b) authority. Of the total, 3.33 million tons of wheat and wheat
products will be made available to 19 countries in government-to-government
donations. One million tons of wheat and wheat products will go to the UN's
World Food Program, and 426,741 tons have been made available to private
voluntary organizations for projects in the New Independent States (NIS) and
in Bosnia, Central American and Caribbean countries, Indonesia, and Kenya.

About 1.5 million metric tons of wheat and wheat products from the
President's July 1998 initiative are being provided to Russia as part of a
larger food assistance package. The food assistance package for the Russian
Federation, announced on November 6, 1998, includes assistance that will be
provided through Title I concessional financing and Food for Progress grant
agreements. Commodity allocations for Russia under P.L. 480 Title I long-term
credit and Food for Progress include: beef, corn, lentils, nonfat dry milk,
planting seeds, pork, poultry, rice, salmon, soybeans, soybean meal,
vegetable oil, and wheat. In addition, nonfat dry milk will be donated from
CCC inventories under section 416(b), and wheat and wheat flour will be
donated under the President's Food Aid Initiative.

Other agricultural exporters also donated food to Russia, Indonesia, and
other needy countries in 1998 and 1999. The European Union (EU) and Russia
signed an agreement for a $500-million food aid package for Russia on January
20, 1999. In October 1998, Canada announced it would provide $1.8 million in
humanitarian assistance to Russia.

The UN Food and Agriculture Organization (FAO) estimates that food aid
shipments of grain from all donors will increase sharply in the 1998/99
international grain marketing year (July-June).FAO projects that grain aid
shipments to Asian countries will nearly double from 1997/98 due to increased
grain shipments to Indonesia, and estimates grain aid shipments of 1.4
million tons to Russia and other NIS, a sevenfold increase from 1997/98.
Grain shipments to needy populations in Africa will remain the same as in
1997/98, while shipments to Latin American and Caribbean countries will
double to an estimated 600,000 tons following Hurricane Mitch.

Funding for U.S. international food assistance and export credit guarantee
programs will continue at higher levels in 1999 to address ongoing financial
problems in Asia and Russia, but U.S. funding for food assistance likely will
drop back in 2000, and U.S. credit guarantee approvals are projected down
slightly in 2000. Government funding for cost-share programs to promote U.S.
products abroad is projected to be stable, while funding for export subsidy
programs will continue below URAA export subsidy commitments. 

The U.S. and other exporting nations will likely review export subsidies,
food assistance, and export credit guarantees as they prepare for the next
round of trade talks for the World Trade Organization. For example, the
Cairns Group (e.g., Argentina and Australia) and the U.S. advocate
elimination of direct export subsidies, which currently are used primarily by
the EU.

Karen Ackerman (202) 694-5264 ackerman@econ.ag.gov  

BOX TRADE POLICY

With rising U.S. food aid shipments in 1999, total U.S. export program
shipments could amount to more than 40 percent of U.S. wheat exports in
fiscal 1999. Although export programs facilitated over 70 percent of U.S.
wheat exports from 1986 through 1995, the share had dropped to 25 percent in
the last 3 years. For more information on U.S. export programs for wheat, see
the special article in the next Wheat Situation and Outlook Yearbook. The
report summary will be released on March 26, 1999. The summary and full
report will be available at http://usda. mannlib. cornell.edu/reports/erssor/
field/whs-bby/


COMMODITY SPOTLIGHT

Coffee Exporters Counting on Improved Earnings in 1999/2000

Brazil and other coffee-exporting countries are expecting a smaller 1999/2000
Brazilian crop to draw down world supplies and reverse the 1998/99 downturn
in prices and foreign exchange earnings. The value of world coffee exports in
1998/99 is heading down to $11 billion, off 10 percent from 1997/98, after
rising to $14 billion in 1996/97 from $6 billion in 1992/93. While export
volume is expected to increase in 1998/99, sharply lower prices will reduce
the value (AO August 1998).

Producers in Central America and Africa, where coffee exports are critical to
national economies, have been hard hit by the drop in revenue. The loss in
export revenue is particularly threatening when the global economy is on
shaky footing, and producers are seeking improvements in coffee productivity,
national infrastructure, and world-wide consumption. 

The world coffee crop in 1998/99 (July-June) is estimated at 106.8 million
bags (60 kg or 132 pounds each), up 9 percent from 1997/98. Brazil accounts
for about one-third of world output. Prices for arabica coffee (milder in
taste than robusta and the type most widely consumed in the U.S.) have been
lower since last summer due to sharply higher 1998/99 production,
particularly in Brazil. Prices for robusta varieties, used primarily in
soluble coffee and known to consumers as instant, have strengthened because
severe drought cut production in Asia. During January-June 1999, world prices
for arabica coffees are expected to average 30 percent below a year earlier,
more than offsetting an expected 5-percent increase in robusta prices. 

These lower prices for green (unroasted) coffee are being passed along to
U.S. consumers. U.S. retail prices for roasted coffee fell 20 percent during
fall 1998, compared with a year earlier. As large Brazilian supplies continue
downward pressure on world prices, U.S. retail prices for roasted coffee are
expected to average around $3.50 a pound in January-June 1999, about 10-15
percent below a year earlier. Continued strong robusta prices, however, are
expected to keep U.S. instant prices for January-June 1999 at around $10.50
to $10.75 a pound, slightly above a year earlier.

Converting Coffee Beans
Into Foreign Exchange

Coffee is one of the world's most highly traded commodities; forecast world
exports of 80 million bags in 1998/99 represent 75 percent of world coffee
production. Exports represent a much smaller share of global production for
other commodities only 30 percent of sugar, 20 percent of wheat and oilseeds,
10 percent of coarse grains, and 5 percent of rice production is exported.
Coffee production is regionally concentrated while demand is worldwide, and
in the largest consuming markets the U.S., Germany, France, and Japan, which
together consume half of world exports coffee production is negligible.
Coffee prices, which average $3,000 a ton, put it near the top in terms of
total export value, along with soybeans, corn, wine, and cheese.

Coffee consumption is increasing at roughly the rate of population growth
worldwide. Emerging markets in Eastern Europe and Russia accounted for much
of the recent growth in world coffee demand, however, as total consumption
has been flat in the major Northern Hemisphere markets. And while consumption
is fairly stable, production varies 5-10 percent annually and market prices
fluctuate widely. Average world prices for green coffee slumped to 55 cents a
pound in 1991/92, rose to $1.50 in 1994/95, and will likely wind up near $1
in 1998/99.

Across all producers, coffee accounted for a steady 3 percent of export
earnings in the 1990's. Coffee accounts for 5 percent of Brazil's export
earnings, but for Colombia the share is 20 percent. Coffee also contributes
20-30 percent of total export earnings for the Central American countries of
Guatemala, Honduras, Nicaragua, El Salvador, and Costa Rica. African and
South American coffee producing countries overall earn 5 percent of their
export revenue from coffee. Coffee is less important to Asia overall, but
Vietnam's exports have contributed a growing share of its export earnings,
rising from 2 percent to nearly 15 percent in the last 6 years. 

Large coffee supplies and loss in coffee export revenue in 1998/99 are
testing the resolve of the Association of Coffee Producing Countries (ACPC)
to maintain export earnings by managing world supplies. The ACPC, formed in
1993, comprises 13 countries and accounts for 75 percent of world coffee
exports. ACPC members attempt to mitigate large swings in world coffee prices
by agreeing to limit exports, but the organization has no mechanism to
enforce the limits. 

The strategy of holding back supplies to raise prices is generally beneficial
to producers in a market with fairly inelastic demand, where a curtailment of
quantity sold brings a proportionately greater increase in price, which
pushes up total revenue. Nevertheless, such cartel-like activity is difficult
to maintain, since members may be tempted to increase sales to take advantage
of the higher prices, thereby undermining the strategy.

Brazil's export limit for 1998/99 was initially set at 15 million bags, the
same as a year earlier. The Brazilian government has offered loans with
favorable terms to encourage producers to hold stocks, and prospects for a
lower 1999/2000 crop and higher prices are also encouraging growers to
refrain from rushing coffee to the market. But even under these
circumstances, the mid-January currency devaluation and ensuing financial
difficulties are expected to push exports to more than 19 million bags.

Coffee yields vary widely, depending on climate, growing conditions, coffee
type, and management skills. On average, an acre yields about 4 bags of
coffee, although up to 8-10 bags are attained in some Central American
countries. Producers can increase productivity by planting trees with
increased cold-hardiness and drought resistance at higher per-acre densities,
by irrigating and fertilizing with drip tubes, and by harvesting and
processing higher quality, uniformly ripened beans. 

An average 4-bag yield earns $400 to $800 an acre, while specialty coffees
from Central America earn $1,500 to $3,000 an acre. Coffee grown in Jamaica's
famed Blue Mountain region earns up to seven times the world average. 

Coffee losses to the vagaries of weather (freezes, droughts, hurricanes) can
be devastating to economies dependent on coffee exports. In 1998, Hurricane
Georges and Tropical Storm Mitch caused widespread destruction in Central
America. Preliminary estimates of losses from these two storms of 750,000-1
million bags equate to around $100 million in value. Coffee was lost directly
to rains and high winds, as well as indirectly with the destruction of roads
and bridges necessary for access and transportation. The coffee economy will
not fully recover until roads in Honduras and Nicaragua are rebuilt, which
will take several years.

The recent earthquake in Colombia apparently did not seriously affect the
coffee crop, but some drying sheds were damaged. The industry reportedly
avoided serious damage because processing facilities are dispersed throughout
the country, so not all were affected.

Initiatives by the governments of a number of coffee-exporting countries
reflect the importance of coffee to their economies. In Colombia,
improvements to the "coffee highway" connecting primary producing areas have
been proposed, although opposition to erecting toll booths to pay for the
project has been encountered. In Kenya and Venezuela, governments have
announced intentions to encourage coffee plantings following a dropoff in oil
export revenues. In Brazil, government loans are supporting harvest wages and
good orchard maintenance for growers willing to postpone sales until market
prices pick up again. Brazil's loan program shows the government's resolve to
support the coffee economy, despite pressure to cut government spending.

For all countries, financing these programs is more difficult when export
revenues are dropping, since funding is linked to the very revenues the
programs are supposed to help generate. Also, such programs generally
increase world supplies of coffee, which leads to lower prices.

Coffee Prices More Volatile?

Coffee prices are among the most volatile in world commodity trading,
historically more volatile than prices for crude oil, gold, sugar, cocoa,
corn, and soybeans. However, coffee prices have declined less than prices for
other commodities in recent months in the face of devaluing currencies,
bountiful supplies, and weak demand. Coffee's major markets, located in
relatively strong economies of North America and Western Europe, have fared
better than markets in Asia and East Europe.

World coffee prices swing as producer- and importer-held stocks rise and
fall. Stock levels reflect fluctuations in production driven largely by crop
cycles and weather. During the early 1990's, a relatively calm period for the
coffee market, producer stocks ranged from 40 million to 50 million bags,
around 50 percent of total use. Since 1994/95, producer stocks have trended
down toward 25 percent of use, while importers' stocks have declined even
more sharply. As a result, price volatility has increased.

The fortunes of coffee exporters depend increasingly on supply management by
producers, because importers have become less willing to hold stocks to
buffer the price volatility. Traditionally, U.S., European, and Japanese
importers could react to increased coffee prices by using up stocks. In
recent years, however, U.S.and other importers and roasters have moved toward
just-in-time inventory to avoid carrying costs. When supplies tighten in one
region because of smaller crops, importers turn to other regions to satisfy
roaster demand. Because of low importer stocks, as world supplies tighten,
prices can be expected to increase proportionately more than supplies
decrease, and export earnings will increase, at the expense of coffee
consumers. The higher costs of green coffee are passed on through higher
prices for roasted beans. Conversely, a rebound in coffee production will
depress prices and lead to lower export earnings, unless stocks can be held,
at exporter expense. 

The U.S. is the largest single-country consumer of coffee, importing $3.6
billion of coffee last year. As world prices for green coffee soared to $2 a
pound in late 1994, U.S. imports dropped to 15 million bags, the lowest total
in the 1990's (AO May 1995). U.S. inventories, which had risen to over 10
million bags, were drawn down to 2 million bags, while monthly roastings
stayed near 1.5 million bags. By late 1998, green coffee stocks had decreased
to nearly 1 million bags as roasters counted on plentiful supplies readily
available from South America. In the past few months, U.S. stocks have
increased due to attractive prices and talk of a smaller upcoming world
supply.

U.S. retail coffee prices follow the prices for imported coffee fairly
closely. For example, during July-December 1998 world prices for green coffee
averaged $1 a pound, 30 cents below a year earlier, and retail prices for
roasted coffee averaged $3.62 cents a pound 84 cents below a year earlier.
Thus, both markets showed a similar percentage decrease.

Prospects for Brazil's Crop 
In 1999/2000

Forecasts by private analysts and Brazilian government officials indicate the
1999/2000 coffee crop will be much smaller than USDA's 1998/99 estimate of
35.6 million bags. These forecasts anticipate a drop of about 10 million
bags, or 30 percent. Brazilian coffee production can be projected within a
range of 5 million bags, taking into consideration the biennial bearing
pattern (expected year-to-year yield fluctuations caused by biological
competition between fruiting and branch growth) along with measures of
capacity, incentives to maintain yields, and occasional damage from freezes
and droughts. However, more precise forecasts are possible only with direct
observation of coffee flowering and fruit development.

In the 1990's, Brazil has produced an average of 26 million bags, ranging
from 17 million to 36 million. Brazil's off-year crops average 5 million bags
less than on-years. The drop can be greater in years of freeze, drought,
and/or excessive stress from an above-average on-year crop. 

Over the last 100 years, Brazil has experienced 24 moderate-to-severe
freezes, which occur mostly in July and August. Severe freezes cause tree
damage, as happened in 1994. Devastating freezes have occurred three times in
Brazil, most recently in July 1975, reducing the 1976/77 crop to 9.3 million
bags from an expected 22 million. A drought can be as damaging as a freeze;
for example, drought reduced 1986/87 production to 13 million bags, down 19
million from 1985/86. Drought or freeze during a year following a large crop
lowers production in Brazil 16 million bags, on average.

The size of Brazil's coffee crop is affected also by the degree of orchard
care, which includes fertilization, pest and disease management, weed
control, irrigation, pruning, and tree replacement. Coffee trees, like most
tropical and subtropical crops, are highly sensitive to changes in
environmental and agronomic conditions. Flowering is triggered by rainfall or
irrigation, and fruit development hinges on tree vigor. While orchard care is
difficult to measure, world coffee prices affect the willingness and ability
of growers to bear the costs. The low prices in 1998/99, however, will not
necessarily translate into poor orchard care because the Brazilian government
has made grower loans under favorable terms to offset the depressed market.

Factors expected to minimize the off-year production effect in 1999/2000
include full recovery of trees pruned back severely following the 1994
freeze, new plantings and improved cultural practices supported by government
assistance, and good weather for flowering and fruit development so far this
season. The first official USDA forecast of the 1999/2000 Brazilian crop will
be published June 11 on the USDA web site.

John Love (202) 720-5912, World Agricultural Outlook Board
jlove@oce.usda.gov

More USDA information on coffee production by country is available in the
Foreign Agricultural Service report Tropical Products: World Markets and
Trade. See www.fas.usda.gov/ htp/tropical/1998/98-12/dec98txt.htm


WORLD AGRICULTURE & TRADE

Brazil's Financial Crisis & the Potential Aftershocks

The intensifying financial crisis in Brazil, marked by sharp devaluation of
its currency in mid-January, has renewed concerns about the consequences of
the crisis for U.S. agriculture. Latin America and Asia together bought about
60 percent of U.S. agricultural exports last fiscal year, and Brazil's
currency devaluation is already having repercussions in other countries in
Latin America. 

The Makings of a Devaluation

In Brazil, the Cardoso government's initiation of the Real Plan on March 1,
1994 led to 4 very good years. The plan brought economic stability and was
effective in curbing hyperinflation, which had been a chronic problem. Under
the plan, the real (R$, Brazil's currency) was set against a predetermined
goal relative mainly to the U.S. dollar using a "mini-band" mechanism that
allowed only small daily changes in the value of the currency. As the U.S.
dollar strengthened in the mid-1990s, however, the real began to overvalue
relative to the target. The Russian financial crisis in August 1998
heightened fears among investors concerning returns in emerging markets. As
capital flight picked up, observers began speculating that the Brazilian
government would devalue its currency. From mid-August 1998 to the end of
October 1998, the real had lost 2 percent of its value against the U.S.
dollar through the mini-band mechanism. 

The final development leading to the real's sharp devaluation came on January
6, 1999, when a provincial governor, a former President of Brazil, announced
a 90-day moratorium on debt payments to the central government to protest
strict fiscal measures under an agreement with the International Monetary
Fund (IMF). The move raised investors' fears, spurring capital flight.
Reportedly, about $1 billion left the country in the few days immediately
following the debt moratorium. 

Recognizing that the real was under attack, Brazil's Central Bank decided on
de facto devaluation on January 13, 1999 by widening the band in which the
real could be traded each day while preventing a free fall in the currency.
The alternative would have been for the government to defend the real and
potentially deplete its foreign currency holdings. The Central Bank president
then resigned, leaving his successor to implement the devaluation. A new
currency band was established with a floor of R$1.20 and ceiling of R$1.32
per U.S. dollar. This implied possible daily currency movements against the
U.S. dollar of plus-or-minus 4.76 percent. 

The new band lasted for only 2 days, during which another $1 billion in
capital reportedly left Brazil. The next step was to allow the real to float
freely, and by February 3 it had tumbled by 32 percent and was trading at
R$1.79 per U.S. dollar. To increase market confidence and stop any panic on
stock and bond markets around the world, the decision was taken to completely
abandon the mini-band. As part of the package and to discourage investors
from withdrawing funds from the country, the Central Bank of Brazil announced
that short-term interest rates would increase from 29 to 39 percent. For now,
the strategy seems to have stopped the panic, as the pace of dollar flight
has declined, although reportedly a total of $7-8 billion had left the
country in January. However, risk remains of a spread of the crisis to other
countries. 

Minimal Short-term Impact 
On U.S. Ag Trade

In the short run, Brazil's devaluation will have relatively little impact on
U.S. agricultural trade with Brazil, though an expected reduction in U.S.
agricultural exports and increase in agricultural imports will likely
increase the U.S. agricultural trade deficit with Brazil ($684 million in
fiscal year 1998). In the longer run, the potential for effects on U.S.
agricultural trade is greater, particularly if Brazil is unable to regain
financial control and the continuing crisis forces other Latin American
countries to devalue currencies or change policies, such as raising import
tariffs, to stay competitive. 

U.S. exports to Brazil. Brazil is a small market for U.S. agricultural
exports about $0.5 billion in fiscal 1998. The U.S. exports soybeans,
consumer-ready food, cotton, and a small amount of wheat and coarse grains to
Brazil. A lower value real will make these products more expensive to
Brazilian buyers, and in the short term, an overall decline in Brazilian
demand for consumer-ready food products will pressure U.S. agricultural
exports. 

U.S. soybean exports will be affected less than consumer-ready food exports.
Even before the devaluation, the U.S. was not expected to export soybeans to
Brazil this year because of large supplies in Brazil. Most of Brazil's
domestic soybeans and soybean meal go to export markets. Thus, to more fully
utilize their oilseed crushing capacity, Brazilian crushers import soybeans
(500,000 tons in 1998, all from Paraguay; 1.5 million tons in 1997, mostly
from the U.S.). When the U.S.-Brazil price differential was favorable,
soybean imports were stimulated by Brazil's drawback program, which
essentially has allowed duty-free imports if the soybean products are
re-exported. Brazilian crushers have been able to finance purchases via
international loans with low interest rates, supporting continued soybean
imports.

The extent of the fall in Brazilian demand for other agricultural imports
will depend on internal policy adjustments taken to dampen the rise in food
prices. For example, to soften the effect of higher import prices, the
Brazilian millers association proposed elimination of the 13-percent import
duty on wheat flour and the 25-percent tax on bulk ocean freight from
countries outside MERCOSUR, the regional trading bloc that includes
Argentina, Brazil, Paraguay, and Uruguay.

U.S. imports from Brazil. The U.S. bought over $1.1 billion worth of
agricultural products from Brazil in fiscal 1998, mostly coffee, tobacco,
sugar, prepared meat, and orange juice and other fruit products. The U.S.
also imports forest products such as softwood. 

The lower value of the real will make Brazilian goods more price-competitive
in the U.S. market. U.S. consumers will benefit from the lower prices, while
producers who compete with Brazilian importers will be hurt. In the short
run, increases in the volume of imported food and other agricultural goods
from Brazil will be limited by available supply. For example, any near-term
increase in Brazil's exports of frozen concentrated orange juice (FCOJ),
coffee, and tobacco would have to come at the expense of domestic sales.

While the effects on U.S. agricultural trade are expected to be small in the
near-term, Brazil could become a stronger competitor in markets for poultry
meat, FCOJ, tobacco, soybeans and other agricultural products if the real
remains at its lower value over the long term and Brazilian producers respond
by increasing production (although the lower real will raise the cost of
imported inputs). Additionally, policy responses and reforms under the IMF
package (e.g., tax code reform, budget deficit reduction) could improve
efficiency and potentially lower production costs in the long run. 

Other Latin American 
Countries Under Pressure

The international financial crisis beginning in Asia in 1997 generated
speculative pressures in Latin America and slowed growth rates of many Latin
American countries. Brazil's crisis could further affect other Latin American
countries through loss of investor confidence and shocks to intra-regional
trade. Because of Latin America's dependence on foreign capital to finance
current account deficits, the region is vulnerable to sudden withdrawals of
foreign capital. 

In 1997, Latin America had a current account deficit (the difference between
imported and exported goods and services, plus net income and transfers) of
$60 billion, with Brazil alone accounting for more than $30 billion, or
nearly 4 percent of the country's gross domestic product (GDP). In Chile, the
current account deficit reached over 5 percent of GDP, followed by 4.3
percent for Argentina and over 2 percent for Mexico. The deficits have
increased since 1997. World financial markets and institutions become
concerned when current account deficits approach 5 percent of GDP.

A rise in the current account deficit puts pressure on the value of a
country's currency. Most currencies in Latin American countries have lost
value against the U.S. dollar since 1997: Chile's peso over 13 percent,
Colombia's peso 22 percent, Ecuador's sucre nearly 43 percent, Mexico's peso
30 percent, Peru's sol 14 percent, and Venezuela's bolivar almost 18 percent.
Argentina pegged its peso to the U.S. dollar, preventing any devaluation.

Lack of confidence among foreign investors led to a massive drain on foreign
reserves in 1998 for Brazil, the economy that accounts for 40 percent of
Latin America's GDP. At the end of 1998, foreign exchange reserves declined
to $40 billion, down from nearly $70 billion at the end of August 1998. To
head off outflows of capital, other countries followed Brazil in raising
short-term interest rates in 1998: Argentina to 10 percent, Chile to 14
percent, Colombia to 33 percent, Mexico to 31 percent, and Venezuela to more
than 44 percent. 

The principal risk from tightening monetary policy is a slowdown in economic
growth that will further weaken domestic and import demand. As interest rates
rise, the cost of capital also increases, reducing use of credit for working
capital. High interest rates at this time, however, are important to curb the
flight of capital and provide these countries time to deal with immediate
problems.

Latin America has a significant level of intra-regional trade, which
magnifies the potential for the Brazilian crisis to spread. Nearly 40 percent
of Brazil's total imports and 60 percent of agricultural imports came from
other South American countries in 1997. In addition, total exports are a
significant portion of GDP for these countries, ranging from nearly 9 percent
for Argentina to 28 percent for Mexico. However, the U.S. is a much more
important trade partner for Mexico than for Brazil.

With relatively higher import prices and lower purchasing power, Brazilian
import demand will fall. A decline in Brazil's import demand could have a
ripple effect on its regional trading partners in Latin America, particularly
Argentina. Because Argentina pegs its peso to the U.S. dollar, the lower
value of the real will make Argentine exports to Brazil more expensive. With
about 30 percent of its products exported to Brazil, Argentina could be more
vulnerable to a trade-linked spread of the crisis than other countries in the
region. Argentina, in particular, could look to other markets for wheat and
corn exports, intensifying competition with the U.S. To soften the blow of
Brazil's currency devaluation, Argentina requested that Brazil reduce its
low-cost financing measure for consumer goods exports to MERCOSUR members.
Recently, Brazil agreed to eliminate the measure.

Suchada Langley (202) 694-5227 and Chris Bolling (202) 694-5212
slangley@econ.ag.gov hbolling@econ.ag.gov


RISK MANAGEMENT

Farmers Sharpen Tools to Confront Business Risks

As in any industry, risk is a part of the business of agriculture. With farm
income currently under pressure from declining farm prices, USDA's Economic
Research Service is exploring the subject of risk management in agriculture.
This article, the first in a series, describes a variety of management
techniques farm operators use to survive swings in weather, markets, and the
economy. Other topics in the series will include USDA's farm risk initiatives
and an analysis of the effectiveness of different crop and revenue products.

Farmers face an ever-changing landscape of weather, prices, yields,
government policies, global competition, and other factors that affect their
financial returns and overall welfare. With the shift toward less government
intervention following passage of the 1996 Farm Act came recognition of the
need for a more sophisticated understanding of farm risk and risk management.
Risk management strategies can help mitigate the effects of swings in supply,
demand, and prices, so that farm business returns can be closer to
expectations.

Risk management is, in general, finding the combination of activities most
preferred by an individual farmer to achieve the desired level of return and
an acceptable level of risk. Risk management strategies reduce risk within
the farming operation (e.g., diversification or vertical integration),
transfer a share of risk outside the farm (e.g., production contracting or
hedging), or build the farm's capacity to bear risk (e.g., maintaining cash
reserves or evening out cash flow). Using risk management does not
necessarily avoid risk altogether, but instead balances risk and return
consistent with a farm operator's capacity to withstand a wide range of
outcomes.

Although farms vary widely with respect to enterprise mix, financial
situation, and other business and household characteristics, many sources of
risk are common to all farmers, ranging from price and yield risk to personal
injury or poor health. But even when facing the same risks, farms vary in
their ability to weather shocks. For example, in an area where drought has
lowered yields, falling prices resulting from large worldwide production
could have devastating consequences for local farm incomes. With such a
downturn, some bankruptcies are likely to occur, and producers who are highly
leveraged and have small financial reserves or lack off-farm income would be
most vulnerable.

What do farmers themselves say about the risks they face? USDA's 1996
Agricultural Resource Management Study (ARMS), conducted in the spring of
1997 (about a year after passage of the 1996 Farm Act), asked producers how
concerned they were that certain types of risk could affect the viability of
their farms. Three risk factors of greatest concern to farm operators were
uncertainty regarding commodity prices, declines in crop yields or livestock
production, and changes in government law and regulation. Issues such as
price and yield have historically been a focus of government farm programs.
But new policy areas, such as water pollution control and waste management,
may well affect future legislation and regulation of agriculture and pose new
challenges to operators.

ARMS data show that producers specializing in wheat, corn, soybeans, tobacco,
and cotton were generally more concerned about the threat of low yield and/or
low price than any other risk. Reduced government intervention in markets for
program crops (wheat, corn, cotton, and other selected field crops) under the
1996 Farm Act may have heightened producers' uneasiness about price risk.

Producers of other field crops, nursery and greenhouse crops, and poultry
expressed greater concern about changes in laws and regulations than about
other risks. This perhaps reflects fears that changes in environmental and
other policies could require costly compliance by the agricultural sector.
The other field crop producers may be wary of changes in regulations
addressing soil conservation, land use, and tillage practices, while
livestock producers may be particularly concerned about regulations related
to waste management and the spread of disease.

Livestock producers also expressed concerns about their ability to adopt new
technology, perhaps because failure to invest in new production techniques
could put them at a cost disadvantage to other producers. For farm operators
involved in contracts, expenditures necessary to satisfy production
requirements imposed by contractors, such as modification of existing
livestock buildings, may add to risk.

Price & Yield Swings 
Pose Primary Risk

The possibility of lower-than-expected yield is one of the risks identified
in the ARMS as a major concern to farmers. Yield variability for a given crop
varies by geographic area and depends on factors such as soil type and
quality, climate, and use of irrigation. Yield variability for corn, for
example, tends to be lowest in the central Corn Belt, where soils are deep
and rainfall is dependable, as well as in areas that are irrigated. In
Nebraska, where much of the corn production is irrigated, yield variability
is quite low. Yield variability is also low in Iowa, Illinois, and other Corn
Belt states, where climate and soils provide a nearly ideal growing
environment for corn production.

In areas less well suited to corn production, yield variability is generally
higher, and producers must deal with the prospect of yields that can deviate
significantly from planting-time expectations. Risks associated with high
yield variability and the resulting income variability can be mitigated by
programs such as Federal crop insurance, as well as by diversification and
other tools to help spread farm-level risk.

Like yield variability, price variability differs among commodities. In
1987-96, crop prices showed relatively more variability than livestock
prices, largely because crop supplies are affected by swings in crop yields
while livestock supplies have been more stable, although recent variability
in the hog market illustrates some exceptions exist. Crops that exhibited the
highest price variability (deviations above or below the mean exceeding 20
percent) include dry edible beans, pears, lettuce, apples, rice, grapefruit,
and grain sorghum. The variability of beef cattle, milk, and turkey prices
was less than 10 percent, perhaps reflecting lower production risk and, in
the case of milk, the existence of a Federal dairy program.

Price variability can change across time depending on year-to-year
differences in crop prospects, changes in government program provisions, and
shifts in world supply and demand conditions. For example, corn price
variability was quite high during the 1920's and 1930's, due largely to the
collapse of grain prices after World War I and very low yields in 1934 and
1936. Corn prices stabilized during the 1950's and 1960's, a period of high
government support, stable yields, and consistent demand. Sizable purchases
of corn by Russia early in the 1970's affected variability during that
decade, while low U.S. yields in 1983 and 1988 contributed to increased corn
price variability in the 1980's. Variability returned to near long-term
average levels in 1990-96.

"Natural Hedge" 
May Stabilize Revenues

Price and yield risks faced by a producer in a given situation, as well as
the strength of the relationship between price and yield (the price-yield
correlation) can influence the effectiveness of different risk management
strategies. The stronger the negative correlation (i.e., yield and price
moving in opposite directions), the better the "offsetting" relationship (or
"natural hedge") works to stabilize revenues.

The price-yield correlation for a commodity tends to be more strongly
negative for farms in major producing areas, because yields there are more
positively correlated with national yields, and crop yields among farms
within a region tend to move together. For example, in a major corn-producing
area such as the Corn Belt, corn yields tend to be more positively correlated
with a national corn yield, and therefore more negatively correlated with the
national corn price. For wheat, where production is more dispersed and U.S.
production is a smaller share of the world's crop, the natural hedge is
weaker, making incomes more variable for most wheat growers.

When other factors are held constant, the magnitude of a producer's natural
hedge has important implications for the effectiveness of various
risk-reducing tools. A weaker natural hedge (where low prices more often
accompany low yields), for example, implies that forward contracting or
hedging in futures is more effective in reducing income risk than when a
strong natural hedge exists. In this situation, locking in a sales price for
part of the expected crop works to establish one component of the farm's
revenue, reducing the likelihood of simultaneously low price and low yield.
As a result, hedging can sometimes be an effective risk management strategy
for farms outside major producing regions.

Deciding how much to hedge is more complicated than just assessing
price-yield correlation. Income risk is also a function of price variability
and yield variability. Hedging effectiveness declines as yield variability
increases, and corn yields are typically more variable outside the Corn Belt.
Since yield variability tends to outweigh the impact of price-yield
correlation, hedging is generally not as effective in less consistent
production areas as in the Corn Belt. 

No Single Approach 
Suits All Farms

While factors such as yield variability, price variability, and price-yield
correlation can be used to gauge the likely effectiveness of various risk
management strategies, producers' attitudes toward risk are also determinants
in selecting strategies. Some farmers are less risk averse than others, and,
for example, might feel more comfortable in a highly leveraged situation
(e.g., carrying a large mortgage) than would others. Similarly, producers may
differ in their preferences for risk management tools, some perhaps feeling
more at home with forward contracting with a local elevator while others may
turn to hedging to manage their risks.

Because farmers face different degrees of variability and differ in their
attitudes toward risk, there can be no single approach to suit all farms.
Overall, farmers appear to be relying increasingly on forward contracting and
other risk management tools to reduce their farm-level risks, due in part to
the recent trend toward reduced government intervention in farming. Even so,
the 1996 ARMS indicates that keeping cash (or liquid assets) on hand for
handling emergencies and for taking advantage of good business opportunities
was the number-one strategy used by farms of every size, every commodity
speciality, and in every region.

Farm size apparently plays a role in choice of risk management strategy. The
ARMS found that operators with annual gross sales of $250,000 or more were
more likely than smaller operators to use hedging, forward contracting, and
virtually all other types of risk management strategies. In contrast,
operators with sales under $50,000 were less likely to use forward
contracting or hedging, and fewer reported using enterprise diversification
to reduce risk. 

The ARMS data also indicated that producers in the Corn Belt and Northern
Plains were somewhat more likely to use risk management strategies than those
in the Southern Plains, Northeast, and Appalachia. About 40 percent of
producers in the Corn Belt and Northern Plains regions used forward
contracting in 1996 and about 25 percent used hedging in futures or options.

Farm legislation also affects adoption of risk management strategies. About
one-third of producers nationwide reported receiving direct government
commodity payments in 1996. Of these, between 5 and 8 percent (1-3 percent of
all U.S. farmers) indicated they had added or increased use of at least one
risk management strategy or tool (forward contracting, hedging or
futures/options, insurance, or other strategy) in 1996 in response to
provisions of the 1996 Farm Act.

A period of financial stress may induce an operator to shift risk management
strategies. The 1996 ARMS questioned farmers about production, marketing, and
financial activities they might undertake if faced with financial difficulty.
Producers with sales of $50,000 or more indicated they would adjust costs,
improve marketing skills, restructure debt, and spend more time on management
decisions. 

Producers with sales under $50,000 (who generally receive a substantial share
of household income from off-farm sources) also responded that they would
adjust costs when faced with financial difficulties. But small-farm operators
would be more likely than larger operators to sell farm assets or scale back
their operations. Further, small-scale producers were much less likely to
spend more time on management or on improving their marketing skills. 

When individual efforts to deal with financial stress fail and large numbers
of farms face significant financial loss, the Federal government has often
stepped in with assistance to agriculture in the form of direct payments,
loans, and other types of aid. Most recently, the 1999 Agricultural
Appropriations Act included $2.375 billion for emergency financial assistance
to farmers who suffered losses due to natural disasters. Under this
legislation, farmers are eligible for payments either for losses to their
1998 crop, or for losses in any 3 or more crop years between 1994-98. Farmers
with crop insurance receive slightly higher payments than those without, and
those receiving emergency benefits must agree to buy crop insurance (if
available) in 1999 and 2000. In addition, the legislation provides an
incentive for purchasing higher levels of crop insurance coverage in 1999 by
earmarking an estimated $400 million to subsidize farmers' insurance
premiums.

Such assistance is undoubtedly critical for producers who are facing
financial difficulty. However, it raises questions as to how the potential
for direct payments in times of disaster affects producers' decisionmaking
with regard to tools and strategies that can help them manage risk and
perhaps avoid financial stress. Linking receipt of government assistance to
adoption of a risk management strategy, namely the purchase of crop
insurance, encourages producers to gain experience with a program that can
provide protection in crisis years in the future. Understanding the risks
faced in farming and the use of different tools by producers can lead to new
strategies and educational approaches to cut risk and can perhaps help reduce
the incidence of farm financial stress.

Joy Harwood (202) 694-5310, Richard Heifner (202) 694-5297, Janet Perry (202)
694-5583, Agapi Somwaru (202) 694-5295, and Keith Coble 
jharwood@econ.ag.gov rheifner@econ.ag.gov jperry@econ.ag.gov


BOX
A Selection of Strategies for Mitigating Risk

Farmers have many options in managing the types of risks they face. For
example, producers may 1) plant short-season crop varieties that mature
earlier in the season to beat the threat of an early frost; 2) install
supplemental irrigation in an area where rainfall is inadequate or
unreliable; or 3) use custom machine services or contract/hired labor to
plant and harvest quickly during peak periods.

Most producers use a combination of strategies and tools, because they
address different elements of risk or the same risk in a different way.
Following are some of the more widely used strategies.

Enterprise diversification. Assumes returns from various enterprises do not
move up and down in lockstep, so low returns from some activities would
likely be offset by higher returns from other activities. Diversification can
also even out cash flow. According to USDA data, cotton farmers are among the
most diversified in the U.S., while poultry farms, with poultry and poultry
products accounting for 96 percent of the value, on average, of their
production, are the least diversified.

Vertical integration. Generally decreases risk associated with the quantity
and quality of inputs (or outputs) because the vertically integrated firm
retains ownership control of a commodity across two or more levels of
activity. Vertical coordination also diversifies profit sources across two or
more production processes. In farming, vertical integration is most common
for turkeys, eggs, and certain specialty crops. 

Production contracts. Guarantee market access, improve efficiency, ensure
access to capital, and lower startup costs and income risk. Production
contracts usually detail inputs to be supplied by the contractor, the quality
and quantity of the commodity to be delivered, and compensation to be paid to
the grower. The contractor typically provides and retains ownership of the
commodity (usually livestock) and has considerable control over the
production process. On the downside, production contracting can limit the
entrepreneurial capacity of growers, and contracts can be terminated on short
notice. 

Marketing contracts. Set a price (or pricing mechanism), quality
requirements, and delivery date for a commodity before harvest or before the
commodity is ready to be marketed. The grower generally retains ownership of
the commodity until delivery and makes management decisions. Farmers
generally are advised to forward price less than 100 percent of their
expected crop until yields are well assured to avoid a shortfall that would
have to be made up by purchases in the open market.

Futures contracts. Shift risk from a party that desires less risk (the
hedger) to one who is willing to accept risk in exchange for an expected
profit (the speculator). Farmers who hedge must pay commissions and forego
interest or higher earning potential on money placed in margin deposits.
Generally, the effectiveness of hedging in reducing risk diminishes as yield
variability increases and the relationship (correlation) between prices and
yields becomes more negative. Hedging can reduce, but never completely
eliminate, income risk. 

Futures options contracts. Give the holder the right, but not the obligation,
to take a futures position at a specified price before a specified date. The
value of an option reflects the expected return from exercising this right
before it expires and disposing of the futures position obtained. Options
provide protection against adverse price movements, while allowing the option
holder to gain from favorable movements in the cash price. In this sense,
options provide protection against unfavorable events similar to that
provided by insurance policies. To gain this protection, a hedger in an
options contract must pay a premium, as one would pay for insurance. 

Liquidity. Involves the farmer's ability to generate cash quickly and
efficiently in order to meet financial obligations. Some of the methods that
farmers use to manage liquidity, and hence financial risk, include: managing
the pace of investments (which may involve postponing machinery purchases),
selling assets (particularly in crisis situations), and holding liquid credit
reserves (such as access to additional capital from lenders through an open
line of credit).

Crop yield insurance. Provides payments to crop producers when realized yield
falls below the producer's insured yield level. Coverage may be through
private hail insurance or federally subsidized multi-peril crop insurance.
Risk protection is greatest when crop insurance (yield risk protection) is
combined with forward pricing or hedging (price risk protection).

Crop revenue insurance. Pays indemnities to farmers based on revenue
shortfalls instead of yield or price shortfalls. As of 1998, three revenue
insurance programs (Crop Revenue Coverage, Income Protection, and Revenue
Assurance) were offered to producers in selected locations. All three are
subsidized and reinsured by USDA's Risk Management Agency.

Household off-farm employment. May provide a stream of income to the farm
operator household that is more reliable and steady than returns from
farming. In essence, household members working off the farm is a form of
diversification. In 1996, according to USDA's ARMS data, 82 percent of all
farm households reported off-farm income exceeding farm income. In every
sales class (including very large farms), at least 28 percent of the
associated farm households had off-farm income greater than farm income.


SPECIAL ARTICLE

Value-Enhanced Crops: Biotechnology's Next Stage

Biotechnology's next quest, to provide field crops with value-enhanced
qualities for end-users (output traits) is underway. Biotechnology's first
stage featured crops with improved agronomic qualities (input traits) valued
by farmers, such as resistance to pests. The industry now visualizes a system
in which farmers grow crops designed for the specific needs of end-users in
food manufacturing, the livestock sector, and even the pharmaceutical
industry. Breaking with agriculture's traditional supply-side orientation may
not be easy, however. Whether biotechnology's second stage is a wave or a
modest ripple will hinge on several economic and technical factors. (See
small box at end of article.)

U.S. farmers already grow, on a relatively small scale, a number of
high-value crops, such as food-grade soybeans and white corn, developed
through conventional breeding. These commodities are typically classified as
specialty crops that have fairly "thin" markets that can easily be swamped if
production surges. 

Genetic engineering promises to facilitate development of crops with more
improvements in end-use characteristics than conventional breeding has been
able to accomplish. In some cases, these traits will appeal to wider segments
of the market than conventional specialty crops have done, although in other
cases their markets will be narrower in scope. To succeed, however, the
products first must be able to deliver, not just improved quality traits, but
also good agronomic performance. Second, and no less important, the crops
must prove their overall value to the producer and user. In many cases,
pricing and marketing arrangements will not be business as usual and may
require several changes.

Farmers quickly saw the value of the first wave of biotech crops with
built-in protection against insect pests or resistance to selected
herbicides. Acreage of biotech-developed soybean, corn, and cotton has soared
since their commercial introduction in 1996 (AO August 1998). Adoption of the
next stage of biotech crops may proceed more slowly, as the market confronts
issues of how to determine price, share the value, and adjust marketing and
handling to accommodate specialized end-use characteristics. And competition
from existing alternative products will not evaporate. Pitfalls that have
accompanied the first generation of biotech crops, such as the trade dispute
with Europe over approval and labeling of genetically modified crops, will
also affect the next stage of products.

Some industry analysts believe the development of more end-use quality traits
will largely "decommodify" the existing marketing system for field crops. In
other words, there would be a movement away from bulk handling and blending
of undifferentiated crops under very broad grades and standards categories
and toward a system that can meet more specialized needs of buyers, even to
the point of preserving the identity of a crop from the farm to the user. The
added costs of such specialized handling will have to be justified by the
value of the new crops to buyers.

What Are Some of the New Crops?

Many promising new value-enhanced or output traits are starting to appear
among the major field crops, most (although not all) created through
biotechnology. Some are already available; others are still a few years away
from the market. Following are highlights of some leading developments.

High oleic soybeans, with around 50,000 acres planted in 1998,  yield oil
that contains less saturated fat than conventional soybean oil. Because it is
more stable, the oil does not require hydrogenation for use in frying or
spraying, which reduces processing costs. Moreover, hydrogenation creates
trans fatty acids, which studies have associated with adverse serum
cholesterol levels. In addition to its desirable health qualities, high-oleic
soybean oil has a longer useful life, which appeals to the fast-food
industry. High-oleic soybeans may also serve as a platform for stacking other
traits, i.e., including more than one specialized biotech trait in a single
variety.

Soybeans with improved animal nutrition that bolster the protein and amino
acid content of soybean meal are near commercial introduction. Soybean meal
is the most important protein source for U.S. livestock and poultry.
Increased levels of the amino acids lysine and methionine in particular have
potential to reduce the proportion of higher cost protein meals required in
the ration.

Improved food-quality soybeans are currently in production. While most of the
focus for soybeans is on improving oil and meal characteristics, since these
uses represent the bulk of the market, some new varieties have improved food
qualities. For example, high-sucrose soybeans that have a better taste (less
"beany") and greater digestibility were introduced recently, and around
25,000 acres were planted in 1998. While soy protein has played a minor role
in the U.S. food supply, improvements could help expand domestic consumption,
as well as offer good export potential. 

New varieties of canola, bred for superior oil qualities, are already on the
market, although they are less important in the U.S. than in Canada, where
canola is a major crop. High-lauric canola has been grown in the U.S. since
1995, and plantings reached 80,000 acres in 1998. It produces an oil composed
of about 40 percent lauric acid. This fatty acid is a key ingredient in
soaps, detergents, lubricants, and cosmetics, and the lauric acid in the oil
from this canola variety replaces lauric acid from coconut or palm kernel
oils produced in Southeast Asia. High-stearate canola is expected to be
introduced within a few years. The oil from this variety, high in stearic
acid, solidifies at room temperature without hydrogenation and would be used
for baking, margarine, and confectionery foods that cannot use liquid oils.
It would be a healthier alternative to tallow, currently the major source of
stearic acid. 

Mid-oleic sunflower seed, a conventionally bred type, has a modified fatty
acid profile. It was grown on 100,000 acres in the U.S. in 1998, and
plantings are expected to expand sharply this spring. Mid-oleic sunflower
seed produces low-saturated-fat oils with 60-75 percent oleic acid, compared
with 16-20 percent from standard sunflower hybrids. The oil has potential to
replace cottonseed and partially hydrogenated soybean oils in frying and
salad oils. Because the mid-oleic has higher yields that are comparable to
standard hybrids, this type is expected largely to replace high-oleic
varieties that contain 77-89 percent oleic acid and that currently account
for 10-15 percent of U.S. sunflower acreage. The market for the high-oleic
variety has tended to be limited to higher value uses as a cocoa butter
substitute in cosmetics because its reduced yields have required high
premiums.

Value-enhanced corn will offer several improved nutritional traits for
livestock feeding. Since grain is fed primarily as a source of energy, many
of the new value-enhanced varieties aim to increase the content or
availability of energy. But some new varieties will also include more protein
and better amino acid balances, which would reduce the need to buy
supplemental feed ingredients. More variations on this theme are in the
works, and a few varieties are already on the market. 

High-oil corn, developed through conventional breeding, is the most important
corn variety now available with an enhanced nutritional profile. This variety
has been commercially available for about 6 years, and acreage has increased
significantly each year, reaching 900,000 acres in 1998. Although its oil
content varies, high-oil corn can contain as much as double the 3.5-4 percent
oil in traditional "commodity" corn. The higher oil content means more
energy, which improves feed efficiency; it also reduces the need to add fat
to some rations and delivers higher levels of essential amino acids like
lysine and methionine. In addition, the higher oil content reduces dust
levels and improves palatability. Although high-oil corn was not developed
through biotechnology, it will likely be used as a common platform to stack
new input and output biotech traits.

Low-phytate or low-phytic-acid corn, providing increased availability of
phosphorous, will be marketed within the next year. It has environmental
appeal because its use in feed means hogs and poultry will pass less
phosphorous in their waste, reducing pollution problems. And because of its
greater digestibility, it holds the added promise of cutting feed costs, by
allowing the animal to absorb more of corn's phosphorus content and
eliminating the need for phosphorus supplements.

Several existing, conventionally bred corn hybrids have improved traits for
food and industrial purposes. These include hard endosperm corn, desired by
dry millers for preparing food products, and corn with altered starch
content, such as waxy corn  used largely by the wet milling industry. Further
improvements in food and industrial use characteristics are expected through
biotechnology research. 

A substantial portion of cotton acreage is already planted to biotech
varieties with crop protection traits, but most end-use traits are probably
3-4 years away. Colored cotton, a trait that would reduce the need for
chemical dyes, is already available on a niche market basis. Another major
area of research is fiber quality improvement, such as polyester-type traits,
to make sturdier fabrics. Some researchers hope to develop wrinkle-resistant
cotton and even fire-retardant qualities. Improvements in cottonseed are also
envisioned that could make cottonseed oil more useful as an animal feed.

Wheat lags behind the other major crops; even first-stage input-trait biotech
varieties are not commercially available. The lag in part reflects technical
factors; it is more complex to breed wheat than corn, for example. The
primary reason, however, is economic. The wheat seed market is relatively
small; many farmers save seed instead of purchasing it (unlike corn seed,
virtually all of which is purchased), creating fewer incentives for the
private sector to invest in wheat research. But in recent years, investment
in wheat research has increased substantially, and use of reliable genetic
transformation methods portends payoffs in the next few years. Like corn or
soybeans, the first biotech wheat, which should be introduced soon, will
likely offer crop protection traits such as herbicide tolerance. 

Wheat quality traits will concentrate on major end uses such as bread making,
other baking, and noodle making. Current end-use trait research focuses on
modifying gluten and starch content, creating uniform kernel size, bolstering
mineral content, and numerous other traits that could improve wheat milling,
dough properties, and bread and noodle texture. The case of hard white wheat
(AO August 1998), a conventionally bred crop, may be instructive in switching
crop variety development more to an end-use focus.

Nutraceuticals, a category of biotech or conventionally bred crops designed
to produce medicines or food supplements within the plant, may be developed
using any number of crops, depending on the nature of the pharmaceutical or
nutritional supplement to be produced. Researchers claim nutraceuticals, also
called "functional foods," could conceivably provide immunity to a disease or
improve the health characteristics of traditional food e.g., canola oil with
a high beta-carotene content. 

Will Farmers Adopt These Crops?

Farmers quickly adopted the first-stage biotech crops that enhance crop
protection or lower input costs. The pace of adoption will likely be much
slower for many value-enhanced crops, despite their excellent prospects.
While both input and output traits involve higher seed costs (seed premiums
often incorporate a technology fee) and may require some agronomic changes,
the value-enhanced crops will require additional changes and costs to bring
the crop to market.

To be a successful supplier of value-enhanced crops, producers may need to
clean all harvesting equipment between uses on different output-trait crops,
provide separate storage bins, and make substantial changes in marketing
arrangements. These steps present few obstacles if higher product prices
generate sufficient returns. But until some new products are well
established, there may be a chicken-and-egg syndrome: buyers may be
discouraged by an erratic or insufficient supply while growers confront a
market that is too thin to support large enough premiums.

USDA-Illinois Market News recently began a value-added grain survey of
producers. While the survey primarily covers market opportunities for
conventionally bred specialty corn and soybeans, it illustrates the types of
issues that can arise with any specialty crops. For example, the survey
reported that heavy signup by producers for 1999 white corn contracts
squeezed premiums, and contracting opportunities were no longer available for
some value-enhanced grains. The survey reported additional premiums for some
high-oil corn were available from early contract signup bonuses and for
certain crop chemical usages, although premiums for high-oil corn also
weakened as more producers signed up.

Given the current low-price environment and the great amount of flexibility
in planting decisions, farmers are certainly receptive to new products that
offer potential for premium prices. However, there probably will be more
interest in contracting and in other means of reducing risks than has been
the norm in commodity markets. As demand for the new crops increases, new
marketing channels will likely develop. Farmer interest will increase if
improved technology can prevent the lower yields often associated with
current specialty crops. Finally, the ability to stack genes (include more
than one specialized biotech trait in a single variety) will likely mean that
desirable input traits will be offered along with output traits to meet the
needs of producers. 

Changes to Come in Marketing 
& Coordination

The advent of additional value-enhanced crops, both biotech and
conventionally bred, may bring higher costs to preserve and deliver this
value to specific end users. The most stringent handling system, identity
preservation, requires that a crop be completely isolated  from the grower's
field through harvest and on-farm storage, to the elevator and subsequent
shipment to the final destination; there can be no commingling with similar
crops. For some traits, controls over storage and assembly from farm to
processor may be less stringent if testing can verify the desired quality.
For these traits, segregation, rather than the more stringent identity
preservation, might be the more accurate term. Barley used for malting is
handled in this way; it is separated from barley going into feed, but
preservation of its identity is not required.

In any case, increased costs, such as for separate storage facilities at the
farm or elevator, may be incurred to market value-enhanced crops. For
complete identity preservation (organic crops provide an example), separate
handling could mean dedicated rail cars, trucks, or holds in barges, or at
least thorough cleaning of carriers before and after use. Use of intermodal
containers for transporting crops may be appropriate in some instances, but
this may increase costs even further. 

The marketing arena will experience a clash of the traditional,
volume-dominated system with the need to handle smaller quantities of
specialized product at higher unit costs. In many cases, farmers may bypass
sales through the country elevator and sell directly to the buyer. Some
analysts expect that more marginal elevators that are unable to compete on
volume with the bigger operations for commodity crops will improve their
prospects by dedicating themselves to the special handling of new crops.

Signs are emerging that the major agribusiness firms, including grain
merchandising companies and large cooperatives, are also preparing for these
marketing changes. The 1998 annual report of Archer Daniels Midland Co.
(ADM), for example, one of the largest grain firms in the world, extensively
discussed the growing potential for more trait-specific grains. The company
recognized that growing, handling, and transporting crops on an
identity-preserved basis will become an increasingly large part of the
domestic and export grain market. Cargill, another major agribusiness firm,
has started a program through its seed division to provide farmers with bins
for handling value-added production, to help producers gain entry into
markets where they can gain premiums for their crops.

When farmers grow crops for specialized end uses, success requires
coordination among technology providers, farmers, and end-users. More control
will be required throughout the growing and marketing process, from selecting
the seed to delivering the crop to the final customer, and the higher the
investment, the greater the incentive to establish rigid specifications. This
could mean a vertically integrated system owned largely by one firm.  

Although a greater focus on end-use traits will probably mean further
integration, such integration will not necessarily be accomplished through a
vertical system under the same ownership.  Even at this early stage, new
alliances, joint ventures, partnerships, and other arrangements are being
formed to take advantage of opportunities along the "value chain."
Contracting is expected to become more common as a means of mitigating
producers' risk and thus providing the farmer a greater incentive to grow a
quality trait crop (see box in previous article). Although contracting,
especially production contracting, has been quite limited for the major field
crops, it is widespread for many vegetables and specialty grains (AO
January/February 1999).  

Of all value-enhanced crops, some of the nutraceuticals are the most likely
to be grown in a system with tight controls from farm to end user because of
their very high value and the need for precision in their production. A few
other new crops may fit this pattern, but many may not require such tight
control. In these cases, where fewer controls are needed and thus costs for
specialized production and marketing are lower, less coordination will be
required and the process may remain closer to the current open market system.

Pricing Tied to Commodity Markets?

The prices of commodity crops are shaped mainly by supply and demand factors
in the market, with sporadic influences from government policies. For
value-enhanced crops, a central issue will be how to determine the price that
reflects the quality attributes that account for added value to the buyer.
Because existing grades and standards do not directly address most end-use
concerns, and because there will be a diversity of new end uses to value,
effective measurement technology will be critical to verify the presence of
the trait and quantify the amount. 

Currently, most specialty crops receive price premiums relative to a futures
reference price or a spot cash price at a specific location, and many of the
new output-trait crops may be priced similarly. The exact price discovery
mechanism for output-enhanced traits, however, is uncertain and will require
time to develop. The producer must cover costs of production and marketing,
and the buyer must achieve a reduction in input costs and/or increased
earnings before a market for an enhanced output trait can begin. 

The willingness of the buyer to pay participants in the supply chain will
depend on many factors, including price and market size for the final
product, competing sources of the trait and their prices, potential for cost
reduction to the processor, volume of the trait handled, and overall
competitiveness of the market. A link to a futures market provides a useful
means of price discovery; if value-added crops are successful enough, futures
exchanges might eventually be compelled to modify contract specifications.

An alternative approach would be a system of prices administered by the
buying firm, which could well be adopted in a tightly controlled system like
vertical integration or contract production. It would probably be more common
for very high-value traits and perhaps for quality crops without substitutes. 

The Case of High-Oil Corn:  
Early Evidence of Changes To Come 

Although high-oil corn is a very promising product, its experience may
illustrate many of the issues that other value-enhanced crops may also face.
High-oil corn acreage has increased significantly each year since its
introduction, but it has been dwarfed by acreage of pest-resistant Bt corn,
which was commercialized later. In 1998, U.S. plantings of Bt corn,
incorporating the leading biotech corn input trait developed from the
bacteria Bacillus thuringiensis, reached about 16 million acres, while
high-oil corn plantings amounted to about 900,000 acres. 

But acreage data alone are misleading as an indicator of a crop's importance;
high-oil corn serves as a prototype that might provide valuable lessons for
other new crops. On the supply side, the high-oil seeds are widely available
through many seed companies, and contracting opportunities are available
through the Internet. Price premiums are paid on a sliding scale that has
ranged as high as 30 cents per bushel, depending on the oil content of the
delivered crop (tested at the elevator), and when the crop was delivered. A
joint venture of technology providers and grain merchandisers has developed a
large network of participating elevators; growers can sign up for specified
delivery times throughout the year to avoid a post-harvest glut and even out
the flow of product. A major transportation company is cooperating to create
a supply chain.

From the use side, demand for high-oil corn is concentrated in two segments
of the market: export markets, largely in tropical countries where the cost
of fat is generally high, and U.S. farm-level livestock feeders. By using
high-oil corn, the farmer saves the costs of purchasing and mixing
supplemental fats. However, the industry likens the current marketing
situation to picking the lowest hanging fruit off the tree first; the next
stage of building demand will be tougher, because it will require a high
degree of coordination between growers and end users. The greatest share of
the potential market is the large integrated poultry and livestock
operations, which will need huge volumes of the product at levels that cannot
yet be supplied. Another critical problem is competition on the energy side
from this country's enormous and cheap supply of waste fats and grease
generated by the fast-food and other industries, as well as competition from
synthetic amino acids like lysine. 

Nevertheless, development of the high-oil corn marketing system as it
currently exists is a substantial achievement. If high oil is stacked with
other traits, it will be well positioned for future growth. Continental Grain
has managed the export business for high-oil corn, a business that is likely
an attractive asset in Cargill's proposed acquisition of Continental.

Several Issues Far from Settled

Despite the technical potential to develop a myriad of new quality traits,
the marketplace is not likely to support designer or boutique crops to meet
every specialized use, and the traditional commodity system for crops will
not disappear. Stacking of numerous traits may expand survival prospects, but
ultimately the benefits of the improved crops must exceed their additional
costs.

The market will determine the economic viability of these new crops, for both
domestic use and export. Some crops may not survive the marketplace test.
Some new crops will remain small simply because of their agronomic
limitations, similar to minor oilseeds like sunflowers or canola that can
grow profitably only in certain regions.

Competition from existing products will remain intense for some end uses. For
instance, many new varieties of corn and soybeans will offer increased amino
acid content for animal feeds. But two of the largest U.S. lysine producers
have announced plans in recent months to expand production, which should lead
to sharp price competition. Because of lower costs, commodity crops will
continue to appeal to a large segment of the market, but new crops with broad
appeal will benefit from economies of scale and declining costs as markets
grow. 

Many uncertainties accompany the newly forming institutional arrangements to
price and market the crops, and to provide a means of sharing the value and
bearing risks. Many farmers are apprehensive about tightly controlled
production and marketing channels that could potentially reduce their
independence. Technology firms have made huge investments that they will
presumably try to recoup through favorable marketing arrangements, but the
farmer will have to share in the added value to spur adoption.

Finally, several public policy questions could arise as value-enhanced crops
gain popularity. For example, will market news reporting expand to cover many
new crops? Should government grades and standards be modified? And what will
be the role of the public sector if disputes arise over nongrade factors or
verification of test results and equipment? 

The rate of introduction of value-enhanced crops, driven largely by
biotechnology, is expected to accelerate in the next few years, assuming
consumer acceptance of biotech crops. While previous attempts to develop a
more consumer-oriented, end-use crop focus have had limited success,
indications are that this new effort may be different because of the vastly
superior quality enhancements possible through genetic engineering.

Peter A. Riley (202) 694-5308 and Linwood Hoffman 
(202) 694-5298
pariley@econ.ag.gov

BOX - SPECIAL ARTICLE

Value-enhanced crops may be produced through conventional breeding techniques
as well as through genetic engineering.

USDA does not make official estimates of acreage or production of genetically
modified varieties the data are included in the total estimates for the
various crops. The numbers cited here were developed from industry sources,
and are not official USDA data. 

BOX - SPECIAL ARTICLE
Defining Biotechnology

Biotechnology can be defined as the use of biological organisms or processes
in any technological application. Genetic engineering can be thought of as a
subset of biotechnology, describing a set of techniques for altering the
properties of biological organisms. Using genetic engineering techniques,
individual genes can be transferred between organisms, or genes in an
organism can be modified to create plants, animals, or microbes with improved
traits for biotechnological applications. In this article, the terms
"biotech" or "biotechnology," "genetically engineered," and "genetically
modified" are used interchangeably

BOX - SPECIAL ARTICLE
Distinguishing Commodities by Quality Traits

Early indications of the transformation from bulk handling and blending of
undifferentiated crops to a system that can meet more specialized needs of
buyers have appeared in connection with conventionally bred crops entering
niche markets. For example, one snack food manufacturer, in order to maximize
control over its final product, specifies the preferred corn hybrids it will
purchase. Some buyers of soybeans for food use, including some for food
products exported to Asia, specify varieties with particular end-use
characteristics. For organic crops, the degree of product control extends
beyond varietal selection to include production methods.

A large degree of institutional inflexibility exists in the current crop
marketing system: margins are low and profits are a function mainly of large
volumes. In general, it costs more to provide additional handling and storage
facilities to isolate specific crop varieties than to handle conventional
commodities; how much more depends on the quantity as well as the degree of
control needed. Buyers who can obtain the traits or quality they need more
cheaply through the conventional system will have little incentive to change.

Attempts to shift the commodity system to one that could better handle
differentiation by end-use characteristics are not new and have been well
documented by Professor Lowell Hill at the University of Illinois. Hill has
noted, for example, that as early as 1954 USDA developed a quick method for
determining the oil and protein content of soybeans so that farmers could
market soybeans according to the value of the oil and meal they would yield.
But the measure was never adopted in grain standards. Similarly, in the case
of wheat, numerous attempts to incorporate protein content into grades and
standards have failed over the years. Current grain standards basically
describe physical characteristics with relatively little bearing on end-use
performance, although wheat buyers routinely specify protein requirements,
and supplemental testing is done at different points in the marketing chain.

In international trade, most buyers have long expressed interest in
purchasing high-quality grain, but in practice have often balked at paying
more for such quality. The Canadian Wheat Board has controlled varieties
grown and exported from Canada to try to capture premium markets, but most
exporters sell blended grain meeting minimum grade requirements. However,
given the declining role of large state trading organizations in several
countries in recent years, there are signs of some shifts in buying habits.
As millers and other private buyers gain influence in import decisions, there
are indications that quality concerns are becoming more important. 

The critical difference now, in the era of biotechnology, from previous
efforts to add quality dimensions is genetic engineering's ability to deliver
vastly enhanced quality traits. New crops may lead to reduced processing
costs or add to the marketability of the finished product to the consumer.
However, the extent of the move away from the old commodity system will be
determined mainly by costs and benefits, i.e., how much users are willing to
pay for the additional value.

SPECIAL ARTICLE

Testing May Facilitate  Marketing of Value-Enhanced Crop

If the proportion of value-enhanced crops on the market increases
significantly, as expected, there will be a parallel need for tests to verify
and measure the presence of specific traits.  Current grades and standards
for commodity crops are supported by routine sampling, inspection, and
measurement procedures specified by USDA's Grain Inspection, Packers, and
Stockyard Administration (GIPSA).  Grains are tested primarily for visual
traits such as cleanliness or damage, and the testing procedures are well
accepted, quick, and relatively inexpensive. 

Testing of value-enhanced crops will likely require development of genetic
markers to identify specific varieties as well as tests to verify the
presence of added or altered traits or nutritional properties.  The issue
becomes more complicated if the new variety was produced by genetic
engineering technologies.  Recent European Union (EU) regulations require
labeling of any products that contain DNA or protein from genetically
engineered products; labeling regulations also have been proposed in Japan. 
It is also possible that a market for products produced from inputs that have
not been genetically engineered will develop in the U.S. in conjunction with
certification of foods as "organic."

U.S., grain is commonly blended at the elevator.  In the absence of easy,
cheap, or acceptable testing, the proliferation of value-added crops in the
supply chain will require methods for identity preservation. Value-added
crops might require a "field-to-table" paper trail for product identity to be
strictly preserved.  On the other hand, if a test can verify a minimum
content of a certain trait that satisfies users' needs, it may be possible to
allow some blending of crops.  Thus, the availability of rapid, accurate, and
inexpensive tests to verify or quantify the value-added trait could have a
strong influence on the cost of marketing value-enhanced crops.

The need for testing raises several economic, technical, and possibly
political issues that will shape future market arrangements for value-
enhanced crops.  Will the tests be acceptable to both buyers and sellers? 
Can the tests be performed economically, rapidly, and simply with reliable
accuracy?  Are there reliable techniques to ensure random sampling and
adequate representation within a test sample?  USDA's standard sampling
protocols for testing grains and seeds could be adopted as standards for
qualitative and quantitative testing of value-enhanced traits.  In addition,
work is in progress in both the U.S. and Canada to develop methods and
standardize procedures for testing of grain quality and value-added traits. 

Many new crops in development will offer enhanced nutritional properties,
such as increased oil, protein levels, or starch content, or qualitative
alterations in the amino acid content or the fatty acid composition of the
oil.  Tests to verify and quantify the presence of these properties are being
developed primarily for pricing and marketing purposes.  

One very promising technique for rapid assessment of these traits is near-
infrared spectroscopy (NIRS). The pattern of absorption or reflection of NIR
light is unique for each compound, and NIRS determines the quantity of a
compound present by measuring the amount of NIR light absorbed or reflected. 
Following initial purchase of NIR spectrophotometers (about $20,000), the
tests are inexpensive, rapid, simple enough to be performed by on-site
personnel with minimal training, and have been found to be accurate and
reproducible.  This technique has already become popular among grain elevator
operators for on-site testing of high-oil corn (HOC), and it can also be used
to measure protein and starch content as well as the levels of a specific
amino acid or fatty acid in grain or processed products.  GIPSA recently
began offering a testing service upon request for corn oil, protein, or
starch using NIR technology.

Other testing methods will be required to analyze new crop varieties for
specific proteins or to quantify high-value products such as vaccines or
pharmaceuticals, for example.  One such test, the ELISA (enzyme-linked
immunosorbent assay), analyzes for a specific antibody reaction that marks
the presence of the expected protein.  ELISA tests and similar assays are
currently used to detect mycotoxins in corn and other grain.  These
procedures require minimal equipment, and only a very small amount of the
product need be tested.  Multiple samples can be processed in a few hours,
making the assay relatively adaptable for on-site testing at grain elevators
or processing plants. 

Because of EU regulations, as well as the possibility that genetically
modified foods will be ineligible for certification as "organic" in the U.S.,
EU researchers, private seed companies, and commercial testing services in
the U.S. are developing quantitative tests to detect protein and DNA in
genetically engineered crops and products.  The ELISA test can be adapted to
detect genetically modified protein.  A number of methods are available to
detect specific DNA sequences, the most powerful being the polymerase chain
reaction (PCR).  In PCR, specific DNA fragments are reproduced or amplified
and separated on a gel, and the size and intensity of the DNA band produced
indicates the presence and quantity of foreign DNA within the plant.  PCR is
a very sensitive procedure, capable of detecting specific DNA sequences at
very low levels, so reliable standards and controls are necessary, and the
sensitivity of the technique can lead to false results if the methods are not
precisely followed.  As a result, PCR will not lend itself to easy adaptation
for rapid, on-site testing.  Several companies have recently begun offering
PCR-based testing of biotech products, and the procedure will likely remain a
service provided by contract labs.

If a need develops to certify that products contain no DNA or protein
resulting from genetic modification, a consensus on an acceptable threshold
level of detection will be critical: will there be a minimal level of
genetically altered material allowed in a sample while still permitting a
designation that it contains no biotech products?  Current genetic testing
methods are so sensitive that in a test for zero tolerance for biotech
material (to guarantee that a product contains no DNA or protein resulting
from genetic modification), non-biotech products would fail to meet the zero-
tolerance standard if they have, for example, had minimal, inadvertent
contact with biotech products through minor storage and handling overlaps. It
would be wise to set minimally acceptable standards high enough that
detection by standard methods is meaningful and accounts for variation
between testing facilities.  Scientific and industrial communities in the
U.S. and Europe are currently proposing to set a sample threshold of 1-3
percent genetically engineered material for designation of a product as
containing no protein or DNA resulting from genetic modification.

Terri Dunahay (202) 694-5312 tdunahay@econ.ag.gov

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