October 8, 1998

Farmers producing cotton in 1992 will remember the LDP or "POP" payments available on cotton during the fall of '92 and winter of '93. While the issue of LDP's has not received much attention this year around the Cotton Belt, it is nevertheless particularly important to us in Georgia because many of our cotton producers very likely have begun growing cotton in just the last 3-4 years and thus have no knowledge or experience with LDP's.

Very Simply- What Is The LDP?

For cotton, the Loan Deficiency Payment is calculated as the Loan Rate minus the Adjusted World Price (AWP). For the 1998 cotton crop, the national average loan rate is 51.92 cents per pound. The AWP is the A-Index or "world price" of cotton adjusted for US grade and location. This "adjustment" typically means that the AWP is about 14 cents under the A-Index.

For example, if the A-Index were 64.00 cents, the AWP should be about 50.00 cents. The LDP would be 1.92 cents per pound (51.92 loan rate minus 50.00 AWP).

The LDP is calculated weekly. The LDP is announced on Thursday afternoon and is good for Friday through noon on the following Thursday. The LDP announced on Thursday afternoon is calculated based on the performance of the A-Index for the period just ended (the previous Friday, then Monday, Tuesday, Wednesday, and Thursday of the current week).

Why are growers eligible for the LDP? Well, this is part of the Step 1 competitiveness provision of the government cotton program. The "loan repayment rule" of Step 1 states that if the producer places his/her cotton in CCC storage, the CCC loan must be repaid at the loan rate plus storage and interest charges or the AWP, whichever is less. This allows buyers to purchase cotton at competitive rates when US prices are high relative to world prices. The government picks up the tab for the difference. So when the AWP is below the loan rate, the grower can simply apply for the LDP and agree not to put cotton in the loan. It's the same money either way.

Eligibility

This is the difficult issue. There are 2 factors: production and "beneficial interest".

My research and inquiries suggests that all production is eligible for LDP (there has been some suggestion that production only up to the farm's program yield level is eligible). Consult the local FSA office but my understanding is that under the new farm bill all production is eligible.

To be eligible for the LDP, the grower must have "beneficial interest" in the cotton. This means he/she has title and control. What does this mean? Okay, let's consider a few examples:

• Cotton already contracted. Suppose a producer contracted part or all of his/her cotton last spring or summer or sometime prior to harvest. Is this cotton eligible for LDP? Theoretically, this cotton could not have been placed in loan anyway because it was contracted and obligated for cash delivery. However, provided the cotton has been classed and provided title has not yet passed to the buyer (invoice has not been sent from the warehouse to the buyer), contracted cotton is probably eligible. When title is passed may depend on the language contained in the contract. FSA must determine this.
• Cotton sold under a "call contract" or price-later. It is typical for many farmers to sell their cotton in the fall under some sort of price later contract. This is often called "putting the cotton on call". The farmer is quoted a basis the May or July futures and advanced a portion of the price put the final price is not fixed. This is popular because title of the cotton is passed and no storage charges accrue to the grower. Is this grower eligible for LDP? If an advance has already been received then title has passed and the cotton is probably not eligible. The LDP would have to be applied for prior to transfer of title.
• Uncontracted (recap) sale. For sales of cotton from the warehouse, this should be little problem. If the producer decides to sell cotton on the cash (spot) market shortly after harvest or sometime later this winter or next spring, he/she is eligible for any LDP provided beneficial interest has been maintained and cotton has not been stored under loan.

Farmers must apply at the local FSA office for the LDP. They will not automatically get it. If the cotton is already forward contracted, a copy of the contract will most likely be needed at the time of application.

The LDP received will be the rate in effect at the time they apply except in the case of mill-direct sales. On mill-direct, the LDP will be the rate at the time of ginning. So most likely the farmer will be required to apply for the LDP prior to ginning then the rate will apply based on proof and time of ginning.

LDP's (the total of all crops) are subject to a $75,000 per entity limitation. This is different from the $40,000 limit on transition payments. Producers should monitor their situation carefully.

My understanding on coops or marketing associations is that LDP's will be added to the pool for all their customers. Questions still exists on whether the producer applies for the LDP or the association. Producers participating in coops or associations need to clarify this with the association.

A-Index and LDP Situation and Outlook

The direction and magnitude of the LDP depends on the A-Index. The A-Index typically mirrors the world stocks and supply/demand situation. Prior to this season, the A-Index (world price) has not been low enough cause an AWP below the loan rate. We've not had LDP's since the 1992-93 crop year and for most of the period since the A-Index has been in the 70-80 cent area or better.

The recent downtrend in the A-index is due to world economic conditions and foreign cotton stocks-to- use. Typically, US cotton futures prices and the A-Index move together within a narrow range. The current downtrend in the A-Index (over 4 cents per pound since early September) has been met with a smaller decline in US cotton futures. Thus the gap has widened somewhat.

The most recent (October 9^th) USDA supply and demand estimates show world and foreign production down from earlier estimates, but use is also down and stocks increased. This suggests that the A-Index will likely continue under pressure for at least a while longer and the LDP increase or remain near it's current levels.
 

* AWP is the average A-Index for the previous week minus the adjustment.

** LDP is the loan rate (51.92) minus the AWP if the AWP is less than the loan rate.
 

Words Of Caution and Suggestion

The key is "beneficial interest". If producers have any questions on when beneficial interest passes from them to the buyer based on how they expect to sell their cotton, they should contact FSA, their buyer, and the gin. In the case of contracted cotton, it may be necessary to change language in the contract if this is possible.

If the producer has already lost beneficial interest but the cotton is not contracted, he/she can effectively capture the LDP in the form of a "marketing loan gain" by placing the cotton in loan then repaying the loan at the AWP. Marketing loan gains are treated within the $75,000 limit.

Most contracts call for "prompt delivery". Producers and gins should be clear on the time requirements for prompt invoice and delivery of the cotton. The producer retains beneficial interest until the date of invoice and can apply for LDP with grade reports and copy of the contract. Producers must be aware of the point of time at which beneficial interest transfers. In some cases this could be at ginning or even at harvest.

Lastly, the farmer's objective is NOT to maximize the LDP amount. The goal is to maximize total receipts (cash price plus LDP). The temptation, particularly for uncontracted cotton, is to hold on to the cotton waiting to see if the LDP increases or decreases the following week. If the LDP gains 2 cents but the cash price drops 3 cents, the net result is a 1 cent loss. Producers need to consider their LDP timing in light of their overall marketing plan.

Taking an LDP does not require the farmer to then sell his/her cotton. It can be stored and sold later but not stored under CCC loan.

Producers are encouraged to discuss this situation with FSA, their ginner, and buyer. While the information and discussion presented here is believed to be accurate, FSA is the final authority on rulings pertaining to eligibility and beneficial interest.

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