Editor’s note: The following was written by Alejandro Plastina, Iowa State University Extension economist, for the university’s Ag Decision Maker newsletter.
Agricultural production in the Midwest is a non-point source polluter of water bodies, affecting their recreational value, increasing costs for water treatment plants and contributing to the hypoxic zone in the Gulf of Mexico.
Midwestern states are addressing this contentious topic through local Nutrient Reduction Strategies. These science- based strategies are intended to serve as guidelines for the implementation of voluntary practices to reduce nitrate and phosphorus loads going into creeks, lakes and rivers. However, they overlook a critical component of voluntary programs: economic incentives.
This article discusses selected economic incentives faced by farmers when deciding how much nitrogen (N) fertilizer to apply, and rationalizes why farmers tend to apply N at higher rates than the agronomically optimal level.
Optimal N rate
The Corn Nitrogen Rate Calculator (online at http://cnrc.agron.iastate.edu/) uses results from multiple agronomic research experiments in Illinois, Iowa, Michigan, Minnesota, Ohio and Wisconsin to calculate the N application rate that maximizes the net return to N.
The Maximum Return to Nitrogen (MRTN) calculation is state- and crop rotation-specific. For example, the MRTN rate for corn following soybean in Iowa when the corn price is $3.80 per bushel and the N price is 40 cents per lb. is 138 lbs. of N per acre, with a profitable range of 124-150 lbs of N per acre. However, over the period 2010-18, data suggests the average application rate was about 220 lbs. of N per acre per year.
What can be driving the “overuse” of N fertilizer when compared to the “optimal” MRTN rate?
A production system of continuous corn requires more N. Before the ethanol era, continuous corn accounted for less than 10% of total Iowa farmland in corn and soybean. Between 2007 and 2019, the area on continuous corn averaged 4 million acres, or 17% of total Iowa farmland in corn and soybean.
N application typically occurs before the crop is marketed. Consequently, N decisions are made with uncertainty about the price that will be obtained for the crop that is being fertilized. The wider the range of crop prices entertained by a farmer when deciding how much N fertilizer to apply, the wider the profitable range for N application suggested by the Corn Nitrogen Rate Calculator.
While crop insurance provides some grounding for crop prices in early spring, and can therefore help mitigate the crop price uncertainty when making spring N applications, it also incentivizes the use of N fertilizer to bump up the actual production history (APH) used to calculate crop insurance guarantees.
For example, in 2019, a farmer in Calhoun County (Iowa) purchasing Revenue Protection with 80% coverage level and an APH of 170 bushels of corn per acre secured a revenue guarantee of $544 for a premium of $12.10 per acre (Risk Management Agency Cost Estimator). Another farmer in the same county with an APH of 180 bushels per acre could purchase a similar policy and secure a revenue guarantee of $576 for a premium of $12.43 per acre.
Comparing the crop insurance policies across farmers, a dime in premiums buys $9.70 extra of revenue guarantee. Ten additional bushels of corn in the APH result in a $32 increase in revenue guarantee per acre.
Using an average price of $0.44 per lb. of N fertilizer over the 2009-2018 period, and an annual opportunity cost of 5% for the investment in extra N fertilizer, the $32 in extra revenue guarantee would have justified an additional 5.5 lbs. of N each year under continuous corn, or 10.75 extra lbs. of N for the corn crop under a corn-soybean rotation.
The 2014 Farm Bill introduced the Agriculture Risk Coverage (ARC) and the Price Loss Coverage (PLC) programs as central components of the farm safety net, and the 2018 Farm Bill ratified those programs with minor adjustments.
The ARC program has a County option (ARC-CO) and an Individual option (ARC-IC), depending on the source of yields used to calculate the ARC revenue guarantee. In particular, the ARC-IC revenue guarantee is based on five-year Olympic average farm yields, and therefore provides long-term incentives to use higher rather than lower levels of N fertilizer similar to those stemming from crop insurance.
The PLC program uses the same set of historical farm yields “for the life of the farm bill” to calculate the size of the payments triggered by low market prices. In 2014, the default PLC yields were those from the counter-cyclical program dating back to the early 2000s.
However, first in 2015 and then again in 2019, farmland owners were offered opportunities to update their PLC payment yields based on their recent farm yields “for the life of the farm bill.” In particular, farmland owners have until
Sept. 30, 2020, to replace the existing PLC payment yields with higher ones based on their 2013-17 production history.
Consequently, the yield updates in the PLC program also incentivize the use of N to bump up farm yields in the expectation of expanding the protection offered by the farm safety net in the near future.
Incentives are key
People who claim that farmers are not making rational decisions when choosing higher N rates than the MRTN rate fail to recognize that they might not be trying to maximize short-term profits, but trying to maximize long-term profits while minimizing long-term risks through the farm safety net.
While limited in scope, this brief analysis illustrates how some of the very same institutions developed to promote agricultural production in the United States generate economic incentives contrary in spirit to the aspirational goals promoted through the local Nutrient Reduction Strategies.
Given that implementing conservation practices is costly to farmers in terms of extra management time, increased cash costs, etc., it can be expected that the former objective will be prioritized during times of low crop margins and financial stress in the farm sector.
Even when cost-sharing is available for multiple conservation practices, the fact that the rates of adoption of conservation practices are typically well below the aspirational levels described in the Nutrient Reduction Strategies is a clear signal that private costs to farmers typically more than offset private benefits stemming from to those practices (even after accounting for cost-share payments).
It might be argued that long-term benefits from continued use of conservation practices, such as improved soil health, higher farmland values, resiliency to weather variability and potential payments for carbon sequestration, should offset short term costs. However, it must be noted that:
- Scientists have not yet reached an agreement on how to measure soil health (let alone measure the impact of conservation practices on soil health).
- There is no market for soil health, and farmland is mostly traded on productivity indexes and comparable market values;
- Price and yield risks associated with weather variability are typically managed through crop insurance.
- Although some incipient markets to purchase sequestered carbon credits from farmers are emerging, the potential to benefit from these markets by Midwest farms with pervasive tiling, harvested cornstalks, no summer cover crops and limited corn-soybean rotations might be limited.
Until economic incentives are explicitly recognized as key components of voluntary conservation programs and studied in depth, the nutrient reduction puzzle will continue to miss a central piece.