U.S. Grain Sales: Inventory Sales Raise Issues for Legislative Consideration

Published by the Government Accountability Office on 1990-05-22.

Below is a raw (and likely hideous) rendition of the original report. (PDF)


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                                                     U.S. GRAIN SALES
                                                     Inventory Sales Raise
                                                     Issues for Legislative


                   United States
GAO                General Accounting Office
                   Washington, D.C. 20648

                   Resources, Community, and
                   Economic Development Division


                   May 22,199O

                   The Honorable Kent Conrad
                   United States Senate

                   Dear Senator Conrad:

                   During fiscal years 1988 and 1989, the U.S. Department of Agriculture
                   (IJSDA) sold about $8.2 billion of government-owned   grain that had been
                   obtained largely as forfeited collateral from farmers under IJSDA'S nonre-
                   course loan program. The sales, which reduced large and costly grain
                   inventories by about two-thirds, primarily involved exchanges for com-
                   modity certificates- a form of federal payment used in farm support
                   programs in lieu of cash. In response to your concerns about whether
                   USDA had received reasonable prices for the grain it sold, this letter (1)
                   discusses USDA'S policies and procedures for selling grain and (2) com-
                   pares prices USDA received for selected sales with local market prices.

                   IJSDA'S overall policy for certificate exchange sales was to price grain as
Results in Brief   close as possible to estimated local market prices. Implementing instruc-
                   tions further specified that exchange prices should be at or below esti-
                   mated local market prices rather than at or above them in order to
                   encourage sales. USDA determines selling prices for exchange sales based
                   on estimates of local market prices instead of collecting actual daily
                   commodity prices for the approximately 7,000 elevators that store its

                   We examined, as you requested, a sample of sales from about 500
                   exchanges in the states of North Dakota, South Dakota, Minnesota, and
                   Nebraska for which data on local market prices were readily available.
                   The 500 sales, which amounted to $84 million and 36 million bushels of
                   wheat and corn, took place between April 1, 1988, and March 31, 1989.
                   On the basis of this sample, we estimate that on average USDA'S sale
                   prices for the 36 million bushels of grain were about 5 cents below local
                   market prices which averaged $2.42 per bushel (these results cannot be
                   generalized beyond the 500 sales in our sample universe). We found no
                   generally accepted criteria to measure the reasonableness of the sale
                   prices in relation to the need to reduce inventories.

                   The grain sales were instrumental in reducing costly federal grain inven-
                   tories. However, current grain stock policy does not address a number of

                   Page 1                                         GAO/RCED-90-120   U.S. Grain Sales
                                                                                                                  -.”       )

             important areas such as when IJSDA should initiate sales to control inven-
             tory costs and whether USDA'S authority for grain sales should be
             expanded or restricted. Further, the financial incentives under the cur-
             rent agricultural loan program offer little assurance against the future
             buildup of large and costly grain inventories.

             USDA'S nonrecourse loan program is one of several federal programs
Background   intended to help stabilize farm income. Under the program, producers
             can obtain loans from USDA on wheat, corn, and certain other farm com-
             modities. In exchange for promising these commodities as collateral,
             USDA pays producers an amount equal to the loan rate, normally
             expressed in terms of a dollar amount per bushel. The loan period is 9
             months for most crops during which time the farmer is responsible for
             paying storage costs. The producer may repay the loan at any time
             (with interest) or forfeit the commodity as full payment at the end of
             the loan period. Forfeited crops become part of the government’s

             Producers’ decisions on whether to forfeit commodities under the pro-
             gram are based primarily on how market prices compare with loan
             rates. For example, when market prices are less than loan rates, produc-
             ers will generally choose to forfeit their commodities thereby effectively
             receiving the loan rate as their selling price. Conversely, when market
             prices are higher than loan rates, producers would be inclined to pay off
             their loans and sell their commodities.

             As a result of rising loan forfeitures, USDA'S grain inventories increased
             from about 1 billion bushels in fiscal year 1985 to a peak of 3.2 billion
             bushels in mid-fiscal year 1987. Inventory storage problems became so
             severe that in 1986 USDA resorted to storing grain temporarily on barges.
             With increasing inventories, USDA'S annual storage, handling, and trans-
             portation costs for bulk grain’ also increased about 300 percent from
             approximately $353 million in fiscal year 1985 to almost $1.4 billion in
             fiscal year 1987. In 1987, USDA projected that storage, handling, and
             transportation costs for all commodities would exceed $3 billion for fis-
             cal years 1988 and 1989. The Congress included in the Omnibus Budget
             Reconciliation Act of 1987 a provision requiring the Secretary of Agri-
             culture to reduce the projected 1988 and 1989 fiscal year expenditures
             for commercial storage, handling, and transportation of federal grain
             inventories by $230 million.

             lIncludes corn, wheat, barley, oats, rye, soybeans, and sorghum.

             Page 2                                                             GAO/RCED-90.120   U.S. Grain Sales

                            Following the 1987 congressional directive to reduce storage, handling,
                            and transportation costs, USDA sales of grain inventories increased.
                            Between fiscal years 1987, when federal bulk grain inventories were at
                            their peak, and 1989, USDA reduced its bulk grain inventory from about 3
                            billion bushels to about 1 billion bushels (about 67 percent). By way of
                            perspective, federal exchange sales of bulk grain during this period
                            equalled about 12 percent of the estimated production in the United
                            States. USDA'S bulk grain storage, handling, and transportation costs also
                            decreased from about $1.4 billion for fiscal year 1987 to about $525 mil-
                            lion in fiscal year 1989, a reduction of approximately 62 percent.
                            Appendix I summarizes the increases in inventories and storage, han-
                            dling, and transportation costs prior to 1987 as well as their decline in
                            subsequent years.

                            USDA can reduce government-owned grain stocks through cash sales or
Policies and Practices      through exchanges for negotiable commodity certificates. However,
for Grain Sales             because USDA is generally prohibited from selling grain for cash unless
                            market prices reach legislatively established levels, most of the grain
                            sold from federal inventories during fiscal years 1988 and 1989 was sold
                            in exchange for commodity certificates. USDA'S overall policy was to set
                            exchange prices as close to estimated local prices as possible. Imple-
                            menting instructions further specified that sale prices should be set at or
                            below rather than at or above estimated local market prices to
                            encourage sales. IJSDA established sale prices based upon estimated local
                            market prices rather than actual prices because it does not collect price
                            information for its thousands of grain storage locations. To publicize its
                            sales, USDA distributed catalogs that identify the quantities and locations
                            of grain available for exchange with commodity certificates.

Limitations on Cash Sales   About 71 percent of the $8.2 billion sales during fiscal years 1988 and
                            1989 involved certificate exchanges as opposed to cash sales. The rela-
                            tively small amount of cash sales reflect legislative limitations that pro-
                            hibit cash sales unless market prices reach a minimum price level, which
                            is established in accordance with a statutory formula. Under the
                            formula, the minimum price will always be a certain percentage above
                            the loan rate. Restrictions on cash sales stem from concerns that releas-
                            ing federal grain into the market could depress prices and thereby hurt
                            farm income. During the 4-year period ending September 30,1989, soy-
                            beans was the primary commodity to reach the statutory price level that
                            allowed sales through cash.

                            Page 3                                         GAO/RCED-90-120   U.S. Grain Sales

                         Under the certificate authority, there are no restrictions concerning the
                         Secretary’s authority for releasing federally owned grain through
                         exchanges for commodity certificates. The pood Security Act of f$M@
                         authorized the Secretary of Agriculture to issue negotiable commodity
                         certificates to eligible producers instead of cash payments for partici-
                         pating in government farm support programs. These certificates can be
                         (1) sold back to USDA for cash at their face value; (2) sold to other inter-
                         ested parties, such as producers and grain companies; (3) exchanged for
                         commodities in the government’s inventory; and (4) used to pay off com-
                         modity loans. Between April 1986, when USDA began issuing certificates,
                         and September 1989, USDA issued about $24 billion of commodity

Determining Grain Sale   IJSDA uses estimates of local market prices when valuing commodities for
Prices                   exchange sales. Commodity prices can vary by location due to, among
                         other things, differences in transportation costs to major selling mar-
                         kets. Because ~JSDAdoes not maintain actual commodity price informa-
                         tion for its grain storage locations, it estimates local prices through the
                         use of a system called the posted elevator price system (PEP). The PEP
                         system is based on the use of price differentials that reflect the price
                         relationship between each of the approximately 7,000 individual eleva-
                         tors and major selling markets (commonly referred to as terminal mar-
                         kets). Knowing this relationship allows USDA to estimate current market
                         prices for grain in its approximately 7,000 elevator locations, while
                         monitoring actual prices in only 19 major selling markets.

                         USDA originally   computed a sales price by subtracting an elevator’s dif-
                         ferential from the assigned terminal market’s closing cash bid price and
                         adjusting the resulting price for grain quality and grade. However, in
                         order to sell its grain, USDA in 1987 found it necessary to make additional
                         downward adjustments to the PEP price. One adjustment was to account
                         for the uncertainties in pricing grain stored in locations that do not have
                         official grades or weights and are usually 15 to 30 days from the termi-
                         nal markets. In addition, USDA also made a transportation adjustment,
                         which was intended to account for fluctuations in barge rates that were
                         not considered in the PEP price differential. These adjustments affected
                         corn and grain sorghum tied to the Texas and Louisiana Gulf markets
                         and for corn and barley tied to the Pacific Northwest market. These
                         adjustments varied during the period reviewed.

                         Page 4                                          GAO/RCED-90-120   U.S. Grain Sales


    Advertising Grain Sales   USDA uses catalogs to advertise the grain available for exchange of com-
                              modity certificates. Program officials stated that the criteria for deter-
                              mining what grain to advertise for sale could depend on a number of
                              factors including storage costs at a particular location, storage space
                              problems, total remaining inventory of a given commodity, balances
                              remaining on existing catalogs, the nature of commercial demand for the
                              commodity, and the availability of commodity certificates.

                              Within the four states we reviewed, we identified about 500 exchange
SelectedGrain Sales           sales for which local commodity price information was readily available
Average 5 Cents a             through USDA records or newspapers. (Because local price information
Bushel Below Market           was not available for all locations in which USDA sales took place, the
                              sales we identified do not encompass all sales within the four states-
Prices                        see methodology in appendix II for further details). The 500 sales,
                              which took place during the 1 year period ending March 31, 1989,
                              totaled $84 million and involved 36 million bushels of wheat and corn.
                              On the basis of a sample of these sales, we estimate that (1) on average
                              USDA sold its grain for about 5 cents below local market prices (as deter-
                              mined by GAO), which averaged $2.42 per bushel and (2) about 40 per-
                              cent of the bushels were more than 10 cents a bushel below market
                              prices. To be on the same basis for comparison with USDA sales, we
                              adjusted the reported local market prices-closing cash bid prices-for
                              factors including quality and grade (see app. 11).

                              Table 1 summarizes our estimates concerning how USDA sale prices com-
                              pared with local market prices for the universe we sampled. The results
                              are presented both in terms of the number of sales transactions and the
                              number of bushels involved in those transactions. For example, the table
                              shows that we estimate that USDA received a sale price at or above the
                              local market price in about 30 percent of the 500 sales in our universe
                              and 22 percent of the 36 million bushels in our universe.

                              Page 6                                         GAO/RCED-90-120   U.S. Grain Sales


Table 1: Comparison of Sale Prices With
Market Prices for Selected Grain Sales                                                                                   GAO          Sampling
                                                                                                                    estimate      error I+ or -1
                                          Percent of sample universe transactions
                                            The same or over market price                                                   30                      6
                                            1 to 10 cents less than market price                                            35                      7
                                            More than IO cents less than market price                                       35                      7
                                          Percent of sample universe bushels                                                             __-
                                            The same or over market price                                                   22                      13
                                            1 to IO cents less than market orice                                            38                      22
                                            More than 10 cents less than market price                                       40                      21
                                          Average dollar difference between market and sale price
                                            (market less sale)                                                          $.051              SO26
                                          Note, Estimates are for our sample universe of sales in North Dakota, South Dakota, Nebraska, and
                                          Minnesota. They are expressed in terms of GAO’s estimate and the sampling error around that estimate
                                          at the 95.percent confidence level.

                                          The sampling error associated with each estimate provides a range
                                          within which the actual value is likely to fall. For example, our best
                                          estimate is that 30 percent of the sales transactions in our sample uni-
                                          verse were the same or over market price, but the actual value is likely
                                          to fall anywhere between 24 and 36 percent.

                                          To better understand why sale prices were below market prices, we
                                          examined sampled sales transactions that were below local market
                                          prices by more than 10 cents. We found that the primary reason these
                                          sales were below market prices was because of USDA'S adjustments for
                                          price uncertainties. As indicated earlier, USDA reduced exchange prices
                                          to account for increased uncertainties in, among other things, pricing
                                          grain at locations that do not have official grades or weight. Such
                                          adjustments were as high as 16 cents a bushel in the transactions we
                                          examined. According to USDA officials, adjustments were applied gradu-
                                          ally (no more than 2 cents per day) in order to find a price at which the
                                          grain would sell.

                                          We could not find any generally accepted criteria for what a reasonable
                                          sale price should be in relation to the need to reduce inventory costs.
                                          Such criteria would need to consider a number of factors including the
                                          benefits of avoiding storage costs as well as the possible impact that
                                          sales could have on local market prices. For example, while it might be
                                          financially prudent for USDA to discount the price of its grain in order to
                                          avoid storage costs, discounting the prices too much would (1) reduce
                                          returns to the federal government and (2) possibly depress local market
                                          prices thereby hurting local farmers.

                                          Page 6                                                         GAO/RCED-90-120        U.S. Grain Sales

                                 Past grain sales have helped USDA to control the growth of federal grain
Other Issues                    stocks and reduce the associated storage costs. Additionally, some of
                                USDA grain sales occurred during a period when the United States was
                                experiencing one of its worst droughts-the      1988 drought contributed
                                to corn and wheat production declines of 30 and 14 percent, respec-
                                tively, under 1987 levels. Consequently, it is possible that the sales
                                helped to moderate the impact that the drought could have had on the
                                availability and price of grain, On the other hand, federal policy does
                                not address some important aspects of acquiring, storing, and selling
                                grain stocks, For example, how large should grain inventories be
                                allowed to accumulate and to what extent should USDA be allowed to sell
                                grain at or below the legislative release level? Further, can or should
                                farm programs be modified to prevent future buildup of excessive stock

II   rIvt?ntory Size            One important inventory management question concerns how high or
                                low grain inventories should be allowed to go before actions are taken to
                                increase or decrease them. Federal grain stocks are thought to serve a
                                number of purposes, which include providing a cushion against times
                                when production is not adequate to meet the nation’s food requirement.
                                While these and other needs have been used to support the desirability
                                of maintaining federal stocks, they have not been translated into target
                                levels for the minimum and maximum quantities of grain that USDA
                                should maintain in its stocks, Without such target levels, it is difficult to
                                determine when actions should be taken to increase or decrease

            ty f’or Releasing   A second question relates to IJSDA'S authority for releasing grain stocks;
            Grain Stocks        more specifically, whether USDA should be given more flexibility to
                                release grain through cash sales of grain stocks or whether its authority
                                for certificate sales should be restricted. These are questions that arise
                                from what could be considered an inconsistency between USDA'S author-
                                ity for cash sales versus its authority for certificate sales. For example,
                                the use of cash sales is restricted to those times when market prices
                                equal or exceed legislatively established price levels. The intent of this
                                restriction was to avoid depressing market prices through the release of
                                federal grain unless market prices reached certain minimum levels,
                                However, USDA has no such restrictions concerning certificate sales and
                                therefore has the potential to considerably influence market prices
                                through release of federal grain stocks. This inconsistency illustrates the
                                underlying issue-should USDA be allowed more flexibility on cash sales

                                Page 7                                          GAO/RCED-00-120   U.S. Grain Sales

                            or be restricted on its use of certificate sales? In discussing possible
                            restrictions on certificate sales, it should be recognized that such restric-
                            tions may limit USDA'S ability to effectively manage future stock levels.

Avoiding Excessive          Finally, there is a question concerning whether production incentives of
Inventories in the Future   federal crop support programs should be modified to avoid accumulat-
                            ing large grain inventories again. One way to avoid the problems associ-
                            ated with managing large federal grain inventories is to avoid the
                            buildup of excessive inventories. This could be done by modifying the
                            incentives in the federal program that create the inventories. For exam-
                            ple, the federal government acquires grain because it is more profitable
                            for farmers to forfeit their crops under the loan program than to sell the
                            crops on the open market. To reduce this incentive, the loan rate could
                            be tied to the level of grain stocks- the higher the stock level, the lower
                            the loan rate.2 This would reduce the incentive for farmers to

                            USDA grain sales helped to reduce large and costly federal grain invento-
Conclusions                 ries. Our analysis indicates that for selected sales in four states USDA, on
                            average, received 5 cents per bushel less than local market prices. It is
                            difficult to evaluate whether these sale prices were reasonable because
                            we found no generally accepted criteria for price reasonableness that
                            considered the need to reduce grain inventories. However, in the course
                            of developing information for this review, we identified several policy
                            questions concerning the acquisition, management, and sale of federal
                            grain inventories that we believe warrant congressional consideration
                            during the upcoming farm bill debates.

                            Resolving questions on federal grain sales and inventory management,
Matters for                 such as those that are discussed in this letter, could have significant
Congressional               implications for future farm policy. Over the next few months, the Con-
Consideration               gress will be considering changes to the nation’s farm policy as it delib-
                            erates over the 1990 farm bill. Therefore, as part of these deliberations,
                            the Congress may want to consider addressing questions concerning (1)
                            how high or low federal grain stocks should be allowed to go before
                            actions are taken to decrease or increase them, (2) whether USDA'S

                            *In 1985 Icgislation, the Congress took a similar approach to control dairy surpluses. It linked price
                            support levels with projected surpluses-a surplus projected to exceed certain levels would trigger a
                            reduction in the price support.

                            Page 8                                                           GAO/RCED-00-120     U.S. Grain Sales

                      authority for grain sales should be expanded or restricted, and (3)
                      whether USDA'S farm support programs can or should be modified to
                      avoid the buildup of unnecessarily large inventories,

                      IJSDA had three primary concerns with the information in this letter (see
Agency Comments and   app. III). First, it believed that a grain exchange should not be consid-
Our Evaluation        ered a sale and that, as a result, combining grain exchanges with cash
                      sales produces a “grossly inaccurate” total dollar sales figure. We agree
                      that there are differences between the two types of transactions and
                      recognize this throughout the report. However, we believe that charac-
                      terizing grain exchanges as a type of sale is consistent with commonly
                      accepted definitions of the term. Further, we note that Commodity
                      Credit Corporation (ccc) financial documents also refer to the exchanges
                      as sales. Therefore, while we have revised the report to highlight that
                      exchange sales are included in the total dollar sales figure, we continue
                      to refer to exchanges as a type of sale.

                      Second, USDA stated that its overall policy was to set exchange prices as
                      close to market price as possible-not at or below market price as indi-
                      cated in the report. We clarified the report to distinguish between USDA'S
                      overall policy of pricing as close to the market as possible and its operat-
                      ing instructions which provided that adjustments to exchange prices
                      should be sufficient to result in prices being at or below the estimated
                      market rather than at or above the market in order to encourage sales.

                      Finally, USDA stated that it does not specifically adjust its grain prices
                      for buyers’ risk. In subsequent discussions with USDA staff, it was agreed
                      to characterize these adjustments as adjustments to reflect pricing
                      uncertainties resulting, in part, from unknown grades and weights of
                      grain in local elevators.

                      Our work was performed between April 1989 and February 1990 in
                      accordance with generally accepted government auditing standards. To
                      review USDA policies and procedures for grain sales, we interviewed offi-
                      cials and obtained documents at USDA'S Agricultural Stabilization and
                      Conservation Service (ASCS) in Washington D.C., and at ASCS' Kansas
                      City Commodity Office. ASCSis responsible for managing the storage and
                      disposal of government-owned grain. To compare USDA sale prices with
                      local market prices, we identified sales in four states for which we could
                      obtain historical local market prices, sampled from among these sales,

                      Page 0                                         GAO/RCED-90-120   U.S. Grain Sales
n,                                                                                 h.

     and then used standard statistical techniques to estimate price compari-
     son for the sample universe. Appendix II contains a detailed explanation
     of the scope and methodology for our price comparison.

     As arranged with your office, unless you publicly announce its contents
     earlier, we plan no further distribution of this report until 7 days after
     the date of this letter. At that time we will send copies to the Secretary
     of Agriculture, Office of Management and Budget, and other interested

     This report was prepared under the direction of John W. Harman, Direc-
     tor, Food and Agriculture Issues, (202) 275-5138. Major contributors to
     this report are listed in appendix IV.

     Sincerely yours,

     J. Dexter Peach
     Assistant Comptroller General

     Page 10                                        GAO/RCED-90-120   U.S. Grain Sales
Page 11   GAO/RCED-90-120   U.S. Grain Sales

Appendix I
Ending Bulk Grain
Inventory Balances
and Storage, Handling,
and Transportation
Costs for Fiscal Years
1985 Through 1989
Appendix II                                                                                          15
Methodology for
Comparing USDA Sale
Prices With Local
Market Prices
Appendix III                                                                                         18
Comments From the
U.S. Department of
Appendix IV                                                                                          20
Major Contributors to    Resources, Community and Economic Development                               20
                             Division, Washington, DC.
This Report              Kansas City Regional Office
                         Program, Evaluation, and Methodology Division,
                             Washington, D.C.

Tables                   Table 1: Comparison of Sale Prices With Market Prices for                     6
                             Selected Grain Sales
                         Table II. 1: Sample of USDA Sales for Comparing With
                             Market Prices

                         Page 12                                      GAO/RCED-90-120   U.S. Grain Sales



    Ascs       Agricultural Stabilization and Conservation Service
    ccc        Commodity Credit Corporation
    PEP        posted elevator price
    USDA       U.S. Department of Agriculture

    Page 13                                        GAO/RCED-90-120   U.S. Grain Sales
Appendix I                                                                                                                    *

Ending Bulk Grti Inventory Balances and
Storage, Hmdling, and Transportation Costs for
FiscallYears 1985 Through 1989

               Inventory and                                             Fiscal year
                  costs                      1985               1986             1987               1988                 1989
               Bulk graina
                  inventorv                    979             1.851              3.041             1.580               1.019
               Bulk grain
                  Storage and
                     handling                $289             $585              $1,270              $949                $506
                 Tranwortation                 64          ___ 101                 119                (14P                 19
               Total                         $353             $686             $1,389               $935                $525
                 Storage and
                    handlina                 $105              $128               $106                $37                $81
                 Transportation                70                79                 66                 51                 21
               TotaP                         $175              $206               $172                $88               $102
                  commodities                   -___
                  Storage and
               --_____-                      $394              $713            $1,376               $986                $586
                  Transportation               134               179               185                 37                 41
               TotaP                         $528              $892            $1.561             $1.023                $627
               Note: Inventory is in millions of bushels Cost for storage, handling, and transportation   IS in millions of
               alncludes barley, corn, oats, rye, sorghum, soybeans, and wheat
               bShows a minus because estimated accruals carried over from the pnor fiscal year exceeded actual
               ‘Totals may not add due to rounding

               Page 14                                                             GAO/RCED90-120          U.S. Grain Sales
Appendix II

Methodology for Comparing USDA Sale Prices
With Local Market Prices

                                      As requested, we compared selected grain sale prices received by USDA
                                      with local market prices in four states-North    Dakota, South Dakota,
                                      Nebraska, and Minnesota. The sales we examined took place during the
                                      1 year period beginning April 1, 1988, and ending March 31, 1989. Dur-
                                      ing this period, USDA made a total of 24,864 grain sales for about $3.2
                                      billion; 7,369 of these sales representing about $702 million were in the
                                      states we examined.

                                      In the four states we reviewed, we found no central record of local mar-
                                      ket prices for all locations from which federal grain had been sold.
                                      Therefore, we obtained selected local market price information from
                                      various sources. We used the daily local closing cash bid prices from
                                      IJSDA'S Agricultural Marketing Service and a daily newspaper, the Grand
                                      Forks Herald, to obtain prices for 109 locations within the four states. In
                                      addition, we obtained weekly local closing cash bid prices for another 68
                                      locations in North Dakota, South Dakota, and Minnesota from a weekly
                                      newspaper, AGWEEK. It is important to recognize that the prices we
                                      used to approximate local grain prices were cash bid prices and, as a
                                      result, there is no assurance that any grain was actually sold at those

                                      We matched locations where we could obtain local commodity prices
                                      with the locations where USDA sold grain and found that 503 of the sales
                                      were at locations where we could obtain local market closing cash bid
                                      prices. We next sampled from among the 503 matched locations as
                                      shown in table II. 1.
Table 11.1:Sample of USDA Sales for
Comparing With Market Prices                         Auctions                              PEP exchanges
                                                  Winter        Spring           Winter           Spring
                                                 - wheat
                                      -..__-.....-.             wheat            wheat             wheat             Corn              Total
                                      Samde            28            21               50               50              50               199
                                      Universe         28            21               85              102             267               503
                                      Note: When wheat advertised In catalogs at the PEP price CM not sell, USDA sometlmes offered it to the
                                      highest bidder through an auction process under which USDA reserved the right to reject all bids.

                                      Before comparing the closing bid prices with the USDA sale prices, we
                                      made a number of adjustments to the closing bid prices, which are
                                      detailed below.

                                      Paye 15                                                         GAO/RCED90-120        U.S. Grain Sales
Appendix II
Methodology   for Comparing USDA Sale
Prices With Local Market Prices

1. We added 6 cents per bushel for the added value, according to USDA,
that grain physically stored in a warehouse has over grain at the receiv-
ing side of a warehouse. USDAadds 5 cents per bushel to their price for
this factor.

2. We deducted loadout expenses exceeding 5 cents per bushel charged
by the storing warehouse. USDAmade this adjustment to their prices to
standardize loadout charges a buyer can plan on paying at any ware-
house storing USDAgrain.

3. We adjusted for the change in the futures’ market from the prior trad-
ing session to the time the sale is made. USDAmade this adjustment to its

4. We applied grade discounts for differences between the standard
grade quoted by the respective publications and the actual grade USDA
exchanged. These discounts account for differences in grain quality. We
applied the discounts that USDAused.

5. For winter and spring wheat, we adjusted the price for differences
between the actual protein value and the quoted standard premium. We
applied the premium factors that USDAused.

6. For locations where only the weekly local closing cash bid prices were
available, we adjusted the price to the appropriate day based on the
changes in the price at the applicable terminal market.

7. We adjusted the price for the premium that commodity certificates
were selling for in the market on the day of the sale.’ This adjustment
allows for the differences between trading on the cash market and the
certificate. To make this adjustment, we used the premium that USDA
recorded for that particular day. During our review, certificates did not
trade at a discount.

After making all necessary adjustments, we calculated the difference
between the USDAsales price and the GAO-adjusted local market price. We
then used a standard statistical technique to estimate price comparisons
for the universe of sales from which we sampled. The estimate calcula-
tions include sampling errors that define the upper and lower bounds of

‘For auctions, IJSDA added this step to its PEP price calculation to reach a benchmark price. On the
basis of the auction bids, USDA then decided the actual price it would exchange grain that could be
the same as, above, or below the benchmark price.

Page 16                                                         GAO/RCED-90-120      U.S. Grain Sales
Appendix II
Methodology   f’or Comparing USDA Sale
Prlcea With Local Market prices

the estimates within a g&percent confidence interval-19    out of 20
times, the procedure we used would produce an interval capturing the
true value. The results of our sample cannot be generalized beyond the
sample universe of 603 USDA exchanges.

Page 17                                      GAO/RCED-GO-120   U.S. Grain Sales
Appendix III

Comments From the U.S. Department
of Agriculture

                                                      DEPARTMENT                 OF     ABRICULTURE
                                                             OFfiCE      Ol’    THE     SECRETARY
                                                              WASHINOTON,              D.C.   ZDZSO

                 Mr. John W. Harman                                                                                    APR 0 6 1990
                 Director,     Food and Agriculture       Issues
                 Rasources,      Community,    and
                    Economic Development        Division
                 United    States    General   Accounting    Office
                 Washington,      D.C.    20548

                 Dear      Mr.   Harman:

                 We have        reviewed    the     draft   report,            “U.S.     Grain Sales:     Lnventory     Sales Raise
                 Ieeuea       for Legislative          Consideration.”                 and submit the   following      comments:

                          In the opening          paragraph         of the letter       to Senator       Conrad,     the statement      is
                          made that the Department                  of Agriculture        has “sold      about $8.2 billion          of
                          government-owned             grain.”       This statement         is grossly      inaccurate       in that
                          this amount includes                grain     “sold”    for cash and grain          acquired     from
                          Commodity Credit             Corporation         (CCC) by private        parties     through     the exchange
                          of commodity         certificates.              The latter    are not “sales.”            Also,    under the
                          heading      Results       in Brief,        the letter      contains      the following       statement,
                          “Its     overall     policy       for these exchanges           was to price        grain at or below
                          local      market prices,           in order       to encourage      sales.”      Again,     an exchange of
See Comment 1             certificates         for the grain            is not a sale.

                          It has been CCC’s policy                to value its grain           at or as close to the local
                          market price         as is possible         and practical        to determine.             Any adjustments
                          in this system,         either      temporary      or permanent,           to account       for factocs,
                          such as transportation              adjustments       and fluctuations             in barge rates,        were
                          made only for the purpose of more accurately                           reflecting        actual    market
                          prices     at the locations           where the grain was stored.                    No adjustments       were
See Comment 2.            made for “buyers’           risk”     although     one would expect             that buyers and
                          potential        buyers who make the market,              factor       their      perception     of risk     into
                          their     bid prices.         Accordingly,       we believe        that the following            statement
See Comment 3.            under the heading           “Policies       and Practices        for Grain Sales”             is inaccurate:
                          “In order        to encourage       exchange      sales,    USDA attempted            to set its prices         at
                          or below the local            market at virtually           every      location       where it stored
                          grain,”      and further,         under the heading         Determining           Grain Sale Prices,         the
                          report      states,    “During      fiscal     years 1988 and 1989, USDA attempted                     to set
                          sales prices         at or below local          market prices.”

                 We believe      a correction     should, therefore,     be made in stating  CCC’s overall
                 pricing    policy     to remove any reference       to a policy which would price  grain
                 below local       market prices.


                 Richard  T. Crowder
                 Under Secretary   for International                       Affairs
                    and Commodity Programs

                             Page 18                                                                       GAO/RCED-90-120          U.S. Grain Sales
               Appendix Ul
               Commenta From the U.S. Department
               of Agrienltnre

               The following are GAO'S comments on the Department of Agriculture’s
               letter dated April 6, 1990.

               1. GAO continues to believe that a commodity certificate exchange is a
GAO Comments   type of sale. (See p. 9.)

               2. GAO has recharacterized the “buyers risk” adjustment. (See p. 9.)

               3. GAO has distinguished between USDA'S overall pricing policy and its
               operating instructions. (See p. 9.)

               Page 19                                       GAO/RCEDBO-120   U.S. Grain Sales
Appendix IV

Major Contributors to This Report

                        Jeffrey E. Heil, Assistant Director
Resources,Community     Robert Robertson, Assignment Manager
and Economic
Development Division,
Washington, D.C.
                        Carl Lee Aubrey, Evaluator-in-Charge
Kansas City Regional    Cecelia M. DiRaimo, Evaluator
Office                  Thomas M. Cook, Evaluator
                        Fredrick C. Light, Evaluator
                        Gregory H. Land, Computer Analyst

                        Harry M. Conley, Statistician
Program, Evaluation,
and Methodology
Division, Washington,

(Omm)                   Page 20                                GAO/RCED-90-120U.S.Grain Sales
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