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Managing risk in today’s agriculture

By Milo Hamilton
Market Advisor
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2009 was a very difficult year for many rice farmers. Through the hardships of price fluctuations and weather problems, it was virtually impossible to foresee the year-end outcome. For those few producers who were able to effectively handle risk in their operation, they were profitable, and it is from those growers that we can learn the lessons necessary to tackle 2010.

From a grower’s perspective, the term “farmer” is perhaps in error in today’s climate. “Agricultural businessman” would be more accurate because it is important that each operation function as a business. This entails planting the crops that will most effectively ensure a profitable return at the end of the year, which are not always traditional crops or the ones that made up the best mix in the past. It helps both the bottom line and the cash flow considerations to know what crops will best fit your rotation and planting mix for the year.

Diversification of crop production helps protect the producer from wide swings in sector-specific crops. If he has split his acreage among two or three different crops, he will not be able to generate astronomical returns in the crop with the best prices. But, he will be able to guarantee positive net returns for the year in whichever crop is most profitable, allowing him to keep farming.

Input prices

Inputs are some of the most common prices to deal with, but can be some of the most fickle ones. We have all seen fertilizer and fuel prices double in cost in a matter of months. Some growers pre-purchased these inputs early in the season to mitigate risks, but most did not. It is a very difficult decision to know when to forward purchase and one that many growers struggle with on a yearly basis.

Whether citing cash flow or tax reasons, or simply that they believe that prices will go down, most producers do not efficiently handle these risk-laden factors. Like establishing planting intentions, growers should look at today’s prices and compare them with the expected sale price. If a profit can be turned, then a large percentage of the producer’s needs should be locked in. This strategy will help the grower minimize the costs of doing business during the year and will help the business to post profits on a consistent basis. When the growers who claim to be able to hit the “top” of the market have long gone bankrupt, the efficient risk manager will still be producing food and fiber. Many of the input prices in this market are hinged to key factors that can be monitored daily – the prices of natural gas (fertilizer and drying costs) and oil (diesel fuel) and the U.S. dollar value (impacts sale and import prices). Monitor these factors and look for trends to pick the appropriate times to manage risk.

Pricing possibilities

As growers look to the new year from a planting perspective, they should focus not only on what the prices of a commodity are at this time, but on what they are expected to be at the time of sale. There are multiple ways to accomplish this: Using futures contracts, forward contracting a portion of expected production and various hedging strategies comprising the most obvious.

Regardless of the way that you choose to handle risk, “locking in” a portion of your crop can help eliminate the need to take out emergency loans at the end of the season to cover short term costs, as well as the weeks of sleepless nights associated with watching market prices. Use the tools available to their fullest extent, and large portions of the crop can be managed in this way, paving the way for consistent gains and positive net returns.

A last word of warning

By utilizing all of these methods, it makes production agriculture look very simple – lock in inputs and prices, grow the crop and take the rest to the bank. Unfortunately, as we all know, it is not quite this simple. The real hinge point is in the “growing the crop” portion of the equation. While all of these methods are available to help a grower ensure a profitable year, the crop must be produced to reap the benefits.

This is where the last consideration comes into play: How much of the risk can be effectively managed? This portion of the production equation must be determined on an individual basis. Look at the best possible scenario a grower could hope to experience during a BAD year and subtract a percentage (grower specific). This will give the producer a good idea of where the key risk management mix should be on his operation. If a grower is uncertain or uncomfortable doing this himself, he can get help from local Extension services or private companies. Regardless of locale or operation, the ability to effectively manage and mitigate risks in today’s agriculture is crucial for long-term profitability.

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