Farmers Must Manage Risk as Volatility Increases
Posted by Unknown in Risk on Sunday, 12 May 2013
Crop farming
is a risky business, and according to a Purdue Extension agricultural
economist, farmers need to successfully manage that risk now more so
than ever.
There are two
distinct types of risk farmers need to be concerned with - operating
risk and financial risk. Operating risk is what's associated with grain
prices, input costs and yields. Financial risk refers to the way
producers finance their business - whether through debt or their own
equity.
Both types of
risk have intensified in the last few years as the volatility in
commodity markets and input prices has caused grain producer's profit
margins to become unstable.
"The volatility
we've seen in the margins has increased dramatically since the
mid-2000s," Mike Boehlje said. "We had a fairly stable set of prices
and, more importantly, costs, for most of the ’90s and the first half of
the following decade. But since about 2005, we've had significant
volatility not only in prices but also in costs, resulting in a dramatic
increase in margin volatility."
During the last
three to four years, farmers generally have seen much higher grain
prices. But even so, Boehlje is quick to point out how quickly that
changes.
"Just look at
what's happened since August of this year to prices," he said. "We've
now taken over a dollar off of corn prices and closer to $2 in some
markets."
Even with all
of the uncertainty, Boehlje said there are strategies to help farmers
manage their risk. The first is by locking in margins when both
commodity and input prices are favorable.
"Margins can be
protected by using futures markets or contracting to lock in
grain-selling prices and by contracting input prices for fertilizer,
seed and chemicals," he said.
Second, farmers
need to buy crop insurance. Determining the level at which to insure
the crop can be a challenge, but Boehlje said he recommends higher
levels of coverage right now because of the volatility.
Third, producers need to pay special attention to managing financial risk, especially when it comes to debt.
"Be careful
with borrowing money," Boehlje said. "Now may be the time to pay down a
little debt and position yourself to be able to handle this increased
volatility by not having as much debt."
For those
producers who already have long-term debt, Boehlje suggested taking
advantage of historically low interest rates by fixing their loan rates.
And, finally,
farmers need to use sound operating procedures, including taking
advantage of the best possible seed and technology, and making sure
operating costs are under control.
"Don't get lax in cost-control in good times because that can certainly hurt you when times aren't so good," he said.
