The risks in agriculture must be managed, and the responsibility for this increasingly rests with farmers themselves. Risk management is necessary in a number of situations in the agricultural sector. The volatility of prices for all agricultural products has increased steeply in recent years, mainly as a result of the liberalization of agricultural markets. At the same time, policymakers have reduced measures to support and secure markets to a minimum.
The two main risks in agriculture – harvest and price fluctuations – are likely to increase even further in the future. On one hand climate change will lead to a higher number of extreme weather events that may have negative effects on yields, while on the other a worldwide imbalance between supply and demand can be expected in the long term due to structural factors. Demand for food is increasing because of population and income growth, while at the same time water, land available for cropping and energy are becoming scarce. Lower global stocks of commodity crops will further magnify these price fluctuations.
The responsibility for managing risks that used to be reduced by price and market support mechanisms now lies in the hands of the farmers.
Securing cashflow through forward contracts
Risk management doubles as a cashflow safeguarding measure in the agricultural sector. That is why farmers are accessing market-based instruments more often in their marketing activities. In practice, this means that the selling prices are secured at an early stage, and leading farms may have already planned their sales before the seed is even sown.
Risk management instruments for agriculture are viable when they stabilize farm incomes effectively. After all, the necessary investments for renewal and maintenance – and above all farm growth and investments in agricultural machinery and technical progress – all depend on this.
Price and production risks make the strongest impact
Selling price and yield are generally considered to be the greatest risks in the agricultural sector. Risk management starts with decisions at individual farm level. What products are to be produced? How is the land to be divided up between crops? What production factors, machinery and methods are to be used? Risks can generally be reduced by diversifying activities within and outside the farm.
Against this background, marketing in agriculture is in a state of major upheaval. During the 2011 harvest year it has become quite clear in the farming sector that traditional marketing avenues have been consigned to history.
It is evident that farms are now tending to market their products via forward contracts. Increasing price volatility means that marketing is becoming ever more significant for each individual farm.
In the case of oilseed rape, early marketing via forward contracts has been the norm for years now. The classic rule of thumb is to market 30% of the crop after sowing, another 30% in the spring, when it is evident how the crop stands have come through the winter, and the rest during harvest – or, if the price level is appropriate and storage facilities exist, at a later time.
This year we have seen wheat for the 2011 harvest being sold in large quantities in advance for the first time. Driving these forward sales were the price peaks at the beginning of the year when European bread wheat had risen to €280/t on the Matif commodity futures exchange in Paris.
This year German farmers marketed 40% of their grain before harvest via advance contracts, most of which were concluded in February. In many cases the contracts achieved were at least €20/t more than the subsequent harvest price. This relieved the financial burden on farms at a very early date and defused the marketing situation during the harvest because less free wheat had to be sold.
In the meantime various contract models have become established in grain and oilseed trading that are derived from current exchange listing prices. This secures a price level for farmers that can be agreed in advance. However, there is even more to it than that because the credit worthiness of agricultural companies as business partners in major financial commitments, such as purchasing machinery, is also supported.
According to DLG market expert Mechthilde Becker, Safeguarding the cashflow of farms through appropriate marketing models for their crops also brings advantages for the downstream agricultural businesses too, such as financing and handling of machinery purchases. Agricultural machinery dealers can rely more strongly on harvest prices in agriculture being secured at an early stage through forward selling, and this, in turn, allows farm businesses to budget for input costs with much more confidence.
Source: Agritechnica.com
