Risk management at forefront for famers in 2013

28-12-2012 | |
Risk management at forefront for famers in 2013
Risk management at forefront for famers in 2013

One thing is certain for corn farmers in 2013, and that is the importance of risk management amid extreme uncertainty in yields and revenues, says Chris Hurt, Purdue agricultural economist.

Three years of below normal corn yields and ongoing drought in the western Corn Belt have the potential to skyrocket corn prices in the coming year, but a return to more normal yields nationwide could send corn prices on their largest ever year to year decline. The wide range of possibilities makes growers vulnerable and emphasises the need for a variety of risk management tactics.

“The key to risk management is to protect against the potential bad outcomes, but still leave opportunities to capitalise on potential good outcomes,” Hurt said.

The first way to do that is with crop insurance. Farmers can choose from a variety of coverage types and levels that offer financial protection from low yields and prices. What makes crop insurance so desirable is that it doesn’t limit the revenue a grower can receive if yields or prices are high.

“Crop insurance is hugely important,” Hurt said. “Sometimes growers are hesitant to sign up because the premiums have to be paid regardless of whether coverage is used. But I think a lot more people understand the value after the drought this year. If not for crop insurance, it would be depression in many farming communities right now.”

Marketing decisions also play a role in risk management. Many farmers forward contract portions of expected crop production to lock in forward prices. But while forward contracts protect growers from falling prices, they also prevent gain if prices increase between the times contracts are made and when crops are harvested.

“Growers should forward-contract only a portion so that if prices go up they still have money to gain,” Hurt said. “It’s common to forward contract 25-30% of expected production for new crop delivery.”

Farmers who do forward-contract also can consider purchasing an out of the money call option against their forward contracts. The option allows the opportunity for farmers to gain revenue if prices go up after contracts are made.

An example, Hurt said, is a farmer who opts to sell corn for $6 per bushel in a forward contract. By purchasing a call option on futures at $7.50 per bushel, the farmer could add $2.50 a bushel to their $6 if corn prices ended up moving to $10 because of drought.

Related website: Purdue University

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