Agriculture today, and specifically farming, is a business faced with many risks. Issues such as climate change, skills shortage and the growth in the financial markets in terms of commodity products have increased the risks these businesses face. Even though agricultural businesses have more tools available to manage and mitigate risks, this has increased the complexity of risk decision-making.
The winners of tomorrow will be the farmers and agri businesses that are able to manage the risks inherent to their farming systems at a reasonable cost. The result of effective risk management practices in agriculture will have some significant benefits for society as a whole such as:
- ensure food security and stability of prices;
- result in a stable and profitable commercial farmer base to ensure that agriculture is able to provide in the food requirements of the future;
- assist in achieving long-term sustainability of the environment;
- reduce the negative effects of natural disasters (floods, droughts etc) on humans and the environment;
- reduce the need for taxpayer funded emergency aid packages;
- create jobs and sustainable employment; and
- improve the stability of farmer incomes and hence expenditure on farm inputs.
The result is economic stability in rural economies.
2. Primary sources of risk in farming
Although the risks provided below have been separated into varying categories, to assist in the risk identification and management thereof, these risks are not independent. Indeed some of the larger impacts on farming businesses are due to the interaction of the risks. Farmers should therefore approach risk management from a holistic viewpoint and should carefully consider the impact of even improbable risks.
Production risk is defined as the overall uncertainty regarding production. Production risk includes contributing risks such as changes in the weather, crop performance, incidence of pests and diseases and machine efficiency. Currently the observed changes in the global climate are posing numerous and potentially significant risks to the production of crops, particularly those associated with water availability and quality as well as rising temperatures.
Price risk results from the unpredictable and competitive nature of the prices of both farming inputs and outputs. Changing prices of products can be observed on formal markets such as the various commodity and futures exchanges, physical markets where buyers and sellers meet or by way of the transactions between individual parties.
In respect of the prices of farming inputs farmers are largely price “takers”, i.e. they have very little or no influence on the prices they pay and there are few risk management tools or instruments available to manage the risk.
For certain crops and products there exist several financial instruments and products whereby the farmer can effect price risk management. But for some the price risk associated with farming outputs can often only be managed to some extent through an effective marketing strategy. Certain producers can be price “takers” for outputs as well, e.g. milk producers.
Changes in government or to government policies relating to matters such as land reform, employment targets, subsidies, animal welfare, food and safety are often uncertain and may have a large impact on farmers.
Funding and funding liquidity risk
A successful farming business has implemented a well thought through funding plan. Farming businesses can be exposed to cyclical cash flow patterns. Therefore, managing the funding risk of the farming business is crucial. The recent crisis has taught us that any business needs to plan its operational cash-flow and investments properly and put in place a funding plan that provides some comfort on the availability of the funds at the crucial times. Where substantial funding is required this should be secured well-ahead of time, so that the lack of available funding does not negatively impact the business.
The appreciation or depreciation of the South African Rand affects both import and export demand and domestic prices for competitively traded inputs and outputs. Currency risk can also have a significant impact on price risk, particularly where prices of inputs or outputs are referenced against a foreign currency, e.g. the price of maize in US$.
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