WithTheGrain: Top tips for managing risk

Author: | Date: 11 Jan 2018

There are four things every grower should consider when managing risk; understanding the volatility or range in enterprise prices and yields, understanding the correlation between different enterprises, diversification and trust in intuition.

Grain & Graze regional coordinator for southern Victoria and high-rainfall zone Regional Cropping Solutions Network lead Cam Nicholson says Australian growers manage risk each year and that it is a natural and accepted part of farming which can, if managed correctly, help generate increased returns.

However, the information available to help growers determine their level of risk based on actuals is limited.

“Risk management requires knowing how often an event happens (the frequency) and what is the impact (the value) when it does happen,” Mr Nicholson says.

“Current communication offerings provide information based on averages, for example average yields, average prices, and average costs. While these convey a value they do not present the extremes, volatility or the frequency which they occur, and therefore they don’t show the risk.”

Recognising the information gap, the GRDC invested in the Grain & Graze projects, where Mr Nicholson and the Grain & Graze team investigated the historic and real-time ranges in yields, volatility and prices. The team generated a new online guidance tool, plus a range of tips to help growers better manage risk.

 

Cam Nicholson

Grain and Graze southern region coordinator Cam Nicholson has developed an online tool to assist farmers in their efforts to manage on-farm risk.

1. Understand the volatility or range in prices and in yields

Growers should investigate historic information and analyse the patterns in price and volatility within and between commodities.

The key drivers of profit in agriculture, namely yield, prices and some costs have a range of values within and between production periods. If we use averages for analysis, it usually overestimates the profits and hides the volatility in those profits.

“Managing risk is not about the middle or the average, it is the opposite. It is appreciating what happens at the extremes, the size or value of these extremes and how often they occur,” Mr Nicholson says.

“Take the time to consider what history tells us about price volatility. Look at the weekly prices for your chosen crop and consider how often you actually get various price points. Compare the weekly prices across a range of commodities such as lentils, oilseeds or wheat.

“While this sounds like a simple tip, it can be quite complicated to decipher actual trends.”

An outcome of the GRDC investment was the development of the Ag Price Guide. This free tool allows growers to apply individual information on price to generate a personalised graph which defines the amount or value of each specified commodity and how often this occurs.

If similar ranges are created by using historic yield information, then the volatility in farm income can be represented.

“This reflects what happens in real life,” Mr Nicholson says.

“For example, there may be high yield but poor prices, so gross income is about average. Less often there will be poor yields and poor prices and conversely we occasionally get high yields and high prices.”

2. Understand the correlation between enterprises

How strongly yields or prices move in relation to each other are referred to as correlations.

Understanding the correlation between different commodity prices and the yields of different crops is essential in understanding and managing risk.

“Using the Ag Price Guide tool, growers can investigate the correlation between commodities,” Mr Nicholson says.

“This can be interesting, for example in some cases when the price of wheat is high the price of barley is generally high, and when prices for wheat are low then barley tends to be low. Other commodities correlate differently, for example the price of lentils is often not strongly correlated to the wheat, barley or oilseed price.

“We found that when prices are correlated you get bigger swings. They tend to be all up at one time or all down at another time.

“If growers wish to manage volatility, they should consider how their enterprises are correlated and choose some commodities which are not strongly correlated, then one can be up when the other is down.

“They might choose to consider more livestock, given that livestock and cropping prices are not strongly correlated. It smooths out the roller coaster ride.”

3. Diversify


Along with considering a range of crop or livestock types which are not generally correlated, growers can diversify their enterprise — a tried and true practice, according to Mr Nicholson.

“Production risk can be managed by diversification in crop and pasture type, enterprise mix, targeting multiple markets and property location,” he says.

4. Trust your intuition around risk

Insights from the Grain & Graze program suggests farmers mainly inform their decisions around risk, based on past experience and intuition or instinct.

“Doing the ‘sums’ to understand the likelihood and consequence is much less common because the information has been hard to come by,” Mr Nicholson says

“The fact of the matter is growers have been managing risk well for years. They should not simply throw out using intuition to analyse risk. Rather, they should keep this as part of the strategy but use the tool to validate their gut instincts.”

GRDC research codes: ORM00004, SFS00020

More information

Cam Nicholson, cam@niconrural.com.au, 0417 311 098

Useful resources

Grain & Graze website

GRDC Project code: ORM00004, SFS00020