Agriculture and the Risks in Farming - Essay Example

Student Name] [Instructor’s Name] [Class Name] Agricultural Risks Agriculture is a risky occupation. Farmers are confronted on a daily basis with decisions that affect their financial returns and overall welfare. The consequences of decisions are often not known with certainty until long after the decisions occur and the outcomes can be better or worse than expected. What are the main sources of risk in farming, and how might farmers change their management practices to reduce their exposure to production risk and to price and market risk? Introduction Like any other business, agriculture comes with associated risks that affect production, profits and the management of the farming process. In the past farmers have used several techniques which have been useful for the mitigation of these risks but in the modern world, the process of farming risk management is a lot more scientific. However, to better understand and appreciate the process of risk management we must first understand what risks a farmer undertakes when s/he engages in the business of agriculture. Main Sources of Risk Risk can be defined in business terms as the potentially detrimental impact on one or more assets as well as expectations for a business enterprise. Risks can come from engaging in some business activity at the present time or taking up certain positions against future expectations. Fundamentally, risk includes both the expectancy of a certain event occurring as well as the magnitude of positive or negative impact it could have for a farmer. With this meaning of risk, there are some primary risks faced by farmers around the world and they have been summarized by Keith (1999) as: Production based risk Risks Connected with Price Third Party Risks Human behavior related risks There are also financial, legal and other risks which a farmer might be faced with but for all practical purposes, these risks are not unique to the farming process while the five main risks mentioned above are directly connected to agriculture in a significant way. For example, production based risks are a part of daily life for all farmer even though there may be some variations. Farmers in certain locations may be blessed with highly predictable and stable weather as well as ample means of irrigation therefore they may have low production risks. On the other hand, framers who work in the Texas plains may have a very different situation because rainfall is very important for them and even if it is timely there is a risk of other natural calamities (Keith, 1999). Price Risks are based on futures prices, basis rates and spreads. These three function similar to the stock market and are dependent upon social and political factors in local as well as global terms. Futures prices are declared by a board of trade like the Chicago Board of Trade or the Kansas City Board of Trade to the extent that local prices are often directly linked with the prices given at these exchanges. Price risks can also be affected by transportation costs, demand for the produce and other external factors (Keith, 1999). Futures prices can be very volatile in the farming business therefore it is a risk which must be managed. Third Party risks come about when there is a danger that a party to a contract may fail to keep up their end of the bargain. Practically, these risks may not apply to insurance companies or futures exchange contracts since they are backed by many other companies and in some cases the government itself but sometimes in certain contracts, the farmer has to take the risk that a buyer will show up with the money on the appointed date or that a supplier will be able to meet the demand of the producer at preset rates (Keith, 1999). These risks may also be created with human behavior related risks since a farmer can make emotional decisions which make him/her more risk averse than s/he should be (Keith, 1999). At the same time, emotional investment in a crop, a business partner or any other individual can lead to making wrong decisions which can have a negative effect on the output of the farm (USDA, 1998). Human behavior risks can be avoided by good management and rational decision making but it is often more important to handle production and price risks which mitigate and reduce all other risks that a farmer can face. Risk Management While risks can be managed in several ways, farmers can handle both the production risks and the price risks simply by changing and improving the way they handle the management of their farms. Of course there is no singular method which can be given for all farmers across the world to manage their production and price risks, but there are general guidelines in place which show how to manage these risks. Production Risk There is one part of production risk which humans have not yet been able to control i.e. the weather. For all practical purposes weather can not be controlled by the farmers and a farm is as much at the mercy of wind and rain as it is at the mercy of the farmer’s skills (Keith, 1999). Since ancient times, prayers, sacrifices and good luck charms have been used to entice the weather gods and enlist their support for the purposes of agriculture but this production risk remains completely out of the control of individual farmers. However, with the improvements made in science and technology, several other production risks have been greatly mitigated by applying skillful management, the use of modern agriculture related technology, getting an understanding of different types of soils, the use of fertilizers to improve yield and the use of pesticides to decrease losses. These methods give a boost to a farmer’s ability to manage production risks on their own. At the same time, things like crop insurance and government support also help farmers get back on track even after crop failures or other significant losses (USDA, 1998). In fact, insurance comes as the primary tool which can help in managing the risk associated with production because the cost for managing this risk can be calculated far into the future by those who are experts at actuarial science. For most farmers, a good track record of yield and a reputation as a good farmer are important in getting lowered insurance costs since they allow insurance companies to make judgments on how much to charge for insurance. With historically high levels of crop without significant crop failures, a farmer can lower the cost of insurance and thereby lower the cost of managing the production risk associated with agriculture (USDA, 1998). Price and Market Risks Future prices tend to be more volatile than any other risk factor which is experienced at a farm. Management of this risk requires an understanding of the agriculture business as well as an appreciation of all the various financial tools which are used to mitigate the risk. For example, a farmer has to understand how futures prices are established on an exchange and how produce can be sold through a fixed price contract or a hedge to arrive contract. At the same time, farmers can use tools like minimum price contracts which establish a baseline for how much they shall be paid for their produce. Finally, they can also use put options on an agricultural commodities exchange. All these options can be exercised depending on the situation of the individual farmer since farms which have little or no outstanding debt as well as strong past earnings can afford to wait until the asking price for their product has risen to a more profitable point. Even if prices fall, a farm in a strong position can put in another crop while keeping the last harvest in storage. This certainly helps their final position in the market but all farmers may not be able to do so. Other risks like weather conditions or mounting debt may force them into contracts which are barely profitable for the farmer (USDA, 1998). Conclusion While farmers face several risks in the same fashion as other business enterprises, there are some risks which are particular to the agriculture field. In terms of production risks, the only unmanageable part is the risk based on weather but in several other situations, modern technology and tools can help reduce or eliminate the risks completely. Similarly, while price fluctuations will always be a part of the farming business, dealing in futures prices and managing the output of the farm in scientifically sound methods can help farmers make the most of their timer and efforts. The process may not be easy but the rewards associated with it are significant enough to suggest that more farmers should follow the risk management processes associated with production and price. Works Cited Keith, K. Optimal Grain Marketing: Balancing Risks and Revenue. National Grain and Feed Foundation, 1999. United States Department of Agriculture (USDA). Building a Risk Management Plan. Risk Management Agency, 1998. Word Count: 1,504 Read More