As the globalization of world grain production becomes more integrated, various agriculture policies set throughout the world increase price volatility paid to producers in our own backyards. Non-agriculture uses (ethanol, biodiesel), price-stabilizing policies, processing demand and, of course, weather are just some factors contributing to price volatility. In this electronic age, where news is quickly disseminated and available throughout the world, price movements in all commodities have increased.
“As the world agriculture scene continues to evolve, price risk management becomes more important in this increasing volatile environment,” says David K. Wong, market specialist with Alberta Agriculture and Rural Development. “However, some basic principles of price risk management should be adhered to.
“There are various types of risks associated with farming. Most farmers know about production risk, or the risk that their crop will or will not turn out as expected. Farmers can control, to some extent, this form of risk by using sound management practices such as selecting what variety to grow, how much fertilizer to add, when and what to spray, etc. Of course, weather is a major component of this risk factor as well.”
The risk factor that affects the bottom line of the operation is price risk. Price risk is the risk of price movement effecting what you are paid for what you grow. “Price movements are a given, as price will change,” says Wong. “However, it is up to the farm manager to control this risk – hopefully to the downside. There are various farm risk management tools available to price grain at acceptable levels. It is important to manage price risk to some extent, as the prices one receives will affect other risks associated with farming such as gross margin risk, cash flow risk and financial risk.”
Gross margin risk, the difference between the selling price and the cost to produce that unit of production, only includes the cash/direct costs of producing that product. Cash flow risk comes into play when funds are needed to meet payments at a particular time. Money must be available to meet financial obligations as they become due.
“Financial risk, therefore, is the ability of the farm to generate enough profit to cover fixed and variable costs, as well as provide living expenses and monies to cover depreciation. For most farms, this is an annual event,” says Wong. “Farmers will reduce their price risk by selling product. The more you sell, the less you are exposed to this price risk, especially if selling into a profitable market. An acceptable price must be met for growers to lock in a price. At this time of year (summer), decreasing your price risk may result in higher production risks, as production is not in the bin and must now be met to meet commitments. However, production risks here can be alleviated by only pricing an amount of production you know you should achieve.”
After reviewing the various risk management tools available to you, as a grower, it is wise to remember that when entering into a grain selling contract, sound business practices and principles are still required, such as:
- good communication with the buyer
- knowing the implications of a production shortfall
- knowing how solvent the buyer is
- knowing your costs of production and how this contract price will affect your farm
- knowing what quantity and quality is expected, delivery point and delivery period, price formula to determine the net price, what price adjustments will be (discounts/premiums), if there is an act of God clause included, and then having both parties sign and date the contract
Always be sure that if you do not understand the contract – ask questions first and get clarification before signing.