Crop farming is a risky business, and according to a Purdue Extension agricultural economist, farmers need to successfully manage that risk now more than ever.
There are two distinct types of risk farmers need to be concerned with — operating risk and financial risk. Operating risk is what's associated with grain prices, input costs and yields. Financial risk refers to the way producers finance their business — whether through debt or their own equity.
Both types of risk have intensified in the last few years as the volatility in commodity markets and input prices has caused grain producers' profit margins to become unstable.
"The volatility we've seen in the margins has increased dramatically since the mid-2000s," Mike Boehlje said. "We had a fairly stable set of prices and, more importantly, costs, for most of the 1990s and the first half of the following decade. But since about 2005, we've had significant volatility not only in prices but also in costs, resulting in a dramatic increase in margin volatility."
During the last three to four years, farmers generally have seen much higher grain prices. But Boehlje is quick to point out how quickly that changes.
"Just look at what's happened since August of this year to prices," he said. "We've now taken over a dollar off of corn prices and closer to $2 in some markets."
Even with all of the uncertainty, Boehlje said there are strategies to help farmers manage their risk. The first is by locking in margins when both commodity and input prices are favorable.
"Margins can be protected by using futures markets or contracting to lock in grain-selling prices and by contracting input prices for fertilizer, seed and chemicals," he said.
Second, farmers need to buy crop insurance. Determining the level at which to insure the crop can be a challenge, but Boehlje said he recommends higher levels of coverage right now because of the volatility.
Third, producers need to pay special attention to managing financial risk, especially when it comes to debt.
"Be careful with borrowing money," Boehlje said. "Now may be the time to pay down a little debt and position yourself to be able to handle this increased volatility by not having as much debt."
For those producers who already have long-term debt, Boehlje suggests taking advantage of historically low interest rates by fixing their loan rates.
And, finally, farmers need to use sound operating procedures, take advantage of the best possible seed and technology, and make sure operating costs are under control.
"Don't get lax in cost-control in good times because that can certainly hurt you when times aren't so good," he said.
For more information on risk management, check out the November 2011 edition of "Purdue Agricultural Economics Report" at http://www.agecon.purdue.edu/extension/pubs/paer/. Boehlje and Purdue Extension agricultural economist Brent Gloy discuss the topic at-length in their article, "Managing the Risk - Capturing the Opportunity in Crop Farming."