Revisiting Risk in 2016
Take a fresh look at methods of managing risk
Gordon Hanson, Senior Vice President – Chief Risk Officer, Farm Credit Mid-America
With a continuing trend of low grain prices and interest rates still hovering near historical lows, we are seeing both critical opportunities and challenges as we move into 2016. While input costs, hedging and diversification are always key management factors, thoughtfully revisiting each in 2016 can help effectively manage the heightened uncertainty and risk in the upcoming production year.
A broader view of input costs
If you had overwhelming evidence that traditional farm input costs were at historically low prices and you had the opportunity to lock in those prices for many years to come, what would you do? I believe thoughtful and proactive producers would jump all over that too-good-to-be-true opportunity. Well, this is exactly the opportunity that farmers have right now with historically low interest rates. You can literally lock in the price of your equipment financing for the next three to seven years, or the price of your real estate financing for the next 10, 20 or even 30 years with long-term fixed interest rates.
While the current window of opportunity to lock in a low fixed rate is still very much open, many economists predict a steady series of continuing interest rate increases. After this current window of opportunity closes, there will be a lot of time for reflection. Some will undoubtedly have painful reflection and ongoing second guessing as variable and adjustable interest rates move higher and higher, while others will have stable, locked-in and historically low interest expense and can focus on managing other volatility and business risks.
Grain price risk — using luck or thoughtful planning
There will always be some crop producers who sell grain in the open market and occasionally fall into high prices that happen to coincide with harvest time or in the summer when they are forced to empty their grain bins. And that may have even happened with increased frequency in recent years. But let’s be objective and honest: Is it luck or a thoughtful pricing and marketing plan?
Luck, even recent luck, is not a sound substitute for a well-reasoned and proactive marketing plan. In contrast, a solid marketing plan with thoughtful forward pricing and hedging strategies provides meaningful price protection and speaks volumes about your commitment to effective risk management.
Diversification — a common risk management technique
Specialize or diversify? Both are valid strategies for farmers. But choose carefully and execute accordingly. For those that choose to specialize, achieving and maintaining high efficiency, including a low cost structure compared to their industry peers, will be key to reasonably assuring long-term viability and success. Higher cost operations will be among the first to succumb to a cyclical industry downturn. Many farm operations will understandably choose to diversify as an effective risk management technique. There are several common diversification strategies, including:
- Produce several different crops to increase annual options and flexibility and minimize the risk of one commodity having abnormally low prices in a given year.
- Engage in both crop and livestock production.
- Supplement farm operations with off-farm income.
Proactive management of interest expense, a sound marketing plan, and thoughtful diversification can all contribute to strong risk management, increased stability and enhanced long-term success.
For more commentary and perspective on trends affecting ag finance, download the Farm Credit Mid-America Insights Report.