Risk Management

Based on Clarkson et al. (2006), there are six requirements that must be met if farmers are to manage risks related to climate extremes, variability and change, ttese include:

• awareness that weather and climate extremes, variability and change will impact on farm operations;

• understanding of weather and climate processes, including the causes of climate variability and change;

• historical knowledge of weather extremes and climate variability for the location of the farm operations;

• analytical tools to describe the weather extremes and climate variability;

• forecasting tools or access to early warning and forecast conditions, to give advance notice oflikely extreme events and seasonal anomalies; and

• ability to apply the warnings and forecasts in decision making.

Farmers have many options for managing the risks they face, and most use a combination of strategies and tools. Some strategies deal with only one kind of risk, while others address multiple risks. Some of the more widely used strategies include (USDA 2006b):

• Enterprise diversification: this is based on the assumption that incomes from different crops and livestock activities are not perfectly correlated, meaning that when some activities produce low incomes other activities will likely offset this decreased earning by producting higher income;

• Financial leverage: this refers to the use of loans to help finance farm operations; higher levels of debt, relative to net worth, are generally considered riskier; the optimal amount of leveraging depends on several factors, including farm profitability, the cost of credit, tolerance for risk, and the degree of uncertainty in income;

• Vertical integration: this can decrease risk associated with the quantity and quality of inputs or outputs since a vertically integrated firm retains ownership or control of a commodity across two or more phases of production and/or marketing, thereby spreading risk;

• Contracting: this can reduce risk by way of guaranteed prices, market outlets, or other terms of exchange which are settled in advance; contracts that set price, quality, and amount of product to be delivered are called marketing contracts, or simply forward contracts; contracts that prescribe production processes to be used and/or specifywho provides inputs are called production contracts;

• Hedging: this uses futures, or options, contracts to reduce the risk of adverse price changes prior to an anticipated cash sale or purchase of a commodity;

• Liquidity: this refers to the farmer's ability to generate cash quickly and efficiently in order to meet financial obligations; liquidity can be enhanced by holding cash, stored commodities, or other assets that can be converted to cash on short notice without incurring a major loss.;

• Crop yield insurance: this pays indemnities to producers when yields fall below the producer's insured yield level; coverage may be provided through such instruments as private insurance or government subsidized multiple peril crop insurance;

• Crop revenue insurance: this pays indemnities to farmers based on gross revenue shortfalls instead of just yield or price shortfalls; for example, in most areas of the United States several federally subsidized revenue insurance plans are available for major crops; and

• Household off-farm employment or investment: this can provide a more certain income stream to the farm household to supplement income from the farming operation.

Most producers use a mix of tools and strategies to manage risks. Since the willingness and ability to bear risks differ from farm to farm, there is usually variation in the risk management strategies used by producers.

Specific risk management measures that can be used include irrigation and water allocation strategies; shelter from wind or cold; shade from excessive heat; antifrost and anti-erosion measures, soil cover and mulching; plant cover using glass or plastic materials; artificial climates of growth chambers or heated structures; animal housing and management; climate control in storage and transport; and efficient use of herbicides, insecticides, and fertilizers. Weather and climatic conditions often determine the type of pests and diseases that will have to be controlled in a given growing season, as well as the efficacy of any control procedures.

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