Sources of Risk

Probably the most obvious effect of risk is the impact of seasonal weather variation directly on producers. However, the collective impact of weather-related production risk and uncertainty on individual producers and their management decisions affects every link in the marketing chain. Risk in agriculture can be broadly defined into several categories (USDA 2006). ttese include:

Yield risk, ttis type of risk is probably the most commonly thought of risk in agriculture, and it reflects directly the impact of weather on farm operations. Temperature and moisture variation are the typical causes of yield risk, with irrigation being one of the only significant approaches to minimizing the impact of hot or dry conditions.

Production risk. Production risk entails all of the factors that affect yield risk, plus the additional impact that adverse weather may have on producers' ability to plant. Two crop specific examples of planting risk include corn/soybeans in the United States and soybeans in India.

For the U.S., cool and wet spring weather may not allow for timely planting of corn. After a certain date, corn planting becomes infeasible due to the number of days to maturity and, as the spring days pass, the increased likelihood of the crop being affected by freezes in the fall. Initially, producers can consider shorter-season varieties of corn, but eventually, acreage that had been intended for corn may be shifted to soybeans. Conversely, good weather throughout the corn planting season often leads to increased corn plantings at the expense of soybean plantings. Potential corn production is reduced or increased and potential soybean production is increased or reduced depending on the weather.

Soybean planting in India can be significantly affected by the timing and consistency of the monsoon. If the monsoon begins early and rainfall remains relatively consistent, soybean planting often continues beyond initial expectations, with a resulting increase in total area planted to soybeans and a likely increase in expected production. Conversely, a late start to the monsoon with a more erratic rainfall pattern both in terms of timing and distribution may lead to reduced soybean plantings compared with initial expectations, and reduced expected production.

Price risk. Commodity prices are critically important in agriculture, not only to producers, but also to buyers up and down the supply chain. Agricultural commodity prices are highly volatile, subject to sharp increases and decreases over relatively short periods of time and over a wide geographical range depending on both local and global supply and demand conditions. Agricultural prices are determined both locally and in global markets, so agrometeorological conditions, adverse or favorable, in one part of the world can lead to uncertainty and price risk in distant markets.

Agricultural commodities often can be substituted for each other, so conditions favorable or adverse to one crop in one part of the world can affect prices in other commodity markets around the world, which in turn can affect production and consumption decisions in those markets. For example, corn, sorghum, barley, and oats can be substituted for each other in animal feed, and more than half a dozen oilseeds can all be used to produce vegetable oils. Price risk for one commodity in one local market can be increased or moderated depending on local and global market conditions for a variety of commodities over a geographical range of markets.

Income risk. Income is defined as the product of price and production minus the cost of producing. Income risk is caused by the three types of risk previously described, plus additional factors including variation in the price and availability of the inputs required for production. For example, if a particular variety of wheat planting seed is grown in Argentina, and producers in southern Brazil prefer that type of seed, then availability and price of the planting seed will have an impact on the incomes of Brazil's wheat producers. If adverse climate conditions in Argentina reduce production of the planting seed and raise its price, Brazil's wheat producers will have to pay more for the seed, thereby reducing income, or switch to another cheaper variety that may adversely reflect on yield, thereby reducing income, tte global interconnectedness of agricultural markets increases the influence of risk beyond local markets.

While adverse conditions in one area or for one crop may adversely impact prices and incomes in another area, substitution by product and geography can also serve to limit the degree of income risk. For example, 25 years ago, South America was not a global source of soy protein. Livestock producers in Asian markets, for example, were dependent on U.S. production of soybeans to meet protein needs. With soybean production now more geographically dispersed, Asian livestock producers' risk is more limited since a short crop and higher prices in the U.S. may partly be offset by better supplies in South America.

Financial risk. Financial risk for agriculture includes the cost and availability of credit, which are impacted by changes in interest rates. Market forces beyond agricultural markets often influence the level of financial risk.

Institutional risk. Institutional risk reflects the legal and regulatory environment created by Federal, State, or local governments. Environmental laws and regulations, income and business tax laws, and Federal agricultural policy affecting production, trade, and consumption are sources of institutional risk. For example, in the U.S., farm policy in the 1930s defined a set of rules affecting the production of peanuts, tte law specified the quantity of peanut production on a particular farm that would be eligible for a government-supported price that exceeded the world market price, tten in 2002, the law was changed to permit anyone to produce peanuts with the support price significantly reduced for all producers, tte risk was that earlier benefits provided by Federal law were reduced for those who originally held quota rights, which had an effect on expected income for those producers.

For estimating global supply and demand for agricultural commodities, the key risk types are the first four types defined above: yield, production, price, and income risk.

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