Despite the good times, risk remains the key feature of farming in Australia

Published 20170306

This week’s annual ABARES Agricultural Outlook conference will no doubt have a strong celebratory mood, given the very positive seasonal conditions that have prevailed over the past twelve months for most of Australian farmers, and the generally strong commodity prices (save for cereals and dairy). However, the defining feature of the agriculture sector in Australia has always been risk, and there is little evidence that concerted efforts are being made during the good time to better prepare the sector for future risks.

Annual returns of farm businesses are the most most volatile of any sector of the Australian economy, and are almost twice as volatile as the average for the economy. Similarly, the volatility of returns experienced by Australian farmers is among the highest in the world, and more than double the volatility in returns experienced by farmers in Europe or North America, as the following graph highlights. 

Consequently, despite the relatively buoyant conditions prevailing for most sub-sectors of agriculture at present, it is fairly safe to assume that conditions will revert to ‘normal’ in the future, and indeed the Bureau of Meteorology has already highlighted that the likelihood of an El Nino event (associated with drought conditions) in 2017 has increased.

Yet of all the major national agricultural sectors globally, Australia possibly has the least developed risk management systems in place. Nations such as the USA and Canada have comprehensive and heavily subsidised multi-peril insurance programs in place that allow farmers to manage cropping risk, as well as deep derivative markets that enable traders and farmers to manage future risk. Europe has heavily subsidised government support programs that result in more than 40% of annual farm income being paid by taxpayers, with specific intervention policies that operate in particular commodity markets. Brazil has a well-developed agricultural bond market, that enables farmers to sell commodity bonds at the start of a production season, generating the funds needed for crop inputs. The bonds can then be redeemed via delivery of  the crop at the end of the season.

Up until 2013, Australia had in place a set of drought support measures, including interest rate subsidies, that operated as a farm of risk management for those eligible to access them. Subsequent to that time, Australian governments have committed to provide greater encouragement to Australian farmers to self-manage risk, rather than rely on public policy measures. Part of that policy has involved changes to the rules associated with farm management deposits, and the most recent statistics indicate that farmers are using those to build financial reserves, and hence be better prepared for a future downturn.

However, a criticism of farm management deposits is that they work for those already in a strong financial position, but not for new entrants to the sector or those who have recently expanded and taken on increased debt, or experienced a period of lower returns. In these situations, the availability of liquid forward markets, or of insurance programs that enable farm business operators to reduce downside risks are preferable. 

Multi peril crop insurance has been much reviewed in Australia, and governments have been reluctant to subsidise premiums to encourage adoption in the same way that north american governments have, noting the difficulty governments have had in reducing those subsidies over time. However, a recent review by the NSW Independent Pricing and Regulatory Tribunal (IPART) concluded that government subsidies to reduce premium costs may in fact be the best way to encourage uptake. The difficulty with multi-peril insurance is that premiums are inevitably relatively high (which discourages adoption) in the initial stages, and it is only when adoption is more widespread that premiums become more affordable. Getting adoption of multi-peril insurance over the initial ‘hump’ is the challenge the IPART recommendation was trying to address.

A challenge with the IPART recommendation is that if it was adopted unilaterally by the NSW Government, it would be very difficult to prevent grain growers from other states taking advantage of the program. A better option would be to implement a national scheme, and a suggestion is that a 150% tax deduction for the cost of multi-peril insurance premiums may be a viable option. This would reduce the effective premium cost, could be phased out over a number of years, and would possibly be cost-neutral given that those insured would generate taxable income in poor years.

Risk management or forward markets for the livestock sector have never developed to any great extent in Australia, although the development of forward contracts in the lamb and cattle feedlot industries do have some potential. Interestingly, the potential development of objective carcase measurement (OCM) in the beef industry may create an opportunity for deeper forward markets to develop, as it would allow the development of a more standardised commodity description system, which is an important requirement for forward markets.

Ultimately, while governments have ‘talked the talk’ about the need for farmers to better manage their own risks, there needs to be some more positive initiatives implemented to make this happen. The alternative will be the inevitable call on taxpayer funds next time a downturn occurs!

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