A new climate for drought policy development

Richard Heath

By the time drought becomes a mainstream issue, resulting in a political imperative to be seen to be doing something, it is almost always at the late stage where emergency measures are required for people who are in desperate need.

It is a sad reality that desperation sells, creating a ripe market for hysterical media coverage demanding support for farms and rural communities in crisis. Of course, no-one is going to argue against helping those in need and indeed the generous Australian spirit has resulted in significant contributions to charity and strong support for government funding allocations. But does this familiar cycle of crisis/hysteria/panicked reaction result in fewer people in crisis when the next drought hits? Almost certainly not.

Droughts are an expected feature of the Australian climate, yet until very recently policy that provided support for affected farmers was based on the idea that droughts were exceptions to the norm. The policy paradigm upheld that droughts were unanticipated, and that exceptional circumstances provisions should be provided to help farmers through these difficult and unpredictable periods. In 2013 the policy framework built around exceptional circumstances declarations was removed in favour of a suite of measures that encouraged preparedness. Unfortunately, the policy response to severe drought periods still seems to carry the baggage of times past; ie. short-term measures designed in a hurry, some would say almost in surprise, as a response to inevitable events.

Climate change is a reality that should be fundamentally changing the way drought policy is developed. One of the most significant impacts of climate change-related impact on Australian agriculture is not that there will be more droughts, but that the ability to recover from droughts is going to be much more difficult due to increased climate extremes. Historically Australia has experienced relatively long and benign inter-drought periods during which financial equity and natural capital lost during drought could be rebuilt. What climate change science tells us is not just that these inter-drought periods will be shorter, but also that those periods will be subject to more extreme weather events such as floods, frost and heat waves.

Policy based on preparedness is a good idea. However, what complete preparedness policy needs to entail is confidence through the provision of tools and research which not just allow for, but actively encourage preparation.  

The remainder of this article explores two areas of agricultural policy which are critical to expectations of preparedness as a viable policy response to drought.  

Farming resilience

The first step in a complete drought policy package is to provide the tools and methods for farm practices to be more resilient. Too often we hear words that are meant to give hope to drought-affected farmers along the lines of ‘there’s so much potential here, we just need to add water’. While well-intentioned, this response is not helpful and reinforces the dangerous attitude that absence of water is an anomaly. Drought policy will never make it rain, but it can enable acceleration of existing research to develop farm practices and technology which can make better use of the rain that does fall.

There has not been enough attention paid during the current drought to the incredible recent improvements in farming practice, resulting in crops being grown and pasture maintained under circumstances that not too long ago would have seemed completely impossible.

Barley yields of three tonnes per hectare achieved with less than 25 millimetres of rain (Figure 1) are an indication of Australia’s world leading research and development for resilient farming systems. Results like this are also a demonstration of the quiet resolve of Australian farmers to get on with implementing solutions to their very real and direct exposure to climate change disruption.


Figure 1: Exceptional yields for less than 25 mm rain. Source: Twitter

Climate change has already had a significant impact on the productive potential of Australian agriculture. A CSIRO study from 2017 [1] estimated that there had been a 27% decline in the water limited yield potential of the Australian wheat crop. The fact that this potential decline has not been expressed in actual yields is due to a correspondingly larger increase in the efficiency of using the water that is available. This efficiency dividend has been delivered through better genetics and better farming practices and is further evidence of the importance of research and development for farm practice resilience. Pasture management has also experienced massive advancements in technology, such as monitoring ground cover and decision support for stocking levels and nutrition. Practices such as drought lotting [2] have resulted in far less degradation to the environment than previous long-term droughts.

A focus on healthy soils, championed by organisations such as Soils for Life [3], is resulting in improved landscapes that are better at storing decreasing rainfall and making that moisture available to more nutritious pastures.

It is important to acknowledge, however, that many practices which improve environmental resilience (such as destocking to preserve ground cover) also come with significant implications for farm businesses. Making early decisions to adjust stocking rates to anticipate conditions has a positive effect on the environment, but results in lumpy cash flow and uncertain future income. Preservation of natural capital does have an ultimate long-term financial reward in the form of healthy and productive landscapes, but policy must account for the fact that there is only so long that businesses can survive without income.

Accelerated research into resilient farming systems that anticipate disruptive impacts on farming systems due to climate change must be a part of any long-term drought measures, along with incentivisation of sometimes-costly shifts to these systems.

Australian agriculture is getting on with implementing practices suitable for a changing and variable climate, regardless of the prevailing policy environment. However, there will always be occasional extended periods of severe drought or other extreme weather events which compromise or quash even the most resilient farming system’s ability to provide sufficient income for business survival. For these occasions a more mature market for financial risk management is required.  

Financial resilience

Financial risk management for Australian agriculture has by default evolved to be relatively conservative. A high level of production and market risk, combined with minimal levels of government support and lack of diverse financial risk management options, has meant that a strong balance sheet and spare borrowing capacity have been the most reliable way to buffer against inevitable downturns.

 


Figure 2: Farm Business Equity. Source: ABARES

The average equity level for Australian farm businesses for all sectors has averaged about 88% since 1990 [4], a relatively high level compared to other sectors of the economy.

Although relying on strong balance sheets can be limiting for capacity to invest in innovation and is a barrier for new entrants, nonetheless it is a sensible and responsible way of guaranteeing financial security in the absence of alternative risk mitigation options. However, this strategy relies on the capacity to confidently rebuild equity between downturns and this is once again where climate change disruption will have an impact.

Climate change will lead to more extremes impacting on production. Droughts will be more severe and periods between droughts will experience other extreme weather events such as floods, frosts and heat waves. Variability in income directly related to weather impact will increase, meaning that the capacity to confidently protect equity will diminish.

There is an alternative option that already exists in many other countries: the availability of a greater range of financial risk mitigation products to help smooth income and provide business security. Multi-peril crop insurance (MPCI) is the product most people think of in this category, however there are other risk mitigation products such as income insurance and weather derivatives that also provide options to manage risk beyond the cropping industry - and for a wider range of income-impacting events.

So why aren’t these products used more widely in Australia? There have been multiple attempts to establish MPCI markets in Australia, although the history of discontinued efforts to create such a market over the past 20 years demonstrates that the domestic MPCI market has existed in a perpetual state of market failure [5].

The next question then becomes whether the Federal Government has a role in helping to resolve that market failure; particularly if Government drought policy relies on preparedness, and financial preparedness will be enhanced by greater availability of these products.

There are several potential reasons for reluctance from our Government (and from some within the sector) to address market failure in agricultural financial risk management. The first is that - based on evidence from overseas - once governments step in to support the establishment of such markets it becomes extremely difficult to extract themselves without triggering substantial market disruption. A second area for concern is that consequences of limiting risk in agricultural production can include increased land prices and the removal of market indicators for inherent risk in production.

Both of these concerns can be overcome with the right structures and support mechanisms.

Currently insurers need to transfer risk for income protection products by setting premiums at levels adequate to cover infrequent and severe events. This means that premiums remain high, uptake remains low and so the market remains immature. If reinsurers’ risk could be capped at a predetermined level, the premium would not need to include the cost of those events. Government funds could be used through a stop-loss mechanism to provide this cap. A stop-loss guarantee such as this in its simplest terms would mean that under defined worst-case scenarios the Government would act as the reinsurer.

By providing a stop-loss guarantee which reduces as the premium pool increases, the Government would only be committed to support until the market matures. When the market is mature, large premium pools collected from across Australia and multiple agricultural sectors would distribute risk and keep farm-level premiums at manageable levels.

A stop-loss approach, compared to direct subsidisation of premiums as happens overseas, is more cost-effective and allows an open and competitive framework within which the market could drive demand and determine the best products and approaches. Given that the stop-loss would only be called on following infrequent and severe events, the cost to Government would be directly comparable to (and could indeed replace) the existing short-term drought funding currently provided.

An open market for financial risk management products would also retain market signals that reflect inherent production risk, i.e. riskier production regions would have higher proportional cost of insurance minimising inflationary risk to land prices.

Conclusion

Being prepared for and resilient to drought is a necessity in Australian agriculture. Avoiding drought-induced farm business financial crises – with all the flow-on effects to communities, mental health and the wider economy – must be the aim of responsible Government policy. But simply saying that farm businesses ‘should be prepared’ without providing the tools and conditions to allow for preparation is not only disingenuous but also irresponsible, and will not reduce the number of people suffering hardship each time there is a drought.

We can already learn a lot from those who are implementing resilient farm practices to maintain production while sustaining the environment through this drought. Climate change science tells us that droughts like this current one will become more common. Researching the practices that are working in this scenario and providing appropriate resourcing to extend and adopt those practices rapidly and extensively are an absolute minimum for legitimate drought preparedness policy.

Financial resilience policy to sustain increasingly variable weather impacted income must also be part of a full suite of preparedness measures. Government must acknowledge that there has been market failure in the provision of income insurance products for agriculture and provide the assistance required to bring this market to maturity.


  1. https://onlinelibrary.wiley.com/doi/full/10.1111/gcb.13604
  2. https://www.mla.com.au/news-and-events/industry-news/getting-drought-lots-right/
  3. http://www.soilsforlife.org.au/home/index.html
  4. http://apps.daff.gov.au/agsurf/
  5. http://www.farminstitute.org.au/BlogRetrieve.aspx?PostID=709582&A=SearchResult&SearchID=9836316&ObjectID=709582&ObjectType=55