De-risking Australian agriculture

Anne Laurie

With a growing consensus that climate change is contributing to more frequent and intense drought periods, support has strengthened to put a long-term, whole-of-agriculture, whole-of-government drought strategy on the national agenda.

In light of the recent push for drought policy reform, the way Australian agriculture manages risk is a pertinent discussion point. In the absence of well-established risk management systems, Australian producers are more exposed to the impacts of frequent drought periods, which can compromise production systems and disrupt food supply chains globally. 

The AFI is currently conducting very timely research into risk management systems in Australian agriculture, focused on two broad avenues of inquiry.

By sourcing available time-series data across commodity sectors, the research seeks to understand the nature of risks faced by Australian farmers and focuses on quantifying the impact of market, seasonal or institutional factors on the total risk profile of a farm business.

The work also aims to identify risk management options available on commodity-by-commodity basis and to assess the adequacy of the options through establishment of a risk option evaluation framework.

While the research is not yet complete, there have been several learnings from the work to date.

It is evident that building resilience and facilitating early intervention is a preferable long-term policy strategy rather than direct support measures. This will involve a strategy that includes a range of Government and industry initiatives, affordable income insurance options, provision of weather derivatives and other financial tools.

Previous Australian Government drought policy has received criticism for crowding out the development of commercial agricultural risk management options. Dismantling the ‘exceptional circumstances’ drought policy created expectations that the commercial provision of risk management tools would be stimulated, however this market is still far from successful.

On the commercial front, the current product offering is diverse with many options developed and offered across sectors. However, development of a well-functioning, mature commercial market for risk management tools does not seem possible without Government incentivisation.

The insurance industry has offered traditional named peril products for decades. Such products have a strong take-up rate, upwards of 75% across Australian agriculture for hail and fire insurance. The multi-peril crop insurance (MPCI) market is still in its infancy. With only a few MCPI products on the market to date, uptake is limited at best. High premium costs have been cited as one of the leading reasons why MPCI has not been more widely adopted. An MPCI rebate scheme was rolled out in 2016 offering eligible Australian farmers $2500 rebates for the upfronts costs of applying for and securing the insurance. However only 69 farmers had claimed the rebates by 30 June 2018.

A 2000 study by the Federal Government MPCI taskforce investigating the feasibility of introducing an MPCI product for wheat and barley concluded that to enable market development Government must participate in subsidising premiums or providing reinsurance provisions in event of catastrophe (Hertzler, Bowe, Barnett, & Cameron, 2003).

Almost every country which has established a mature market for MPCI (e.g. the US, Spain and Turkey) has done so with some level of Government involvement.

Index-based insurance products are very common internationally but have limited availability in Australia. Weather derivatives have provided a useful method to hedge climate risk, such as CelsiusPro who offer weather certificates based on weather index derived from measurement at official weather stations. Their commercial availability demonstrates feasibility but the practicality of such product is more unclear in regards to the high level of basis risk involved (Simmons, Edwards, & Byrne, 2007).

More sophisticated financial risk management products such as futures and forwards have proven to be effective in mitigating and managing market risk. Current trade activity is variable across commodity sectors. The grains industry has a suite of grain marketing tools, including an active futures market which acts as an important price discovery mechanism. There are strong uptake rates in both the livestock and industrial cropping industries, with futures and forwards contracts available for the beef cattle and sheep and trade lamb sectors. To date, uptake has been concentrated to a small number of large corporate style farms who have the capacity to pursue financial innovation. Ultimately, the suitability of futures contracts lies with financial capacity and technical competence.

The research will form recommendations for industry and Government to consider in improving the effectiveness of risk management systems in Australian agriculture. Aside from the role of Government in providing some form of temporary incentivisation to establish commercial risk management product markets, themes have emerged from the work around the provision of underlying infrastructure requirements and addressing data limitations. 

Farming in Australia is always risky and increasing climate volatility makes this worse. The AFI’s research on risk management in Australian agriculture aims to provide evidence to inform robust risk management policy, including drought resilience policy, to strengthen the industry and maintain its viability.

References

Hertzler, G., Bowe, R., Barnett, R., & Cameron, D. (2003, January). Final Report: Multi-Peril Crop Insurance Taskforce.

Simmons, P., Edwards, M., & Byrne, J. (2007). Willingness to Pay for Weather Derivatives by Australian Wheat Farmers.