J A S O N L O U G H R E Y 1 , F I O N A T H O R N E 1 , T H I A H E N N E S S Y 1

1 . A G R I C U L T U R A L E C O N O M I C S A N D F A R M S U R V E Y D E P A R T M E N T ,

T E A G A S C R U R A L E C O N O M Y A N D D E V E L O P M E N T P R O G R A M M E ,

A T H E N R Y , C O . G A L W A Y , I R E L A N D

The Direct Impact of Risk Management Tools on Farm Income: The Case of Irelands Spring Barley Producers

8 9 T H A N N U A L C O N F E R E N C E O F T H E A G R I C U L T U R A L E C O N O M I C S S O C I E T Y

U N I V E R S I T Y O F W A R W I C K

A P R I L 1 3 T H- 1 5 T H 2 0 1 5

Outline

• Objective

• Data

• Methodology

• Results

• Conclusion

Objective

To Estimate the Direct Impact on Farm Income from adopting the Forward Contracting Risk Management tool

What is a Forward Contract?

An agreement to buy a commodity at a certain future time for a certain price

Seifert et al (2004)

Data

• Teagasc National Farm Survey 2004-2013

Retain Farms with five-ten years of data for spring barley production (animal feed)

138 Farms with 5-10 years of historical data for spring barley production (animal feed)

• Teagasc Database of Grain Crop Prices maintained by Fiona Thorne

• FAO Data on International Crop Yields

• CSO Data on Input Costs and Barley Uses

Figure 1: Total Barley Uses by Type Source: CSO

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200

400

600

800

1000

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180019

93

199

419

95

199

619

97

199

819

99

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0’s

To

nn

es

Year

Cereal Products for IndustrialUse (000 Tonnes)

Cereal Feeding Stuffs (000Tonnes)

Cereal Losses (000 Tonnes)

Cereal Seeds (000 Tonnes)

Figure 2: Historical Harvest Area for Selected Crops

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50

100

150

200

250

300

He

cta

re

s 0

00

’s

Year

Winter Wheat

Spring Wheat

Winter Oats

Spring Oats

Winter Barley

Spring Barley

Figure 3: Historical Price Trends for Selected Grain Crops

80

100

120

140

160

180

200

220

240

Eu

ro

Pe

r T

on

ne

Harvest Year

FEED BARLEY

FEED WHEAT

MALTING BARLEY

MILLING WHEAT

Intervention Prices

Source: Teagasc Database of Grain Crop Prices (Thorne, 2014)

Table 1: Census of Agriculture 2010

No. of Producing

Farms

Total Hectares Hectares Per Farm

All Cereals 11,374 273,898 24.08

Spring Barley 9,058 145,960 16.11

Winter Barley 1,499 28,840 19.24

FARM LEVEL DATA

Figure 4: Number of Observations for Spring Barley [Animal Feed] 2004-2013

49

103

58

47

32 25 22

13 22 19

37

0

20

40

60

80

100

120

0 1 2 3 4 5 6 7 8 9 10Number of Recorded Years with Spring Barley

Number of Observations

138 Farms with five or more observations

represent approximately 8,700 Spring

Barley growers

Methodology

Multivariate Empirical distribution based on Richardson et al (2000) Use SIMETAR Simulation Program to simulate 500 alternative

price and yield scenarios based on historical data for crop prices and yields

Assume that Direct Costs are known at sowing time

Arrive with 500 alternative Income Scenarios

Calculate the Direct Profit Impact of Forward Selling 20% of Expected Output (Tonnes) The Direct Impact will vary according to the price and yield

scenario

Figure 5: CDF of the Simulated Feed Barley Price in 2014

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0.900

1.000

90 100 110 120 130 140 150 160 170 180 190 200 210 220 230 240 250

Pr

ob

ab

ilit

y

Price in Euro Per Tonne

PRICE IRFEEDBARLEY

Expected Deterministic

Price of 157 euro

Actual 2014 Price Outcome

Figure 6: The Interquartile Range of the Cumulative Distribution of the Simulated Gross Margin per Hectare in 2014

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Pr

ob

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Euro Per Hectare

Average 25TH Percentile 75th Percentile

THE DIRECT PROFIT IMPACT OF FORWARD SELLING 20% OF

EXPECTED OUTPUT

Figure 7: Cumulative Distribution of the Profit Impact of Forward Contracting [20 Per Cent of Expected Production]

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Pr

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ilit

y

Percentage Share of Average Income

AVERAGE IMPACT ON PROFIT OF ENTERING INTO FORWARD CONTRACT AT 140

AVERAGE IMPACT ON PROFIT OF ENTERING INTO FORWARD CONTRACT AT 150

Figure 8: Cumulative Distribution of the Profit Impact of Forward Contracting [20 Per Cent of Expected Production]

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-2500 -2000 -1500 -1000 -500 0 500 1000 1500

Pr

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Average Direct Profit Impact in EURO AVERAGE IMPACT ON PROFIT OF ENTERING INTO FORWARD CONTRACT AT 140

AVERAGE IMPACT ON PROFIT OF ENTERING INTO FORWARD CONTRACT AT 150

Based on 17.7 ha of

production and 6.1

Tonnes per HA

RISK AVERSION

Farm 1

High Cost

Farm 2

Low Cost

25 HA of Barley Average Yield 7.2 Tonnes Per HA

25 HA of Wheat Average Yield 9.2 Tonnes Per HA

Decoupled Payments of €20,000

Direct Cost Per Tonne of €100 for Barley and €115 for Wheat

Expected Gross Margin =22,000

25 HA of Barley Average Yield 7.2 Tonnes Per HA

25 HA of Wheat Average Yield 9.2 Tonnes Per HA

Decoupled Payments of €20,000

Direct Cost Per Tonne of €80 for Barley and €95 for Wheat

Expected Gross Margin =30,000

Hypothetical Farms

Note: In order to qualify for greening under the next round of CAP, the farmer must add a third crop with minimum of

3HA. This is unlikely to affect the risk aversion results. We assume compliance with EFA requirements.

Conditions of the Simulation

1. Both Farms must commit 20% of Average Expected Output for each crop to a Forward Contract

2. Both Farms must choose the Minimum Forward Price at which they are willing to sell (increments of 5 euro per tonne)

3. The Stochastic Prices and Yields are given by stochastic farm-level model using SIMETAR

4. The constant proportional risk aversion function of Pratt (1964) is applied to each outcome

5. Based on Responses to Forward Contract Question, the risk aversion coefficient is estimated for each farm

6. We Assume Constant Relative Risk Aversion

Table 2: Range of Risk Aversion Values under Two

Hypothetical Farms

Farm

Type

Choice of

Forward

Contract Price

Direct

Cost Per

Expected

Tonne

Risk Preference

Classification

Minimum Relative

Risk Aversion

CRRA

Maximum Relative Risk

Aversion

CRRA

High

Cost

1. 155B 165W

2. 150B 160W

3. 145B 155W

4. 140B 150W

100B 115W

Slightly Risk Averse

Slightly Risk Averse

Risk Averse

Risk Averse

0.01

0.22

0.38

0.51

0.21

0.37

0.5

0.6

Low

Cost

1. 155B 165W

2. 150B 160W

3. 145B 155W

4. 140B 150W

80B 95W

Slightly Risk Averse

Risk Averse

Very Risk Averse

Extremely Risk Averse

0.04

0.39

0.74

1+

0.38

0.73

1+

Note: The estimated average expected prices are 157 euro per tonne for Barley and 165 euro per tonne for Wheat. The estimated

minimum prices for Barley and Wheat are 100 euro per tonne and 105 euro per tonne respectively. The estimated maximum prices are

226 euro per tonne and 242 euro per tonne respectively.

Concluding Remarks

Forward Selling 20% of Output may involve a direct impact of one per cent of expected farm income

High Competitiveness means less vulnerable to shocks More sensitive to the price conditions of the forward contract

Lower demand for forward contract tools unless the forward price is relatively high

More work required on the influence of the Direct Payments on Income Variability and adoption of forward contracts

Does the relatively high presence of livestock offer a good risk management strategy?

Does a progressive farmer necessarily forward sell?

Thank You Questions and Comments are Welcome

Figure 9: Cumulative Distribution of Average Gross Margin Euro per Hectare

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Euro Per Hectare

8 Years or More All Farms