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Risk management strategies should match today's volatile crop, livestock markets

Agriculture.com Staff 09/11/2006 @ 1:40pm

The volatility of market prices has increased the need for producers to set aside old marketing habits and embrace risk management strategies, a University of Nebraska-Lincoln livestock marketing specialist says.

"While producers may have historically been most concerned about production risks such as weather, pests and other natural perils, many of the risks now facing their operations relate to management and marketing decisions," says Darrell Mark, livestock marketing specialist.

Many producers aren't accustomed to the idea of a risk-return trade-off, says Al Prosch, UNL Extension educator. Sometimes producers have to give up some price potential just to reduce variability. As a result, this allows them to spend less time worrying about market prices and instead focus on other aspects of their operation.

Mark says a recent survey shows more than 70% of producers cited risk reduction as their top marketing goal. However, fewer than 20% reported using forward contracts, futures hedging or options hedging to lower their risk.

Risk management strategies can guarantee producers a set price for their crops or livestock, Mark says. For example, corn can be grown, delivered and stored, then sold at a price set before the seeds were even planted. Plus it can be done without risk exposure to not producing the crop.

Producers won't lock in the highest price every year. However, by locking in decent prices, producers avoid the risk of a few consecutive poor years putting them out of business, Mark says.

"It gives the producer control because they know the income is there," Prosch says.

Current trends show tightening profit margins, which make it harder for producers to generate precise amounts of revenue to make ends meet. To make the situation more complicated, commodity prices have become more variable due to domestic and international supply and demand factors, Mark says.

One example is the decrease in foreign beef sales due to bovine spongiform encephalopathy. Risk management tools can assure producers a sale price and protect them from large price drops. This is important in modern agriculture because farms are growing larger and producing more, which means losses add up more quickly, Mark says.

Various risk management tools can be used in the same operation. Combinations can be used according to each producer's individual needs, Prosch says. Some contracts are permanent from start to finish, while others allow the producer some leeway when it comes to getting in and out of an agreement.

"It is scary to some producers to make a commitment and guarantee delivery," Prosch said. "But using different tools and insurance together leases the process."

"It is important for producers to learn to use basic risk management techniques and routinely apply them on their operations," Mark said. "Understanding how to combine a myriad of risk management tools now available is increasingly important and can even offer some strategies where the traditional risk-return tradeoff decision is not quite so difficult to make."

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