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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
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
0
200
400
600
800
1000
1200
1400
1600
180019
93
199
419
95
199
619
97
199
819
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
102
011
20
12
00
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
0
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
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
0.000
0.100
0.200
0.300
0.400
0.500
0.600
0.700
0.800
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
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
-400 -200 0 200 400 600 800 1000 1200 1400
Pr
ob
ab
ilit
y
Euro Per Hectare
Average 25TH Percentile 75th Percentile
Figure 7: Cumulative Distribution of the Profit Impact of Forward Contracting [20 Per Cent of Expected Production]
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6
Pr
ob
ab
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]
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
-2500 -2000 -1500 -1000 -500 0 500 1000 1500
Pr
ob
ab
ilit
y
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
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?