Weather certificates provide affordable risk management

Grain Brokers Australia, May 14, 2019

IN RECENT decades, numerous weather and climate-related natural disasters have impacted agriculture across the globe, repeatedly demonstrating how vulnerable the industry is to extreme episodic events. Some research suggests that up to 70 per cent of agricultural risk is related to weather.

Harsh conditions at Cowell, on the eastern Upper Eyre Peninsula of South Australia, meant winter-crop area and yields were greatly reduced in 2018. Photo: Nufarm EP

Given this recent history, and expectations that the frequency and intensity of such events will increase with climate change, it is becoming increasingly important for farmers to proactively manage weather and climate risks in order to farm sustainably and protect their livelihoods.

Droughts, floods, cyclones, hurricanes, bushfires, heat waves, freezes, wind, frost and localised thunderstorms are some of the challenges facing agricultural production and food security in the world today. Local variables such as latitude, elevation, and proximity to water also have a significant influence on the weather and climate at individual locations.

It is often reported that Australian farmers operate in one of the riskiest climatic environments on the planet. While farming businesses face many sources of risk, the unpredictability of Australian weather is probably the most difficult to manage. And any decrease in income at the farm level has a flow-on effect to the entire rural economy.

Some farmers already apply a variety of strategies to help reduce the impact of weather uncertainties. These include farming in multiple locations to spread the exposure geographically, minimum-tillage and chemical-fallow practices to conserve moisture, diversifying crop types and varieties, spreading the planting period to minimise frost risk, seeking alternative sources of income, and purchasing crop insurance.

Other farmers, however, have failed to adopt basic risk management tactics, despite the clear benefits. Reasons for these failures can be attributed to the cost of adapting the farm business, inadequate farmer education and training, a lack of tools to help facilitate the practical application of risk-management concepts, and poor communication between the farming and meteorological communities.

There is no greater reminder of the threat to domestic agriculture than the drought experienced in the eastern states of Australia last season. Grain production was impacted to such an extent that the east coast turned from a net exporter to a net importer of grain to satisfy domestic demand. That drought is yet to break in many regions, and is threatening to severely impact production again in 2019.

So how can grain growers manage the most significant risk to their business? One weather risk-management tool increasing in popularity in Australian agriculture are weather certificates, or weather derivatives. They are relatively simple products that hedge against the risk of weather-related losses. They are based on an index representing a single variable, such as temperature or rainfall.

They are basically financial options that can be used to transfer some of the risks associated with weather variability away from the grain producer and local community, and on to financial organisations that specialise in managing and trading risk and have the balance-sheet capacity to absorb any loss.

Grain Weather Certificates allow the buyer to establish their weather risk versus their input investment, and potential returns relative to the growing season. They can provide income protection against weather conditions such as a dry season, a wet season, temperature extremes such as frost at flowering, extreme heat at critical stages of crop growth, hail, or excessive rainfall at harvest.

One of the big advantages of weather certificates is that they can be tailored to meet the individual growers’ risks and requirements in the course of a season. Conversely, crop insurance is a generic product that doesn’t consider individual needs or geographic anomalies. Insurance tends to cover low-probability, catastrophic weather, whereas derivatives can cover the buyer for higher-probability region-specific events.

For example, a grower may wish to protect against an abnormally dry season. The weather certificate would pay out if the in-crop rainfall was below a pre-specified amount over a pre-specified time period. On the flip side, a farmer may wish to protect against the possibility of quality downgrading at harvest due to rain. The weather derivative would pay out if rainfall was above a pre-specified amount over a pre-specified time period.

And unlike crop insurance, no demonstration of loss is required, and no assessment needs to be made. Once the event has occurred, pay out of a weather certificate is automatic.

It is based on a weather index which is derived from readings at the Bureau of Meteorology weather station nominated when the weather certificate is purchased, as long as there is sufficient historical data to establish an index, this is usually the weather station closest to the grower’s property.

The cost of weather certificates has also been decreasing relative to crop insurance in recent years as their adoption increases across a variety of Australian industries.

It is generally between 7.5pc and 10pc of the value the buyer wishes to protect. The price will vary slightly by region depending on the likelihood of the nominated event occurring.

With the incidence of extreme weather events increasing and margins getting squeezed by rising input costs, farmers need to look at all options available to decrease exposure to the most significant risk they face each season. Weather certificates provide a transparent, easy and cost-effective option to help Australian grain growers protect their livelihood against the vagaries of climate variability and extremes.

This article was contributed by Grain Brokers Australia



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