Risk mitigation
in Agriculture
PRESENTATION: 25 APRIL 2013 RISK CONFERENCE
GRS ACTUARIAL CONSULTING
Agricultural Industry
Wheat Example
Input Suppliers
Production
Trading & Logistics
Processors
Seed; Fertiliser
Farmer
Agricultural
company
Miller
RISKS
Production Risk
Weather
Operational Risk
Labour
Market Risk
Wheat price
Financial Risk
Interest rate
Technology Risk
Farming methods
Regulatory Risk
Subsidies
Infrastructure Risk
Transport
In this presentation we only consider Production Risk for Wheat Farmers, concentrating on weather risk.
GRS ACTUARIAL CONSULTING
Method
Investigate effect
of decisions
Stochastic
model
Analyse and
model risks
Identify
drivers & risks
Deterministic
Model
Define
project
GRS ACTUARIAL CONSULTING
Method
Investigate effect
of decisions
Stochastic
model
Annual profit of
wheat farmer
Compare output of different decisions
(PrecisionTree)
Simulations in @Risk
Analyse and
model risks
Identify
drivers & risks
80% of project. Example used is effect
of weather on crop yields (StatTools
and @Risk)
Crop; Yield; Price
Deterministic
Model
Income statement
Define
project
Estimate effect of decisions on
statistical distribution of annual profit
GRS ACTUARIAL CONSULTING
Define project
6
5
• Farming decisions:
(What/when/how
to plant?
Chemicals etc, etc)
• How to hedge?
Profit
Decisions
4
3
2
1
•
•
•
•
•
•
Expected profit
Standard deviation
Probability of loss
Sharpe ratio
Expected shortfall
Value at Risk
GRS ACTUARIAL CONSULTING
Define project
6
5
• Diversify
• Farming decisions
• Insurance (fire,
hail)
• Weather
derivatives
• Wheat futures
• Tailor-made
product
• Farming
decisions:
(What/when/how
to plant?
Chemicals etc,
etc)
• How to hedge?
• Expected profit
• Standard
deviation
• Probability of loss
• Sharpe ratio
• Expected shortfall
• Value at Risk
Profit
Decisions
Design hedges & analyse effect
4
3
2
1
GRS ACTUARIAL CONSULTING
Deterministic
4
3
2
1
Income statement (R'000)
Income:
Area 1
R 4 089
6
5
Area 2
Area 3
Area 4
R 2 794 R 2 270 R 1 529
Total
R 10 682
Expenses:
Direct (hectare)
Indirect (hectare)
Indirect (ton)
Fixed
R 2 073
R 1 197
R 412
R 276
R 187
R 1 475
R 857
R 295
R 189
R 134
R 1 251
R 731
R 252
R 153
R 114
R 1 027
R 615
R 212
R 103
R 96
R 5 825
R 3 400
R 1 171
R 722
R 532
Pre-tax Profit (before mitigation):
R 2 016
R 1 319
R 1 020
R 502
R 4 858
Deterministic model is simply the farmer’s income statement
GRS ACTUARIAL CONSULTING
Deterministic
Crop and area planted
Total
Area 1 Area 2 Area 3 Area 4
Size (ha)
Hectares planted
Crop
Yield adjustment:
Yield:
1000
1000
352
352
Wheat
1.1
3.52
Yield per hectare:
Price per ton:
3.2
R 3 300
mt
Income:
R 10 682
252
252
Wheat
1.05
3.36
215
215
Wheat
1
3.2
6
5
4
3
2
1
181
181
Wheat
0.8
2.56
Hectares planted x Yield per hectare x Price
R 4 089 R 2 794 R 2 270 R 1 529
GRS ACTUARIAL CONSULTING
Deterministic
Expenses
4
3
2
1
Adjustment Factors
Directly allocatable Costs ( per hectare)
Lime
Fungicides
Herbicides
Insecticides
Other chemicals
Fertiliser: Inorganic
Seed
R 552
R 188
R 344
R 131
R 71
R 1 641
R 473
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
Indirectly allocatable costs (per hectare)
Fuel costs
Maintenance and repair costs
R 704
R 467
1
1
1
1
1
1
1
1
Indirectly allocatable costs (per ton)
Fuel costs
Maintenance and repair costs
Tyre costs
R 155
R 64
R 4
1
1
1
1
1
1
1
1
1
1
1
1
35%
25%
22%
18%
Fixed costs:
R 532 000
6
5
GRS ACTUARIAL CONSULTING
Identify
6
5
4
3
2
1
For this simplified project:
Driver
Risk
Mitigate
Crop yield
Adverse
Weather
Weather
derivative
Selling price
Market
price
Wheat
futures
GRS ACTUARIAL CONSULTING
Available weather data
Analyse & Model 65
4
3
2
1
GRS ACTUARIAL CONSULTING
Effect of Weather on Crop Growth
Analyse & Model 65
4
3
2
1
GRS ACTUARIAL CONSULTING
Effect of Weather on Crop Yield
Analyse & Model 65
Variable name
Description
Weather factor
Regression
Coefficient
May/June Rain
Number of non-overlapping 10-day periods from
1 May to 30 June with less than 17 mm cumulative
rainfall in a 10-day period.
Drought: Early
Vegetative
-454
Jul/Aug Rain
Number of non-overlapping 10-day periods from
1 July to 30 August with less than 21 mm
cumulative rainfall in a 10-day period.
Drought: Late
vegetative
-250
Heat stress
Number of days with maximum temperature above
Sep Tmax>27
(Severity):
27⁰C in September.
Reproductive
Drought: Early
May/June Evap
Cumulative evaporation form 1 May to 30 June
Vegetative
Constant
4
3
2
1
-190
57
5 388
Error term
GRS ACTUARIAL CONSULTING
Analyse & Model 65
4
3
2
1
GRS ACTUARIAL CONSULTING
Modelled
Derived
Rain 1-10 May
Analyse & Model 65
4
3
2
1
Rain 11-20 May
Rain 21-31 May
Number of periods
Rain 1-10 June
with < 17mm
Rain 11-20 June
Y
Rain 21-30 June
I
Rain 1-10 July
Rain 11-20 July
Number of periods
Rain 21-31 July
with < 21mm
Rain 1-10 August
E
L
Rain 11-20 August
Rain 21-30 August
D
Sep days > 27o
May-Jun Cum Evap
Error term
GRS ACTUARIAL CONSULTING
Analyse & Model 65
@ Risk example 1
4
3
2
1
Model weather:
• Fit distributions
• Correlations
• Example of “Batch Fit”
• Graduation of parameters
GRS ACTUARIAL CONSULTING
Analyse & Model 65
@ Risk example 2
4
3
2
1
Model yield:
• Define distributions
• Define Correlations
• Regression model for yield
• Simulate Yield
GRS ACTUARIAL CONSULTING
Weather Derivatives Available
Analyse & Model 65
Example: Drought Certificate – Put Option on Cumulative Rainfall:
Pay R10 000 for every mm rain below 130mm between 1 May and 31 August 2012 up
to a maximum of R1 000 000
4
3
2
1
GRS ACTUARIAL CONSULTING
Weather Derivatives Available
Analyse & Model 65
4
3
2
1
GRS ACTUARIAL CONSULTING
Weather Derivatives Available
Analyse & Model 65
4
3
2
1
1) Very flexible:
•
Put/Call/Exotic
•
Specific weather station or satellite data
•
Any Strike
•
Rain (cumulative or days); Temperature (Max/Min/Ave; Cumulative or days)
2) Can structure a derivative product on any index or combination of indices
3) Underwritten in South Africa; Reinsured in Europe or USA
4) Financial product or Insurance product
5) Industries: Energy; Agriculture; Building Industry; Marketing; Entertainment; ????
GRS ACTUARIAL CONSULTING
Stochastic
@ Risk example 3
6
5
4
3
2
1
• Define mitigation
• Simulated results
GRS ACTUARIAL CONSULTING
Decision
6
5
4
3
2
1
GRS ACTUARIAL CONSULTING
Decision
6
5
4
3
2
1
GRS ACTUARIAL CONSULTING
Decision
6
5
4
3
2
1
GRS ACTUARIAL CONSULTING
Further Results for different levels of mitigation
GRS ACTUARIAL CONSULTING
Agricultural Industry
This presentation only considered Production Risk for Wheat Farmers. Same process can be followed
for all other risks. Derivative products can be structured on any index.
Wheat Example
Input Suppliers
Production
Trading & Logistics
Processors
Seed; Fertiliser
Farmer
Agricultural
company
Miller
RISKS
Production Risk
Weather
Operational Risk
Labour
Market Risk
Wheat price
Financial Risk
Interest rate
Technology Risk
Farming methods
Regulatory Risk
Subsidies
Infrastructure Risk
Transport
GRS ACTUARIAL CONSULTING
Short discussion of market risk for wheat farmers
1) Why is this important to a farmer ?
2) Correlation to Crop Yield ? (RSA wheat: 2m of 700m tons; Consume 3m tons)
3)
International wheat price ?
4) Price of substitutes ?
5) @Risk Example 4 – Shoe how @Risk fit, project and simulate time series
GRS ACTUARIAL CONSULTING
QUESTIONS ?
GRS ACTUARIAL CONSULTING