NEWS for North Dakotans
Agriculture Communication, North Dakota State University
7 Morrill Hall, Fargo, ND 58105-5665

October 8, 1998

The Market Advisor: Software Available to Analyze Price and Production Risk

George Flaskerud, Extension Crops Economist
NDSU Extension Service

Responses to price and production risk need to be integrated. The typical practice has been to analyze them separately because of the difficulty in analyzing them in combination. But AgRisk software is capable of carrying out a combined analysis, and it is easy to use.

AgRisk is a computerized model for evaluating the returns and risks of different pre-harvest risk management strategies. It projects the distribution of a farm's gross revenue at harvest time for alternative strategies that can involve one or more marketing tools and insurance products. A comparison of distributions enables a producer to better select the appropriate strategy.

The AgRisk program, developed at Ohio State University, is available free on the Internet using the following address: http://www-agecon.ag.ohio-state.edu/agrisk/agrisk.htm. AgRisk can also be ordered on diskette for $15 from: AgRisk Project, Department of Agricultural Economics, The Ohio State University, 2120 Fyffe Road, Columbus, OH 43210. AgRisk runs on the Windows 95 operating system.

Help screens provide the information necessary to use the model as well as the marketing tools and insurance products. The model also helps with interpreting results and statistical concepts. Terms are defined, and many examples are provided. The help screens serve as the manual. Additional information on marketing tools and insurance products is available on the Internet at the following address: http://www.agrisk.umn.edu/.

The model presents distributions of gross revenue for different strategies. Gross revenue includes crop sales, gains or losses from the use of marketing tools, insurance payments, and accounts for the costs of using the marketing tools and insurance contracts.

Marketing tools represented in AgRisk include the cash forward contract, minimum price contract, futures hedge, put options and call options. Insurance products include multi-peril crop insurance (MPCI), crop revenue coverage (CRC) and revenue assurance.

For demonstration purposes, I'll use a hypothetical farm in Ward County. This farm has 1,000 acres of spring wheat, and the AgRisk results are based on five marketing strategies with no insurance, five marketing strategies with MPCI and six marketing strategies with CRC.

The results derived from AgRisk must be regarded as unique to the example farm and a particular time period. Yield variability can differ considerably even among units on the same farm, and the results were derived for wheat price levels and insurance price levels that prevailed on April 17, 1998. Producers need to analyze individual situations, and they should use individual situation results only as a guide in making decisions.

A distribution of gross revenue gives possible gross revenues each year, along with the chance of each occurring. Table column headings give the probability, or chance, of gross revenue being less than the dollar amount presented in the table for a strategy. In effect, it is the amount at risk for that strategy.

Suppose that in the 10-percent column, a specific strategy, such as buying put options on two-thirds of anticipated production, has a gross revenue of $54,298. This means that 10 percent of the time gross revenue following this strategy will be less than $54,298. To state it another way, gross revenue will be less than $54,298 during one in 10 years. Another view is that 90 percent of the time gross revenue will be equal to or greater than $54,298, or that gross revenue will be equal to or greater than $54,298 during nine of 10 years.

The best strategy for a producer will depend on the level of acceptable risk. The best strategy will depend on the producer's risk attitude, risk-bearing ability and future expectations. A producer who desires to avoid risk, or to have a very high probability of survival, may pick the highest return strategy in the 10-percent column. At the other extreme is the producer who is willing to accept risk, has the financial ability to take risk, and has favorable expectations for yields and prices. This producer should closely examine strategy returns in the 50- to 95-percent columns.

Gross revenue was highly variable for this example farm. It could be as low as $21,588 (5-percent probability level) or as high as $217,061 (95-percent probability level), depending on the level of risk management exercised.

The substantial yield variability on this example farm revealed the importance of insuring the crop. Crop insurance was very beneficial at the low probability levels and reduced gross revenue by a relatively small amount at the high probability levels. The CRC and cash sale strategy resulted in a gross revenue of $43,597 at the 5-percent probability level and $210,302 at the 95-percent probability level.

At the 5- to 35-percent probability levels, CRC generated the most revenue and no insurance provided the lowest. At the 50- to 95-percent levels, no insurance provided modestly higher gross revenue than CRC or MPCI. Risk-averse producers would likely select CRC for this example farm. Only those producers who are significant risk takers and who are financially secure should consider the no insurance strategy.

The results were derived from a one-time preharvest pricing scenario; in effect, all cash forward contracts and put options were initiated at the same time. Further, the variability of prices was considerably less than the variability of yields. Consequently, differences in marketing strategies were small compared to differences between the no insurance strategy and the insurance strategies.

Generally, cash-forward contracting 33 percent and buying put options on 33 percent of anticipated production achieved the highest gross revenue, or close to it, at the 5- to 35-percent probability levels. The cash sales strategy consistently generated the most revenue at the 80- to 95-percent probability levels.

In retrospect, buying put options on 100 percent of anticipated production would have actually netted the producer an additional $9,990, using prices from April 17 and Aug. 28. Gross revenue with put options would have been $94,163, but $84,173 without.

Better pricing opportunities did exist earlier in the year. But even those better prices probably would not have enabled most producers to meet all cash flow obligations. An April deadline for selling was consistent with historical seasonal highs in spring wheat prices . Unfortunately, 1998 did not present favorable opportunities for pricing spring wheat.

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Source: George Flaskerud (701) 231-7377

Editor: Dean Hulse (701) 231-6136