Pitfalls for risk management by LDC

[TOM4CWB]

Charlie,

Did you read this news article?

http://www.louisdreyfus.ca/facilities/facilities.cgi?cmd=facility_frameset&facility_id=1 2

The beginning of the article:

"The Canadian Agricultural Income Stabilization Program


Pitfalls for Good Risk Managers

These days, discussions of grain marketing in the context of cash generation for farms fallen on tough times is not complete without some mention of the new federal/provincial farm income stabilization scheme. Here is a program set up to encourage precisely the opposite behaviour to what the government says it wants farmers to do more of, namely price risk management.

Take for example the common risk management tool of incremental selling. Timing sales of a portion of the crop periodically into brief rallies over the course of the year helps move the final price achieved higher within the range of where the market trades.

Eligibility for CAIS renders this tactic meaningless by virtue of its aim to top up farm margins to a 'normal' level when they fall below certain thresholds. Selling at a lower price will generate a bigger payment, selling at a higher price will work against the payout calculation - total farm revenues will be the same either way. So whether a grower uses an incremental selling approach or simply tries to pick the top, the price his or her crops are sold at becomes almost irrelevant..."

Charlie:

At least in the previous NISA program, if a profitable year was at hand, a reward was given in increased savings for a future problem.

I believe we have taken a major step backwards with CAISP.

1. It ties up cash that is needed badly in our farm business.

2. It does not reward good risk management with a financial reward.

3. We are years into the program (Since 2003), and still have no clue how or if it will even work!

What do other people think?

[Braveheart]

Tom, I agree wholeheartedly. The deposit requirement will tie up people's cash. It is not a risk management plan at all, but rather poor excuse for a guaranteed income plan.

The CAISP also creates a situation where, if a farm starts to experience lower returns, well the plan will bump those margins back up. There could be some problems with the farm's capital structure, or debt level, or even it's productive capacity. Having the CAIS Plan discourages people from starting to think about these issues.

CAIS is definitely a step backward from NISA.

[charliep]

With apologies for being the bureaucrat/devils advocate (maybe they are both the same), here are some thoughts.

1) The concern about NISA was that it was simply being used as an investment plan and not being withdrawn by many farmers in low income years.

2) The idea behind CAISP was to build up reference margins in good years and then use this to smooth out the bad years. Good management should contribute to better reference margins and improved coverage in the poor profit years.

3) Are there other programs that should be considered? Example, AFSC revenue insurance program was meant to somewhat mirror the US loan rate. Don't how this concept would be applied to other commodities. Is this an idea?

[TOM4CWB]

Charlie;

I may have missed something on the US loan rate, but do they have to pay $10-30/ac for the loan rate? I did not think they did!

Further my understanding is they know the loan rate before seeding, some years ahead. I understand the farmer picks the day to lock in the loan rate, not the government setting a specific month... as AFSC does.

Could you please explain how the US system works... and how exactly the AFSC crop insurance program models the US system and provides the same type of "level playing field" between them and Alberta farmers.

[charliep]

I highlight I said remotely related.

The US program is the loan rate. It is the guaranteed price the US farmer is able to capture through government support. As an example, the national loan rate for corn is $1.95/bu. Different regions in the US have slightly different loan rates based on location. Prices are set by the government and know to the farmer in advance of seeding. They came down a bit in the past crop year but have been very stable over time.

In the past, a farmer could put their grain (corn in this case) and collect the loan rate for their crop as an advance. If they could sell for more than the loan rate during the year, they would simply pay the loan off. If prices stayed below the loan rate, the farmer would forfeit the corn to the government to put into storage (farmer owned reserve) and keep the loan rate price.

Starting in the mid 1980's, the US government figuring out storing grain this way was kinda stupid and they moved to something else called the loan deficiency payment. This involves following the average price in the different regions and having the government pay the difference between the loan rate/this average price directly to the farmer. No government storage/farmer sells as they wish. The payment is based on total production. These values are calculated daily so the farmer follows the market to maxmize the difference (forget how long they have to do this in the fall/winter) - i.e. the farmer choses the day. Average regional price is based on the daily local cash commodity prices so the farmer is able to pocket any extra money they get through marketing skills (timing cash sales, forward pricing, identity preserved crops, better basis, etc.). There are no premiums involved in paying for this program (free to the farmer).

Revenue insurance in Alberta is also based on a price support level. This level was determine by looking at cost of production, historical prices and US loan rate parity. The revenue insurance price for barley in $2.39/bu as a example. Assuming the farmer has taken out spring price endorsement insurance (a requirement), a farmer can collect half the difference between the revenue insurance price and the calculated AFSC price used in the fall. The payment is made on actual production up to but no more than their crop insurance yield coverage (be it 60, 70 or 80 %). More information than I am providing can be found at

http://www.afsc.ca/NR/rdonlyres/ex2cdwng4eel5zqvuic2ozimqwctq4clwgc7djiivi7adscpmi 5gyvc5f67pfsjeuox4stfbsawqczsanuxvw2irmyg/PI-07 Spring Price End and Rev Ins.pdf

Similarities US loan rate and Alberta revenue insurance - both payout when prices fall below a certain level. Prices are set by government.

Differences.

US pays out the full amount of the difference. Actual yield are used in the calculation. No premiums are paid.

Revenue insurance in Alberta only pays out half the difference. The farmer can only collect on yields up to their crop insurance coverage. The farmer needs to buy spring price endorsement coverage (this may give an extra payment) which involves paying a premium.

I apologize for trying to be short/not covering things in detail but hopefully people get the idea/feel free to ask questions. This is also not meant to support or criticize but rather simply provide information. This discussion which carries forth will deal in these areas.

[charliep]

Under similarities US and Canada - should read price support levels are set by government.

[charliep]

Just a question about the implications on working capital of the CAISP account margin. How big an issue is this? When farmers are having their annual review and establishing their line of credit, is there a discussion of various risk management programs (CAISP, hedging accounts using futures, etc) and implications for cash flow? How well aware are bank service representatives aware of these programs (benefits and costs)?