Manage risk or it will manage you
Tuesday, October 29, 2019
The Canadian pork industry can draw on a range of risk management tools; finding the right mix for your operation is key.
by Geoff Geddes
As bomb defusers can attest, some jobs are riskier than others. While pork producers may not risk life and limb, their livelihoods are on the line when times get tough.
In an ideal world, we could eliminate risk and farming would be stress-free. But, for those forced to live in the real world, the next best thing is risk management.
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"Historically, pork is a sector with a lot of volatility," says Dr. Jean-Philippe Gervais, vice-president and chief agricultural economist at Farm Credit Canada in Regina, Sask. "Because you're dealing with two commodities – pork on the revenue side and feed on the input side – over which you have no control, there is a level of complexity that grain and oilseed producers don't experience.
"Feed and pork prices fluctuate, and the multiple production cycles call for numerous marketing decisions. The pork industry … can benefit greatly from sound risk-management practices."
Apart from the usual risks posed by price volatility, weather and disease, producers today face greater exposure to risk than ever before.
"First of all, pork operations are getting bigger, (so) more total dollars are at stake," says Eric Schwindt, chair of Ontario Pork. "We also have no idea what White House (officials) will do or say on a given day to impact our industry. Then there's the growing threat from African swine fever (ASF), a huge unknown that could have an enormous impact on the bottom line."
The final wild card is trade, Schwindt says. For example, China may need to import pork because of its ASF outbreak but could choose not to buy the meat from Canada and the United States for political reasons.
In a way, the evolution of risk management has mirrored the evolution of pork production in general.
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"Just as the industry has become more sophisticated in areas like biosecurity, we are taking greater advantage of tools and techniques to mitigate risk," says Schwindt.
Get with the programs
The tools available include the suite of business risk-management (BRM) programs funded jointly by federal, provincial and territorial governments.
They offer protection from income and production losses to help farmers manage risks that threaten their businesses.
One such program is AgriStability, which provides support when a large margin decline occurs. AgriStability protects farmers from not only price declines, but also increased input costs and production losses.
"Coverage under this program is unique to your farm history," says Bill Hoar, manager of Western Livestock Price Insurance Program (WLPIP) at Agriculture Financial Services Corporation (AFSC) in Lacombe, Alta. In Alberta, AFSC administers BRM programs as agreed by Agriculture and Agri-Food Canada (AAFC), and Alberta Agriculture and Forestry.
"Producers will receive Agri-Stability payments when their income in the program year drops more than 30 per cent below their historical reference margins," the AAFC website says.
"While participation has been simplified over the years, this tax-based program requires some verification, which can delay the payment process," Hoar adds.
Another federal offering is Agri-Invest, a matching deposit-based program for participants who face small margin declines. Producers can also use the program "to make investments to reduce on-farm risks," the AAFC website says.
"Agri-Invest funds, including the government contribution portion, can be withdrawn at any time," says Hoar.
"The program is simple, responsive, predictable and bankable. Producers often refer to it as a rainy-day fund. The con is that it takes time to build up a balance from which to draw."
Predicting the futures
For those who prefer to go the private route, some intriguing choices exist as well.
"Hedging, futures and options are the main tools available," says Gervais to Better Pork.
"You can use them on your own or through a service provider that pools your resources with other producers and does the work for you. (These tools) can help you lock in a reference price and minimize fluctuations, and you can do it on either the revenue or cost side if, say, you want to secure a certain price for corn or other feed grains."
While producers across the country can use the federal programs and hedging tools, variations exist between provinces in farmers' risk-management approaches.
"In Ontario, most producers have enough land to grow a lot of the feed that they require," says Schwindt. "Feed is your biggest input cost, so growing your own helps hedge the risk."
As well, he says, roughly 30 per cent of Ontario's pigs are processed at producer-owned Conestoga Meats.
"That ownership is a risk-management strategy in itself, as producers are selling pork as well as pigs," says Schwindt. "Typically, those two markets are counter-cyclical, offering natural offsets that aid in minimizing risk."
Ontario's Agricorp-administered Risk Management Program (RMP) also helps livestock producers manage risks – such as fluctuating costs and market prices – that are beyond their control.
"RMP for livestock works like insurance to help Ontario producers offset losses caused by fluctuating commodity prices and production costs. Participants pay premiums based on their insured production and their chosen coverage level," Agricorp's website says.
Out west, AFSC administers WLPIP with joint funding from the federal government and the four western provinces. The program is available in British Columbia, Alberta, Saskatchewan and Manitoba.
"WLPIP offers price protection for calf, feeder and hog producers," says Hoar.
"A producer selects from the available coverage table options for the day and pays the insurance premium. If the settlement price is less than the coverage purchased, an indemnity is paid to the producer to make up the difference."
If the settlement price is above the coverage purchased at the time of expiry, no payment is issued. Hog coverage options for forward prices range from two to 10 months.
This risk management strategy, like others, features pros and cons.
"The program covers risk from a drastic change in price, basis and currency for the product being covered," says Hoar. "WLPIP is voluntary and there is no minimum purchase amount. Another advantage is the timeliness of payments, as this is an index-based program and receipts are not required.
"Keep in mind, however, that there is a premium involved. This has been a challenge for pork producers out west dealing with negative margins and tight cash flows."
Strength in diversity
Though everyone's risk management plan will be different, the best approach is often like a sound investment strategy: don't put all your eggs in one basket.
"We are aggressive traders of futures and options, and are always looking for opportunities to hedge our risk," says Steve Illick, a former director of Ontario Pork and owner of a 1,200-sow farrow-to-finish operation in Orangeville, Ont.
"We also participate in the Ontario RMP and AgriStability. The goal is to look at all the angles, be efficient and put some money away in good years as a cushion for the bad times." Notably, Illick helped create RMP.
Crafting a plan to manage risk can be complicated, so it's wise to keep some basic points in mind.
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"Determine your specific risks that require mitigation," says Hoar. "Financial, credit, price and operational risks are some of the ones you should identify as worthy of analysis."
A firm understanding of your balance sheet and cash-flow statements is critical if you want to understand the risks to your operation.
If you don't feel comfortable working with financial statements, working capital or debt-to-equity ratios, Hoar advises that you seek out someone who is. This individual will be able to stress test your operation and provide markers critical to managing success.
While you must know what risk management is, you should also know what it's not.
"The signal from a risk-management program shouldn't be that we've had a lousy year, but we have this safety valve so let's build more barns," says Illick.
"The purpose is not to put people in a hugely profitable position but to keep the doors from closing," he says. "We don't want to place producers in a spot where the downturn finally ends and they are saddled with a mountain of debt."
Without risk management, you might not have enough good months in the next cycle to overcome previous losses, so you're just drowning in deeper water, he says.
When assessing the value of risk management, you must also consider the bigger picture.
"Agriculture is a huge price-taking industry where you must accept the prevailing prices in the market and are unable to affect them," says Illick. "At the same time, a lot of pinball-machine tilting is going on worldwide; every country has its own rules for playing the game, and it's not always a level playing field.
"When we get into prolonged downtimes in the pork sector, we run the risk of destroying an industry that simply can't wait for the next upswing to come along."
Wading through the options and developing a sound risk-management plan isn't easy, but failing to do so could be hazardous to the health of your business and the industry.
Like defusing a bomb, it's a dirty job, but someone must do this work. BP