Weather Risk for Farmers

I’ve been bicycle touring across America this summer with my lovely wife, Debbie. As you might imagine, we’ve cycled through many areas where farming is king. With gargantuan fields all around us, we knew we’d run into a few farmers! In Belgrade, Montana, just outside of Bozeman, we spoke at length with a dairy farmer. In Iowa, we spoke with a farming couple from South Dakota who grow soybeans and corn.

Our contacts with these farmers suggested that they were not hedging their businesses, but would like to better understand how hedging could help them. Our extended conversation with the South Dakota farmer and his wife really convinced us that farmers bear a lot of risk.

There’s currently a glut of corn on the market, which has caused a drop in price from $7 to $3 per bushel. They are looking at marketing their crops in China and India, where prices are much richer. However, they have a logistical problem. These markets are serviced by ships sailing from the US Pacific coast, and there’s no easy route to ship their grains from South Dakota to the Pacific. Rail cars headed west are hard to come by, thanks in part to this changing marketplace and the oil boom in North Dakota. Meanwhile, the crops can be stored indefinitely only if the weather cooperates.

Which brings us to yet another risk that farmers bear: the weather. This couple’s crops were affected by a drought in 2012, and they are also subject to destruction from hail. The husband showed us a picture that he had taken on his iPhone just the previous evening of a funnel cloud tornado on his property. This got our attention since we’re traveling through the plains on bicycles, and there is often no cover within miles. It was a stark reminder that violent storms can and do arise in this area on a regular basis.

Regarding hedging his weather risk, he explained that there are limited National Weather Station data collection sites in many of the counties in South Dakota. Consequently, many weather derivative market makers will not make markets in many of these areas. He also suggested that there could be significant correlation issues between data collected at what NWS sites are available and weather conditions merely 50 miles away.

So if derivatives aren’t readily available, what about insurance per se? They’ve looked into this. They’ve not hedged their weather risks with insurance because they can’t economically purchase it. There are too many exclusions. When you try to cover all of the weather-related risks, the premiums become prohibitively expensive. I’m not sure whether they’ve exhausted their weather hedging alternatives, but clearly weather risk is a challenging issue for many Midwestern farmers.

When weather risk for farmers comes to fruition, a catastrophe will have long-lasting effect without the proper preparation. Perhaps the most effective weather hedge for farmers, and the most conservative given the premium assigned to these risks, is to self insure the risk over time.

What does that mean…self-insurance? The farmer needs to take a long view, and make a provision for catastrophe. When a bumper crop with healthy pricing showers in healthy profits, some of those profits are needed to underwrite lean years when disaster strikes. If you’re in the farming business, do you set aside funds in good–and average–years for the proverbial rainy day? Sooner or later, the storm will come! You can almost see the clouds on the horizon.

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