Apr 7 2020
The Relationship Between Trends in Farm Size Growth and Risk for Agribusinesses
There are multiple risks that agribusinesses face as it relates to crop production and grain marketing. Most commonly these risks can be encapsulated within measures for production risk, counterparty risk, control risk, and price risk.
- Production Risk – Variability in production outcomes based on weather, pests, disease, and machinery efficiency, and quality of inputs
- Counterparty Risk – The risk of loss due to acounterparty’s unwillingness or inability to satisfy contractual requirements
- Control Risk – The risk of loss occurring as a result of inadequate systems and controls, human error or management failure.
- Price Risk – Composed primarily of basis risk, futures risk, and spread risk, these reflect changes in market values that impact earnings
There’s an abundance of tools for agribusinesses to reduce grain marketing risks, with complexity varying by the risk type an agribusiness is seeking to reduce exposure to.
Our focus will be on price risk, as agribusinesses continue to identify price risk as one of their greatest sources of risk and/or opportunity. It is important to also emphasize there is a balance between the traditional understanding of risk - which is generally centered around loss aversion – and the definition we accept, which also includes price risk to the benefit of an end user.
Farm Size Growth
Recent trends in farm size and ownership composition also suggest that price risk is coming into focus for an increasingly large cohort of agribusinesses. As shown in Figure 6, the median U.S. farm more than doubled from 589 acres in 1987 to 1,201 acres in 2012. Over that same period of time the average U.S. farm size remained relatively static at around 440 acres.
Intuitively this indicates that the number of small and very small farms has increased, while the size of very large production operations has grown substantially in the past 30 years. This is supported by USDA data Figure 7.
In fact, farm production has continued to shift to larger farms over the past three decades. In 2015, 51 percent of price adjusted U.S. farm production value came from farms with at least $1 million in sales, compared to 31 percent in 1991.
Many factors have contributed to this change in composition over the years, with technology and increased specialization exhibiting pronounced impacts. Specifically, the equipment used by producers these days has enabled significant gains in field task automation, while precision agriculture technologies – inclusive of GPS-assisted vehicle guidance – have allowed field operators to scale the acreage they are able to oversee.
These gains have not come without costs however as technology adoption has contributed to a need for increased capital expenditures (CAPEX). In order to achieve meaningful operational leverage from this increased CAPEX, it is intuitive that there has been a reduction in the number of farms through a wave of consolidation.
An outcome from this wave of consolidation is that agribusinesses are increasingly exposed to price risk, while seeing reduced exposure to production risk, counterparty risk, and control risks that are abated by increased operational capabilities, more well- capitalized counterparties, and enhanced business intelligence.
With price risk increasingly at the forefront of agribusiness operations, it is important that these businesses are well equipped to make better decisions on grain price behavior. In addition to providing actionable insights for grain buyers, the cmdty Grain Index Series is also useful in building predictive models for grain basis. To learn more about how cmdty can reduce price risk drop us a line at email@example.com or reach out here.