Issue 31
Marketing Guide 2000
 

Prairie Grains is the official publication of the Minnesota Association of Wheat Growers, North Dakota Grain Growers Association, South Dakota Wheat, Inc. and the Minnesota Barley Growers Association.

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Prairie Grains Marketing Guide 2000

Run risk management tools under "what-if" scenarios before use

By Candice Bowman

Crop insurance is but one of the tools that can be used in conjunction with futures and options to help achieve risk management goals. Other areas that may come to the forefront in coming years include things such as revenue assurance, increased use of forward contracting, labor risk management and hybrid cash contracts that themselves combine use of exchange-traded futures and options with other tools.

In some cases those operators trying to manage risk themselves will use futures and options directly as a part of integrated strategies. In other cases, the parties working with them, such as elevators and other contract writers, will be using futures and options to manage the risk that has been transferred in their direction.

Risk management methods such as straightforward futures trades have been used by some in the business to manage risk for more than a century. But the pure newness of many other tools, and new uses for older tools, means there is a great deal about how they will perform that may be unknown.

Therein lies a caution. The newness and new uses of many risk management tools should not necessarily prevent agribusiness from innovating with them and using them to protect profit potential and manage risk. But it should prompt those in agribusiness to explore every possible outcome that they can imagine before diving in.

Stress testing
An astute speaker I once heard at a risk management summit in Kansas City called this "stress testing." In other words, operators considering the use of various risk management tools and strategies should first run the tools through "what if" scenarios to see how they will perform under different market and production conditions.

These "what if" scenarios should include the worst possible situation the operator can imagine encountering. The risk management strategy should then be run through this "worst case" scenario to see how it might perform. While the chances that the "worst case" scenario will occur very likely may be slim, the operator nonetheless will be aware of possible outcomes.

When considering the use of various risk management tools, however, agribusiness operators should not only test them with "worst case" scenarios, but should also look at the other range of possible outcomes. By comparing how a business might have fared using certain tools over an extended period of time to how it might have fared without them, an operator can get some assessment of the value of various tools to his own operation. No two operations are exactly alike, and risk management strategies that may be ideal for one might be of little benefit for another.

Candice Bowman is Vice President of Marketing at the Kansas City Board of Trade.