Risk management in agriculture: Towards market solutions in the EU
Claire Schaffnit-Chatterjee, DB Research (2010)
Volatility in agriculture is expected to increase – production volatility, mostly driven by climate change as well as price volatility, due to higher production volatility, a tight supply/demand balance, volatile energy prices, and other factors. The responsibility to manage risks is increasingly in farmers’ hands. The EU’s Common Agricultural Policy is undergoing major reform towards greater market orientation. Tighter budgets as well as environmental and trade considerations have led to the reduction of market interventions. The post-2013 CAP is currently being discussed along those lines.
Agricultural producers will need to rely more heavily on market-based tools. We investigated the main risk management tools available for EU farmers pre-dominantly in the light of their effectiveness to stabilise their income – also taking into account, wherever possible, their impact on the environment and their effect on food security. EU farmers will benefit from a growing variety of private risk management tools in the future. Most likely, they will increasingly use financial derivatives and insurance products.
The derivatives market is still limited in Europe but developing, and the potential is significant. Public support may encourage the use of derivatives to cope with price volatility by promoting training on these products, ensuring availability of information and ensuring judicious regulation: this will be essential so that commodity derivatives keep serving their purpose of price discovery and hedging.
The insurance market is also expected to develop, to cope with production risk and mitigate financial risk. The current insurance level in the EU is generally insufficient to smooth major income reductions in bad years. For the sake of environmental sustainability, thus long-term food security, it is important to reward farmers for delivering public goods: biodiversity, water quality and availability, air quality, soil functionality, climate stability, etc. Key to shifting to a more sustainable agriculture (until other actions are taken to price these externalities), payments for the provision of public goods can also contribute to stabilising farmers’ income.
All in all, public policy could be most useful in increasing the risk management ability of farmers. Any extension of the public safety net will reduce the incentives for farmers and other agents along the food supply chain to manage their risks effectively through derivatives, private insurance or on-farm strategies like production diversification. Policies need to empower farmers to take their own risk management decisions and to have access to a diversity of instruments and strategies. More direct interventions are likely better kept as a means of last resort and restricted to measures which do not act at the expense of the rest of the world or of environmental sustainability.