Ep. 6 Forage Risk Management

 [00:01] Introduction: Welcome to Relevant Risk from the Friar Price Risk Management Center of Excellence, presenting conversations and analysis about risk and risk management for food and agriculture supply chain decision-makers, from farmers to consumers and everyone in between. This is a Relevant Risk.

[00:19] John Anderson: Hello, this is John Anderson, director of the Fryar Center for Price Risk Management at the University of Arkansas. Here with another Relevant Risk podcast. And today we’ve got a familiar guest, James Mitchell. James Mitchell’s a livestock economist in the Department of Agricultural Economics and Agribusiness here at the UofA. James, how are you today?

[00:37] James Mitchell: I’m great. How are you doing today, John? Thanks for hosting tonight – today’s podcast.

[00:42] John Anderson: I’m good. It’s good to have you again. And we also have a guest who is new to the Relevant Risk podcast, our good friend and colleague from the other side of the river, Josh Maples at Mississippi State University. Josh, how are you doing?

[00:55] Josh Maples: Doing well, John. Thanks to you and James for the invite. Good to be with neighbors today.

[01:00] John Anderson: Yeah, it’s good to have you. I was going to say we had two distinguished young livestock economists on the podcast today. But Josh, I’m about to stop calling you a young livestock economist. You’re- you’ve about worn that out, so.

[01:14] Josh Maples: I’ll hold on to it as long as I can. I’m not sure about the distinguished part.

[01:19] John Anderson: Well, that’s a good idea. So we want to talk about something that James and I- James and I have had the opportunity to talk about a time or two on Relevant Risk podcast and- cattle markets and cattle production systems. And James, I think last time last time you and I were on a podcast together, we were talking about the Russian invasion of Ukraine and the market impacts of that situation. And you were talking some about the livestock market. And one of the things you said that I think was really important in that conversation, we were talking about how grain markets were reacting and the overall inflationary environment, what was going on with feed prices. And you talked at that time about how important it was and how valuable in this situation grass was. And the fact that the cattle sector has the ability to turn grass into a usable product is a big deal and a big source of value. We’re going to come in today and talk about that issue again, but maybe more from the production side. So you know, the ability to turn grass into meat is a huge advantage for the cattle industry. In a time like this, when feed prices are high, that grass is a really valuable resource but that only works if you have grass. So what is the production situation out there, say, around the country generally? And then and then also specifically in the Mid-South with respect to forage production right now?

[02:50] James Mitchell: Yes, I think you touched on just how important grass is for this industry. Ultimately cattle producers are grass producers, they’re in the business of grass and kind of to motivate a bit further why we care so much about what the Ford situation is, is really the trajectory of inventory cattle numbers is determined by profitability. And you know, the abundance or the lack thereof of forage. So now, we might have stronger cattle prices this year that might signal let’s expand the herd. But if we don’t have the grass to do it, then ultimately that’s going to be what holds us back from expanding. So that’s kind of another motivating factor why we wanted to visit about this topic and nationally just the quickest way to answer that question. We just to go ahead and browse over the on the U.S. drought monitor to kind of see what the situation is across the country. Parts of the U.S. have been in a multi-year drought. So I’m thinking about areas like Montana, the Dakotas, all the way out west too, you know, Washington, Oregon, California, really, really dry, been really dry for a couple of years now. And looking at what their markets have done since that time of being in a drought, we’ve seen quite a bit of liquidation of cowherds out west because again, there’s just a lack of grass available to carry herds through the grazing season. You know, we’ve been starting to get drier here in the southern plains. So Texas, Oklahoma, Kansas. Why is that relevant to us here in the southeast? Well, for those with a good memory, the last time we had a really big drought that really drove cattle numbers down, it was that 2012, 2013 drought that particularly hit Oklahoma particularly hard. And so looking at what the drought in the fort situation looks like in Oklahoma, Texas and Kansas, this is very relevant for us here in the Southeast. Been pretty good as of recent in the Southeast in terms of drought and what the forward situation looks like. Had some moisture the past couple of weeks that’s been good. Looking at you know the hay situation itself. Hay production last year nationally was down about 3.5%. Kind of a lot of variability in that estimate on a state-by-state basis. But as a whole hay production was noticeably lower. Hay stocks coming into the winter were also lower. So we’re in a tight hay situation currently and that really sets us up to need to have a very productive hay season this summer. That’s a quick and dirty way of saying that we really need to monitor what’s happening in the next couple of months to set us up for the future.

[05:40] John Anderson: All right. Josh, what do you see on your side of the river with respect to hay production? It’s still early in the year, probably at the time of the year when folks are pulling the baler out and getting it greased up and ready to go. But we’re not quite cutting hay yet, I would say. So what do things look like over there?

[05:59] Josh Maples: Yeah. I mean, so we’ve had rain, you know, we’ve had plenty of moisture. And if you look at the drought map, you know, some parts of the Mississippi over towards the Delta region are getting a little bit dry here more recently. The bigger thing, John, when I’m out talking with producers right now is more about how much it’s going to cost to produce hay, this summer. And I think that’s going to be an important piece of this whole picture. You know, it’s one thing when we talk about drought and being able to produce the hay in the places where you still have grass, but we do forage budgets here in the ag econ department. Every year we update budgets for about 25 or 26 different forage production systems. So we’re working on getting those out right now for the 20, we call it the 2022-2023 season for hay looking at around a 30% bump in the cost of production for hay this year. So I think it is I agree with James. I think we’re going to be in a situation where here in the mid-south you know we’re probably going to have some better opportunities for sure than our neighbors to the west of us to take advantage of some of the grass that we have. But the cost of doing so is going to be significantly higher as we look into this summer. So I think that’s kind of a wildcard in this thing as well. Fertilizer is a big driver there, of course, fuel seed if for anybody doing some annual stuff. So I think we’ve got a couple of different things that are going on this year that’s making the impact of drought and potentially prolonged drought more unique or different than we saw back in 2012 when the previous kind of similar one that we’re- that we’ve talked about before.

[07:44] John Anderson: Yeah that’s that’s a really good point. I appreciate you bringing the production budgets into this because that’s something that has really been on our minds across all of our crops and the hay world is not immune to that. I do think you know the conversations I’ve had in the last couple of months with people I think people are looking for ways to economize on fertilizer use, of course, there’s only so much of that you can get away with. But as we look at the hay crop and the forage crop generally, including a harvest through grazing animals, when we think of hay as a kind of alongside our other row crops, it seems to me like we don’t have as many or at least as well-developed risk management options on hay as we have with some of our other crops. Obviously, on the price side, you don’t have a futures market, for instance. Almost nobody irrigates hay. Now there’s some irrigated alfalfa in places, but in general, we think of hay as a non irrigated crop. So it’s almost like we use our forage as a risk management tool within our livestock industry. But there’s not a lot of risk management applied to the hay crop itself, is there? What can producers do about that? What can we do better in terms of risk management? And I’ll open up that to both of you to kind of give me your thoughts on that. And I hope that question makes sense.

[09:17] James Mitchell: You want to start us off there, Josh?

[09:19] Josh Maples: Yeah. So I think you’re exactly right, John. You know, typically a lot of times when you talk to producers when you think about hay, it’s- so it’s a risk management piece in that they don’t exactly know how much they’re going to need to put up because, you know, you’re trying to predict what the winter is going to be like to a certain extent. The cost of alternative feed is really important. So supplemental feed, especially this year, you know, that’s another piece that we didn’t mention earlier. But feed costs are high in general, not just hay. We’re looking at high feed costs. So that’s- you kind of weigh those things, right? You weigh- well I’ve got to feed I’ve got to feed my cattle something. Feed costs are currently projected to be pretty high. You kind of weigh that against your cost to production on the side. And overall, you’re trying to kind of think about how much do I need to have to get me through the wintertime whenever I need this? But you’re right, there are not a lot of price risk management tools. There are some rainfall risk management tools that I think that James may touch on in a minute. But it’s a unique crop, it is a really unique crop that has a lot of uses for cattle producers.

[10:36] James Mitchell: Yeah- yeah- oh sorry

John Anderson: How might somebody introduce those into a risk management strategy for their forage base?

[11:08] James Mitchell: Yeah, so I think backing up a second, Josh made a good distinction there between price risk and production risk. So, you know, we typically think about prices when we’re thinking about risk, but there’s also production risk. And in this example, the production risk is that we’re going to be short on forage, either in the form of pasture or in the form of hay production. And so there’s a risk there, as Josh was saying, trying to almost guess how much hay you’ll need to put up to get through the winter. So that is a risk. And then really historically, the only real tools available to producers to manage forage production risk has really just been the things that we can do on our operations, you know, alternative or you know, very precise grazing management practices. An example, in Arkansas, as the 300-day grazing system that Dr. Gadberry and Dr. Jennings have been doing for years, where you’re you’re trying to maximize the number of days that you’re grazing and minimize the number of days that you’re actually having to feed hay. So those are on-farm management practices that have historically been the only tools available to producers to manage the forage production risks. Starting in about 2007, I think, the risk management agency with the USDA started a pilot program for what’s called pasture rangeland and forage insurance, and that’s a rainfall index insurance product and so it was this program that was introduced in 2007 was made available to producers in Mississippi and in Arkansas and I think about 2012 and what pasture rangeland and forage insurances, PRF for short, is it’s an area-based subsidized insurance program as part of the federal crop insurance program. And you know, most area-based insurances for crops traditionally have been, you know based on county yields and county revenue. PRF is a grid-based insurance program where, NOAA, the national atmospheric group there, NOAA for short, has developed individual 12 miles by 12 miles grids, and for each of those grids they calculate historic rainfall and create an index of that. And then for each year also calculate observed rainfall. And so when you compare observed rainfall in a grid compared to what it’s done historically, if it’s above below or equal to average rainfall, distance insurance product would trigger an indemnity payment. And the idea is that these indemnity payments would help producers offset the increased cost of supplemental feed from a lack of forage production, either in terms of hay production or pastureland. And this program is designed for perennial forages, both hay or just pasture grazing. And so it’s a way to not directly manage forage production risk, but to the extent that precipitation, you know, predicts and correlates highly well with forage production, it’s a way to try and manage forage production risk due to a lack of precipitation. And that’s why it is a rainfall index insurance product.

[14:32] John Anderson: So these index products. Josh not to interrupt, I’ll let you come in in a second. Just to clarify, these index-based products and RMA have several of these, the individual producer doesn’t have to collect any information to participate in these. The index is based on historic averages. And then that is compared to actual and this is, I assume at weather stations, NOAA weather stations is that right, James?

[15:01] James Mitchell: Yeah. So for each grid, they calculate a weighted average based on the four closest weather stations to the center of a grid. And so you’re ensuring, you know, a rainfall index calculated for the grid, not for your individual operation, not precipitation on your operation per se, but for the grid that you’re operating or the acreage that you’re insuring would fall in.

[15:26] John Anderson: So the nice thing about those kinds of products is, again, you know, the individual producer doesn’t have to collect information. This is all sort of sort of automated from the producer standpoint. And they tend to be less expensive than individual coverage products. The downside is if you don’t correlate fairly well with those close weather stations, you might have a loss when the grid doesn’t. But overall, those index products have had have in general been a decent compromise between functionality and quality of coverage. Josh, you wanted to add something to think?

[16:02] Josh Maples: Well, I was just going to say, John, and you said some of it, PRF was one of those products I love talking about in Ag policy class because it’s one of those where you you see the issue that, you know, you’re trying to address. You’re trying to address what happens whenever cattle producers you know, miss out on some expected feed, basically, or forage more is more of the correct term. Well, then how do you create a risk management product to fit that? And so, you know, that’s where you end up with these index-based products because it’s just not feasible to develop a product based around actual production for for these for forage production, especially if you’re trying to do it on a nationwide level. So I think PRF is a really interesting, really interesting tool created to try to address this issue. And, you know, it’s certainly a fun one to talk about from need for a product to what we actually ended up with and how we got there. But you’re spot on in terms of your forage production during the periods that you choose, because you know, you’re choosing these intervals, does that correlate with, or does that correlate with the rainfall that you’re getting in those intervals? If it does, the program works as intended. If it doesn’t, then you’re kind of in a different boat from a risk management standpoint.

[17:23] John Anderson: And James mentioned this. I mean, a lot of these index products have been offered on the county level. And, you know, particularly if you’re out west and you know, you’ve got a county the size of Connecticut, that’s a lot of, it’s a lot of opportunities for things to miss.

Josh Maples: Yeah.

John Anderson: This sub-county, the sub-county units in PRF are an attempt to improve on that, and I think an admirable attempt, to get- 12 by 12 is, 12 by 12 miles is still a pretty big area, but it’s a lot smaller than a county. So, that’s to me in terms of index products and how they work, that’s a pretty substantial innovation within this PRF product. Josh, you mentioned intervals. Would one of you mind expanding on that? How do these purchase intervals work? So you’re talking about rainfall within a grid, but also there’s a time dimension to that that I want to be clear on. What intervals can you purchase this product within?

[18:19] Josh Maples: Go ahead, James.

James Mitchell: Yeah- I’ll s-

Josh Maples: You probably got the more recent update on that.

[18:23] James Mitchell: Yeah, so the way this works is, so for the four closest weather stations to a grid, we’re calculating an expected value for this rainfall index. And we’re collecting that data and we’re calculating those index values in two-month intervals. So there are 11 two-month intervals. January, February, February, March. March, April. April, May. So on all the way to November, December. So we’ve got these rainfall- expected rainfall index values for each of those two-month intervals, which would represent historic average precipitation. Within those two-month intervals, we’re also calculating, you know, the observed or actual rainfall index to compare against to determine whether precipitation was above or below the historical average within those two-month arrivals. And so when you’re looking at this product, basically you’re buying coverage and then you’re allocating that coverage to these to these different two-month intervals And the idea is that you want to select the intervals that that best kind of represent, you know, the risk that you’re exposed to on the forage side. So, you know, for example, if we’re talking about, you know, Bermuda, you know, hay production, you might select those intervals that would correspond to the growing season for that that hay, if we’re talking about, you know, forage production risk, if you’re grazing winter pasture, then you would select the coverage and ensure coverage for, you know, those months or intervals that correspond to those months. And so, it’s basically a way to better match, you know, when you want to actually protect yourself against risk from below average precipitation. And I think the max number you can select is you can select six of those intervals at a maximum. So 12 months. And the minimum that you have to select is you have to select at least two of those intervals to assign coverage to. So four months. And the intervals that you select cannot be overlapping. So you can’t select the January, February and February, March intervals. You could select the January, February and the March, April intervals, for example. So those are just kind of a few specific details on you know why they have intervals, they’re two-month index intervals,  and why they’re important and kind of how you use them within this risk management product.

[20:56] Josh Maples: So, John, you can kind of see the- you can think about that from a producer decision standpoint of, you know, do you pick intervals that match up with particular production periods of your forage, and which periods of your forage production are the most important, depending on what you’re growing? But then there’s also the thought about when do you- when is the most risky time for you to get rainfall.

[21:21] John Anderson: Right. You know, and I would add a layer to that, Josh. You might also think in terms of when are the consequences of a shortfall most costly for you in terms of being able to source feed or what that feed is going to cost. So you know, all of those, all of those parameters come into play in making a decision. But I think that- that- that’s a really good perspective on that, Josh, that the two broad issues of when do I really need the forage and when is the forage most at risk, are going to be the key points to that decision. And the way this is set up, I think the idea is, and James gave a good summary of that, this is a program that really is offered- is it offered all over the country, James?

James Mitchell: Yes s-

John Anderson: A big chunk of it, I’m sure. Okay.

[22:10] James Mitchell: I think as of now, it’s you know, like crop insurance, lower 48 — (inaudible) —

[22:13] John Anderson: Lower 48.

[22:14] James Mitchell: Yeah.

[22:15] John Anderson: So if you think about all the different production systems and all the different production environments and having the flexibility to pick coverage suitable to all of those situations, this needs to be a pretty flexible program. And that overlapping interval structure is really intended to do that. James, you mentioned this is a subsidized product. Do you know off the top of your head, what’s the subsidy percentage on this product?

[22:42] James Mitchell: Yes, so the subsidy is going to range based off on the coverage level you select so you can select coverage from 70% to 90% in 5% intervals, so 70, 75, 80, and the-

[22:56] John Anderson: And so let me interrupt you for just a second. When you say 70 to 90%, you’re talking about 70 to 90% of the index value for that group for that period of time.

[23:05] James Mitchell: Exactly. So you would select, let’s say you select a coverage level of 90. And so if the observed rainfall index precipitation for the policy you’ve purchased is below 90, that would trigger an indemnity. So you’d select your coverage level. So, higher coverage levels are going to be more expensive, but they’re also more likely to trigger an indemnity; it’s going to trigger at 90 before it triggers at 70, right. And so the premiums that you pay are going to be higher for higher levels of coverage and they’re subsidized- I don’t know the specifics- it’s between 59% to 51% of the premium is subsidized, and that premium subsidy is going to range between whatever coverage level you choose. I believe that lower coverages would have a higher subsidy. So about 59% of the premium is going to be subsidized.

[24:06] John Anderson: Okay. That’s a- again- you’re getting into levels of subsidy that are comparable to what you would see on the multi-peril insurance on the crop side, which again is in-in relative terms a fairly recent development in the crop insurance world.

[24:23] James Mitchell: Yeah. I don’t have any historical perspective, on what those subsidies have done in terms of how they changed much. I believe they’ve been right around that level for quite some time though. So again, it makes it more affordable obviously than if it wasn’t subsidized at all.

[24:39] Josh Maples: And John, you know, we’re talking PRF here, but it really kind of complements some of the other products that are out there. You start thinking about something like LRP, which is a market price risk type product. You know.

[24:53] John Anderson: Livestock risk protection.

[24:54] Josh Maples: Yeah, livestock risk protection, which is more of a, you know, managing what the market price risk is. So, you know, we’re talking PRF which is kind of aimed, it is aimed more at a production risk, you know, trying to give producers some options to manage their production risk. You can partner that with something that helps you manage market risk, whether that’s a USDA tool or a private tool of some sort. But all of these are kind of part of that broader risk management structure or picture that the producers generally think about.

[25:29] John Anderson: Right. Good- good point. I appreciate you bringing up LRP. Is the LGM, the livestock gross margin product, still out there? I’m getting a little rusty on some of these products.

[25:41] Josh Maples: Yeah. Yeah, I think it’s still out there.

[25:44] John Anderson: So again, I think our traditional view on the livestock side is that you know, the risk management tools have not been as common. They haven’t been as commonly available or as commonly used as may be on the crop side. But there are some tools out there. I think you guys have given us a good overview of an important one today with PRF and again, we’re not trying to sell PRF to anybody. Our purpose here is strictly educational to make sure that people are aware that there is a tool out there that does deal with a really significant risk for our livestock sector. But if somebody did want to purchase this product or at least look into it, James, where would they start?

[26:27] James Mitchell: Yes. So you’d just go to you know the RMA website to find an insurance agency that would sell this product like you would if you were going to go purchase crop insurance before engaging in purchasing, you know, a PRF policy, I would encourage everyone to visit the USDA Risk Management Agency website- they have a decision tool that’s very, very user friendly that you can sit down with and you can find, you know, we talked about grids. You can use this decision tool to find your grid, it will still spit out historical rainfall index data for your grid, so you can see historically what precipitation has done for that grid. And then you can see how, you know, different decisions about intervals and coverages and etc., it will kind of calculate out what premiums are, expected indemnities, etc. So it gives a good opportunity to get some hands-on experience and see how various aspects of this insurance product actually work.

[27:30] John Anderson: Before- before making a purchase.

[27:31] James Mitchell: Yeah, before making a purchase – and you made a good point about how historically we’ve had a lot of risk management products for livestock producers. One specific detail of this, which I think is relevant to that point is, you know, we have risk management products both price risk, reduction risks, that are becoming more widely available to a broader range of producers. Right? So, we were talking about price risk management there for a while. And historically, you know, you’ve got futures and options and a futures contract is a, you know, the quantity component of that is for a very large operation that might not fit, you know, every cattle operation in the U.S. LRP was novel in that it allows you to insure, you know, a really small number ahead on the risk price risk management perspective. Similarly, with PRF, you don’t have to have a thousand acres to use PRF. You can insure one acre with this product. So it’s something that again, is available to a broader range of people in terms of the number of acres that they’re trying to insure. And you don’t have to insure all the acreage for your operation either. For some other policies, you have to insure everything that you’re planning to crop right. Here, let’s say you’ve got 500 acres, you could just for starting out, just purchase a policy for 50 or 100 of those acres, right? So it’s very flexible in terms of acreage as well.

[28:53] John Anderson: So if, for instance, somebody only wanted to insure their hay ground, they could do that, or if they only wanted to insure their winter annual grazing ground, they could do that.

[29:04] James Mitchell: Yeah. So you just, winter annuals, right? So this is actually for Perennial Forages. RMA just came out with a companion to PRF, which is for annual forages as well. So that’s a newer product. I haven’t dove into the details of that. But, just an extension of PRF insurance, they have created a product now that is specific for annual forages as well, not just perennial forage.

John Anderson: Okay

James Mitchell: But yes, you can ensure just your hay ground. You can ensure just part of your hay ground or all of your hay ground. So more flexibility there on your acreage decisions in terms of how much acreage to insure using this.

[29:41] John Anderson: Very good. Gentlemen I appreciate-

[29:44] James Mitchell: And again, we’re not, we’re not trying to sell PRF to anyone. It’s just it’s one tool in kind of your portfolio of risk management practices for your operation. It’s just one of many things to consider when you put together your risk management plan on your operation as well.

[29:59] John Anderson: Absolutely. And that’s an important point. And that’s typically how risk management proceeds through the use of multiple instruments and multiple strategies. And so this is certainly another one for folks to think about in a space where we really haven’t had a lot of tools in widespread use. So that’s a positive thing. James, anything else you want to add?

[30:21] James Mitchell: I don’t think so. I think that that’s all I can give to the subject at this point.

[30:25] John Anderson: Very good. Well, Josh, as our guest, I’ll give you the last word. Anything you want to say?

[30:30] Josh Maples: This was fun, guys. I appreciate the invite. I’m glad y’all are doing these things.

[30:35] John Anderson: Absolutely, hey, we’ll- now that we know that this sort of works- we’ll have you back sometimes, Josh.

[30:41] Josh Maples: That sounds good.

[30:42] John Anderson: All right. Take care. All right. This is John Anderson with the Fryar Center for Price Risk Management at the University of Arkansas, with the Relevant Risk podcast. And we look forward to seeing you next time.

[30:54] Conclusion: Thanks for listening to the Relevant Risk podcast. Production of the Fryar Price Risk Management Center of Excellence in the Department of Agricultural Economics and Agribusiness within the University of Arkansas system. The Fryar Price Risk Management Center of Excellence carries out teaching activities through the Dale Bumpers College of Agricultural Food and Life Sciences at the University of Arkansas in Fayetteville, and research and extension activities through the University of Arkansas System Division of Agriculture. Visit Fryar, Dash Risk Dash Center dot UADA dot Edu. For more information. Thanks for listening!