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The challenge of risk management in Brazil

In agriculture and livestock, while players look for the intensification of the soil use and producing at decreasing costs, managing risks is essential. In recent years, due to the income oscillation, producers went bankrupt. This is the situation of some companies and it would be expected that they make a good use of tools to manage risks. Some of these companies have increased business possibilities; however, it could have resulted in undesirable financial situations.

 

In the Brazilian agricultural production, the search for crop diversification and the use of soil in the second season seems to be the challenge. However, in many cases, there are no alternatives of crops with desirable liquidity and revenue, and increasing the use of soil may push up financial and economic risks.

 

As said by Albert Einstein, “not everything that can be counted counts and not everything that counts can be counted”. Certainly, it is in this scenario that agriculture and livestock are inserted. There is not only one model to continue producing with sustainability and managing risks; there are some aspects to be considered.

 

It is important to mention that risks are related to the production, prices or to the market, to financial, institutional or human issues. Among strategies considered traditional to manage risks, the first to mention is the diversification of crops and activities. The crop diversification favored the soil fertility, the control of pests and diseases and the lower dependency on only one market to sell the production. For Brazil, the challenge is the crop rotation and succession planting. Producers always evaluate the productive system and, in this case, consider more possibilities of succession planting than crop rotation.

 

In terms of productive system, main crops regarding the area in Brazil are soybean and corn. However, evaluating financial return, the second corn crop has low and sometimes negative profitability. Taking into account risks of negative margins on total costs, the probability is higher than 50%. Then, why does the production continue? Certainly, there are aspects related to agronomic matters, cash flow and liquidity, among others, which affect the decision. However, not everything is taken into account.

 

On the other hand, one of the most profitable systems over the last 10 years in temporary crops for grains and fibers is the succession of soybean and cotton, used specially in Mato Grosso and in some regions in Goiás and Mato Grosso do Sul. Then, why is not the soil use improved with second cotton crop? Moreover, why does cotton represent roughly one third of the agricultural area, on average, in each farm? In this case, high operational costs by area unit and the need of specific fixed assets (sunk costs), among other aspects, affect the decision to enter in the activity, to expand or decrease the area and decisions to quit the activity – barriers to entry and to exit.

 

The diversification of trades and the vertical integration are other aspects of the traditional strategy, aiming to operate in distinct markets and the value aggregation. However, this is not an easy task in agriculture and livestock. In general, specialization of trades is observed, rather than diversification.

 

The use of anticipated trades (forward contracts), future markets and hedge is another traditional aspect in risk management. In Brazil, tools are implemented when players apply to obtain credit to plant a new crop or for a livestock activity, but only a small part focused on hedge. As a result, forward contracts and barter are the most used alternatives. The use of futures market to hedge ends up taking the back seat.

 

The crop insurance is another risk management tool in agriculture and livestock. For those who obtain credit related to Brazilian government’s Agriculture and Livestock Plan, there are some insurances related. Still, there are only a few options in the private sector and, when available, producers consider that they have high costs. The revenue insurance, which must be a priority, is minimal over the planted area in Brazil.

 

Anyway, the variety of risks that agriculture and livestock are exposed to leads the business to face challenges besides weather, diseases and crop/activity cycle. Although the technological development provides more and more dynamic tools, knowing what to integrate and when is not an easy task.

 

Throughout the years, producers have managed risks and, fortunately, adjusted their activities. When the statistical evaluation about production efficient frontier positioning is performed, producers’ portfolio, on average, has good aspects, or at least indicate the need of few adjustments. However, it is hard to measure at which costs they have reached a point considered adequate in terms of risks and return. 

 

In this aspect, there are some examples: the second corn crop planting in the Central-West Brazil, with only 40% of the first crop area, and the fact that more than 80% of the cotton area in Mato Grosso is also second crop. Evaluating risk and return, the second corn crop planting tends to push up the risk of the productive system, while the second cotton crop tends to mitigate the risk. Anyway, regarding risk management, statistical evaluations for Mato Grosso, for instance, suggest that the use of soil needs to be performed with both soybean and cotton in the first crop, likewise with corn and second cotton crop. It is the diversification prevailing, because “not everything that can be counted counts and not everything that counts can be counted”.

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