Weather plays one of the largest roles in maintaining farm productivity and profitability, yet it also stands as the variable that farmers have the least control over. Weather is a major element of risk for any agricultural business. Weather Certificates (also called weather derivatives or weather index options) are an innovative tool that will allow farmers to deal with extreme weather events and help to mitigate risks associated with volatile weather patterns throughout the season.
What are Weather Certificates?
Weather Certificates are financial options that provide a form of income protection for organisations and businesses. In the context of farming, income protection can be provided against fluctuations in the weather, such as not enough or too much rain or too high or low temperatures. Weather Certificate payouts are based on a weather index. A weather index is made up of measurements of weather attributes such as rainfall or temperature over a pre-defined risk period, i.e. amount of rain during September. The data that makes up the index comes from an independent source. In Australia it would come from the Bureau of Meteorology. For example an Australian Farmer with a Weather Certificate will have the ability to receive compensation for below average rainfall for a certain period during the year.
Weather Certificates can be structured for any weather risk, so if a farmer is concerned about a particular event, a Certificate can be structured to offset any financial loss that he may suffer as a result of the event. As an example, this could be at the beginning of the season if he is concerned about a germinating or emergence rainfall, a cover for the complete season if spring rains fail to come, a frost or a crop downgrade caused by a rain event at harvest. Whatever his concern is for the season he can hedge it using a Weather Certificate.
In structuring a cover, he firstly decides on the event he wishes to hedge, then picks the risk period the event is likely to occur and finally the trigger points or strike at which he wishes to receive compensation. Most farmers understand the evolving risks they have in each season and would have a clear indication on what is need for a profitable crop and what events will cause financial stress.
Working with a reseller and using historical data, the weather certificate resellers help the Farmer to structure an appropriate cover for the premium the Farmer is willing to pay. Essentially, the process involves the farmer and reseller agreeing on the weather risk, which independent weather station that the measurements will take place on, what threshold or strike needs to happen for a payout to occur, what the risk period is and maximum sum insured will be. Weather Certificates allow Farmers to transfer weather risk from their balance sheet and into the market. If an event occurs that triggers a payout there is no need to file a claim as the payout is automatic.
Applications of Weather Certificates
Weather Certificates can be used across a range of agricultural industries including:
- Grain/ cropping
Weather Certificates can be used to hedge against the risk and volatility in relation to:
- Low/ high Rainfall
- Low/ high temperatures (e.g. onset of frost)
For Farmers in the Grain, Livestock and Horticulture industries, this translates to cost recovery and income protection. Such solutions can be critical for business sustainability.
Weather Certificate example involving a Dry Season for a Grain Grower:
Like any agricultural activity the risks associated with production in Broadacre crops are predominantly found with adverse weather conditions. Lack of rain, or low/high temperatures during the cropping cycle can all have a profound effect on the production and hence profitability of the crop.
Lack of moisture over the crucial emergence period in the life cycle of the plant is critical for a profitable cropping season. If the seed fails to germinate and follow up rain doesn’t arrive on time the plant will die.
The need for innovative solutions in agriculture: Reducing risk in the face of volatility
Weather certificates provide cover for a range of variables that can significantly affect farm productivity and profitability. Farmers can construct and purchase certificates for specific periods and specific thresholds, based on their specific needs and situations. Weather certificates will play an important role in enhancing the risk management strategies of modern farmers in an increasingly volatile climate. Platforms offered by weather certificate providers give farmers the visibility and stability to make informed choices and protect income in a more efficient way.