Using climate information to approximate the value at risk of a forward contracted canola crop

In recent decades farmers have used financial instruments such as cash forward contracts to lock-in a price for increasing proportions of their crop through different stages of the production cycle. Given the high variability of the Australian climate this practice has inherent risk with drought induced crop failure being significantly probable. Under failed crop conditions farmers buy themselves out of the contracted position at prevailing prices thereby compounding the financial burden of crop failure. This paper reports on the role of the relatively recent developments in climate prediction, based on the SOI phase system, to develop crop yield probability distributions using regression approximation and to evaluate the Value at Risk of establishing a forward contracted position. Value at Risk is here defined as the 5% interval of the probability distribution of Enterprise Gross Margin and is used to ascertain the capital adequacy of a business in the face of a worst-case scenario.