CHAPTER 1
Agricultural Markets and Risk Management

1.1 INTRODUCTION

Agriculture has always been a core human activity, and over the past century it has made enormous progress in increasing the production of food and agricultural raw materials. Much of the growth is due to specialisation, verticalisation, expansion in land use and water resources, the improvements in farming techniques and risk management. At the same time, food production has become globalised, is dominated by a few producing countries, and has managed to keep pace with population growth and increasing demand.

The large growth in production, verticalisation and industrialisation has led to increased stress on natural resources and a higher vulnerability to unexpected shocks, including natural disasters and epidemic diseases that impact local and global markets. Climate change, including more extreme weather events, and future economic developments are major factors that drive supply and demand for agricultural products and food security. Risk management, including risk transfer, has been an integral part of advancing agricultural production in coping, mitigating and transferring production risks. The (re)insurance industry and capital markets have been developing products to satisfy the growing need of farmers, agribusinesses and governments to transfer risks.

This chapter provides a brief introduction of the main trends that drives demand and supply in agriculture, while trends in the individual sectors are discussed in subsequent chapters. Key risks and risk management options are discussed for producers, agribusinesses and governments.

1.2 TRENDS AND CHALLENGES IN THE AGRICULTURAL SECTOR

At the change of the millennium, there was a reasonably high level of confidence that projected food demand could be met by improved crop production. In more recent years, the consensus is that future food production will struggle to keep up with growing demand. Part of the change in viewing future global food security is that (i) grain prices were initially assumed to decrease in future decades, (ii) rates of economic development in the most populated countries have exceeded initial projections, (iii) the demand for grain, energy and livestock products has increased more rapidly through higher than anticipated increases in purchasing power, (iv) increases in grain yields have been slowing, and (v) climate change is perceived to have larger impacts on most agricultural activities. The global 2017 World Economic Forum () risk survey revealed that (i) extreme weather events ranked as the likeliest of the 10 most likely risks and ranked as number 2 of the 10 risks with the largest impact and (ii) food security was ranked seventh among the 10 risks with the largest impact.1

Generally, a more sustainable approach to agriculture is needed to use land, water and input supplies more efficiently (conservation agriculture) and to increase farm incomes and food security while adapting to climate change through mixed crop-livestock systems and sustainable livestock production (climate-smart agriculture).2 Producing more with fewer resources, reducing greenhouse gas () emissions (global warming) and enhancing the livelihoods of smallholders in low- and middle-income countries remain key challenges for the agricultural sector. Increasing investments that are backed by safety nets of more specialised and verticalised agriculture (risk transfer) is essential to increasing production.

RISING DEMAND

Recent projections on demand and supply conclude that the agricultural sector will need to produce almost 50% more food, feed and biofuel by 2050 compared with 2012.3 This means global markets will need to produce on average one third more, while sub-Saharan Africa and South Asia will need to double production. There is a consensus that the additional food will need to come predominately from yield increases since expansion of arable land is challenging as it is not readily available due to a lack of infrastructure in remote locations and a concentration of available land in only a few countries.

A key driver of demand is a growing human population that is likely to reach 9.73 billion in 2050 and 11.2 billion in 2100. Demand is undergoing structural changes in that increasingly affluent middle classes in low- and middle-income countries can afford to change their dietary pattern towards more resource-intensive dairy and meat products. As the global demand for livestock products is projected to increase by 70% by 2050 relative to 2010, production of feed from grains and cereals has to increase substantially to satisfy demand for meat and dairy products.4 Additionally, the demand for biofuels, which use the same grains and oilseeds as livestock feed, is projected to continue growing and has increased the competition between food and non-food uses of biomass and created an interlinkage between food, feed and energy markets.

After peaks in 2008 and 2011, food prices have stabilised, but price volatility seems to have increased since 2000. Future food price levels are difficult to estimate and depend on how production systems will respond to resource constraints and climate change. On average, imports are 0-20% of domestic food supply, with some large agricultural economies exporting 50% of their domestic production while many African and Asian countries are among net food importers.

CHALLENGED SUPPLIES

While productivity in all agricultural sectors and key markets has significantly improved over the past 50?years, intensification and industrialisation put increased stress on natural resources, while the industry is going through structural changes. In a number of countries, faulty and distortionary government policy incentives led agriculture production to be highly inflexible to market demand. Global free trade and stringent domestic agricultural policies have added to the vulnerability of individual agricultural sectors and producers. A growing number of interrelated and longer-term trends that are likely to include more frequent natural disasters (climate change), rural transformation, stresses on natural resources and financial shocks in the global economy are difficult to estimate, but all have the potential to severely impact all agricultural sectors.

Structural Changes

The agricultural sector has undergone large structural changes, particularly in high-income countries where farming's share of gross domestic product () has decreased and where the industrial and service sectors have become multiple times larger. Under such changes, agriculture has become more efficient, specialised and verticalised, as well as more capital-intensive and better integrated into the wider economy. Consolidation of smaller farms into large operations has gained efficiency while entire supply chains have been developed and integrated. Although evidence is still limited, the same transformational processes seem to appear in agricultural sectors of low- and middle-income countries. As agricultural production bears large risks and low productivity, agriculture results in low income, most of any young rural population preferring to work in other sectors in cities, which leads to a lack of resources in agriculture, aging of farmers and rural-urban migration.

Productivity

The production of most main crop types has increased by more than 300% (1961-2016) as a function of greater arable land, higher yields and advanced production technology (Section 6.2). However, production of main crop types is concentrated in a few countries that dominate global markets, and while yields of key staple crops have doubled in the past 50?years, they have been stagnating since the 1990s at annual growth rates of 1%. While the area equipped for irrigation has increased at annual rates of 1.6% (1961-2009), it is projected to grow at 0.1% in future decades due to competition for water from other sectors.

Industrial-scale livestock production led the doubling of the global livestock population in 2016 compared with 1961. As grain and oilseeds are important components in livestock feed, a larger part in the increase of crop production is explained by the needs of the livestock industry. Increased livestock mobility, global trading and large differences in biosecurity plans of high- and low-income countries have resulted in a higher overall vulnerability to large-scale outbreaks of epidemic diseases (Section 7.2). Future increases in livestock production are thought to come from larger herds rather than from higher per-animal productivity, which in turn requires larger quantities of grains and oilseeds for feed.

Between 1960 and 2016, the production of aquatic animals increased 50 times based on the adaptation of new production methods and the expansion of aquaculture areas (Section 8.2). Aquaculture provided only 7% of fish for human consumption in 1974, which grew to 44% in 2014. However, intensified production has led to overuse of antibiotics in fish feed, polluted waste waters and environmental degradation. Growth rates in aquaculture production are expected to slow due to constraints in water availability and accessibility of high-quality broodstock.

Driven mainly by commercial agriculture in tropical environments, global forest land decreased by 3% between 1990 and 2015, while over the same time, forest plantations increased in size (Section 9.2). With strong demand for forest conversions from population growth...