Production diversification as a risk-mitigation strategy for summer grain and oilseed producers in South Africa

Abstract

Since the deregulation of the South African commodity market in 1997, local agricultural producers encountered increased levels of price risk. This is due to the volatility and competitiveness of market prices and is expected to increase in future. Currently, only a few risk management strategies are available to mitigate price risk. This fact has led to the opportunity to research one of these strategies, namely production diversification. This study examines the value of production diversification as a risk mitigation strategy for summer grains and oilseed producers in South Africa. The value of this strategy was determined by using Markowitz's mean variance optimisation theory as methodology. Twelve different scenarios were developed using this methodology, which consisted of the three rainfall categories in four regions. The findings showed a decrease in price risk by between 3.04% and 7.29%, on average, when using production diversification. Furthermore, this strategy showed price-risk mitigation of up to 21.07% within the scenarios, when all of these findings are compared with non-diversified production. The findings implies that, if an average or above rainfall season is expected, producers in the eastern Free State and the North-West provinces are recommended to allocate higher percentage of total production to sunflower while producers in the north-west Free State and KwaZulu-Natal provinces should allocate lager areas to soya bean. When a below average rainfall seasons is expected, higher allocation to sunflower is recommended to producers in the north-west Free State and North-West provinces. White maize and soya bean are recommended for the eastern Free State and KwaZulu-Natal provinces during a below normal rainfall season. In the scenarios, production diversification increased return up to 21%, with an average increase of between 8% to 17% within the four regions when all rainfall conditions are considered. In case of the maximum Sharpe scenarios, production diversification showed between 0.95 to 2.80 higher Sharpe ratio scores on average within the four regions included in the study. It is recommended that producers collaborate with climatologists and weather forecast organisations to determine the expected rainfall condition, before production planning, to ensure that the optimal allocation for specific rainfall conditions are selected within the applicable region. The results confirm that production diversification can be used as a risk-mitigation strategy for summer grain and oilseed producers in South Africa.