Risks in Hemp Production

Risks in Hemp Production
Extension Educator and Agricultural Systems Economist
Hemp plants in field.

Matteo Paganelli/Unsplash

The 2018 Farm Bill amended the Controlled Substances Act to allow commercial production of industrial hemp (hemp with less than 0.3% THC by dry weight). Legalization of hemp cultivation has produced a large interest in it as an alternative crop for Nebraska farmers. Anecdotes of very high profits from CBD hemp production has also interested some in the processing industry to build extraction and processing facilities. The development of a hemp production and manufacturing base should be tempered by careful analysis. This article will cover some of the economic considerations of hemp cultivation.

Risks in Agriculture

Five risks are inherent in production of any agricultural  including industrial hemp. Production risk is the first of these risks. Production risk comes from lower yield or quality than expected. 

Weather, disease and insects are common causes of production risk. Machinery problems may also induce production risk. The second common risk is marketing. Price and the ability to sell the commodity or produce will vary with the specific product. Significant marketing risk presents with a new agricultural product. Marketing chains and price discovery are well understood for something like corn, soybeans or wheat. But regional marketing challenges may present for something like wheat or milo if these aren’t commonly grown in the area. Hemp is another uncommon agricultural product that might have marketing challenges. Financial risk is the third common risk in agriculture. Financial risk can present due to higher than expected expenses, lower yields, lower prices or poorer quality all of which reduces cash flow and profitability. Legal risk is the fourth risk that occurs in agriculture. This may take the form of nuisance lawsuits, lack of permits, accidents or any other occurrence that puts one in the position of dealing with the legal system. The final risk in agriculture is human risk. The loss of a key employee or manager can disrupt the management or reduce financial outcomes on a farm or ranch.

Profitability Risk in Industrial Hemp

Greater profitability of hemp, compared to other Nebraska crops in recent years, has attracted interest in hemp production. Hemp budgets and models authored at several state universities show profit possibilities but with high variability. The variability is in part due to the end use, CBD oil, feed or fiber, of the industrial hemp. Profit variability also comes from yield and market conditions just as with other crops. Immature market development along with few willing buyers evokes the possibility of counter party risk for hemp producers. Counter party risk is that where one party to a transaction faces the risk that the other party to the transaction may default. Mature markets, such as corn and soybeans, have much less counter party risk than does industrial hemp.

Gross revenue is calculated as yield multiplied with price (GR=Y x P). Price may be contracted between grower and processor, however counter party risk presents here. A processor might offer some, all or no payment until the hemp is processed and sold. As the time between delivery of the raw hemp and full payment increases, so too does cost to the grower. Steps can be taken by growers to reduce risk and cost. These include contracts with personal guarantees, reviewing processor financial documents and letters of credit. Partial payment of the hemp could be agreed. Processors have counter party risk as well. Demand and/or supply of hemp products may change and cause marketing problems. Processors may use the same risk reduction strategies as growers.

Yield is the second part of the gross revenue formula. Hemp genetics are poorly understood compared to corn or soybeans. Hemp variety testing has been occurring but not extensively in Nebraska. Some University of Nebraska-Lincoln evidence shows that varieties that perform well in some regions of the U.S. do not perform well in Nebraska. Without acceptable yield estimates, budgeting and profit calculation becomes challenging. One strategy would be to build a breakeven sensitivity table with varying prices and yields. This table would give the grower a sense of how risky the growth of hemp might be.              

Another risk to profit is the possibility that industrial hemp may not meet CBD or THC industry or regulatory standards.  If the crop is above 0.3% THC, it must be destroyed. If the crop is low in CBD, the revenue from the sale of it might be a small fraction anticipated. The loss of the crop may be more risk than growers can handle but understanding what the risk is helps the decision making of a grower. Starting with small acreages of industrial hemp reduces the exposure to loss if the crop must be destroyed.

Investment Risk in Industrial Hemp

Most of the machinery used in hemp cultivation is multi-purpose and can be used for other crops or is already on the farm. Investment in those multi-purpose machines can be at least partly recaptured by sale or use for other crops. Specialized equipment is likely to be harder to recapture investment. Growers should consider how investing in hemp production will affect the whole farm business if that investment is lost. If the lost investment were to put excessive financial stress on the farm as a whole, would hemp cultivation be too risky?

A hemp cooperative or LLC may reduce farmer risk. This marketing method could reduce marketing and financial risk for growers. A multi-party marketing and/or processing firm may bring marketing expertise and channels that reduces hemp growth risk. Joint ownership in specialized equipment may be arranged by neighbors so that risk is spread out between the parties.

Risk Reduction

Some strategies have already been mentioned above. Contracts, personal guarantee, letter of credit, partial payment and careful pre-cultivation budgeting with sensitivity analysis are methods to understand and mitigate risk. One tool that should be considered is Whole Farm Revenue Protection (WFRP) insurance. This recently became available to industrial hemp growers. However industrial hemp above 0.3% THC content, which must be destroyed, is not an insurable loss. Replant provisions are not applicable either in WFRP for industrial hemp.

Another consideration for industrial hemp production is where it might be grown. If the grower produces it on land owned by the grower, only the parties invested in the grower’s operation need to consider whether to grow industrial hemp. However, if industrial hemp is grown on rented cropland, the landowner should be consulted. The profit potential may increase rental rates much as seed corn does. Or the landowner may not approve of raising industrial hemp on their crop land. In any case, communication about the grower’s hemp plans with the landowner is a good risk reduction strategy

Conclusion

Although this article has used CBD production in industrial hemp fiber and seed for food and feed might also be produced. The same risks and management principles remain for these two products. But profit potential seems more elusive than for CBD. 

Canada has approximately 20 years of industrial hemp production and marketing. There are at least three cycles of rapid expansion in hemp production and rapid decline, boom and bust cycles. This pattern shows that production can exceed market demand in a short time period. In this case market price volatility and market access can be challenging. Recent anecdotes and farm media stories appear to confirm the risk that hemp growers face. Growers thought they had a market for the hemp that was going to be produced but found the purchasing business no longer exists or had to wait for payment many months after harvest. Processors may face the same risks described above. A full understanding of the risks when at the forefront of market development will help the business owner or farmer navigate them successfully.              


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