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Assess risks in raising industrial hemp

There are specific, unique risks involved in raising and marketing industrial hemp.

February 24, 2021

6 Min Read
Hemp plants
UNDERSTANDING RISK: Industrial hemp may be one of the rising alternative crops across the U.S., but there are many risks involved in producing and marketing a new crop. iStock / Getty Images Plus

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 have 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. Here are some of the economic considerations of hemp cultivation.

5 risks

Five risks are inherent in production of any crop, including industrial hemp:

1. Production risk. Such risk comes from lower yield or quality than expected. Weather, disease and insects are common causes, along with machinery issues.

2. Marketing. Price and the ability to sell the commodity will vary with the specific product. Significant marketing risk is present with a new agricultural product such as hemp. Marketing chains and price discovery are well understood for crops such as corn, soybeans or wheat. But regional marketing challenges may be present for hemp because it is an uncommon product.

3. Financial risk. Such risk can be present due to higher-than-expected expenses, lower yields, lower prices or poorer quality — all of which reduce cash flow and profitability.

4. Legal risk. 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.

5. 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

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 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, 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.

Gross revenue is calculated as yield multiplied with price. 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, such as 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 or supply of hemp products may change and cause marketing problems.

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 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 of anticipated revenue.

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

Most of the machinery used in hemp cultivation is multipurpose and can be used for other crops or is already on the farm. Investment in those multipurpose 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 multiparty marketing or processing firm may bring marketing expertise and channels that reduce hemp growth risk. Joint ownership in specialized equipment may be arranged by neighbors so that risk is spread out between the parties.

Risk reduction

Contracts, personal guarantees, letter of credits, partial payments 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 insurance, which 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 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 cropland. In any case, communication about the grower’s plans with the landowner is a good risk reduction strategy.

In addition to 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.

Full understanding

Canada has about 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 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 those same risks. A full understanding of the risks when at the forefront of market development will help the business owner or farmer navigate them successfully.

Tigner is an Extension agricultural systems economist educator at the University of Nebraska-Lincoln.

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