Planning for rainy days

The current drought has been a hot topic for many financial advisers considering an investment in agribusiness. In our view, when reviewing any potential investment for your clients you must always consider the risks, and for agribusiness investments the risks include those of an agricultural and environmental nature. So any impacts of drought and other environmental factors have always been a serious part in the development of agribusiness projects — but only now are people starting to take notice.

Given the changes to non-forestry managed investment schemes, the current year may be one of the last remaining opportunities for your clients to participate in non-forestry agribusiness. The drought is constantly making headlines, and many financial advisers are looking to see what the experts are predicting for the weather and what various projects are doing to mitigate drought risk.

Australia has a long history of dealing with droughts. Our weather pattern means that we will be visited by droughts from time to time. The severity of the drought we are currently experiencing has been the worst recorded in this country.

However, there is growing optimism from both the Bureau of Meteorology and from old timers in the bush that the worst of the drought is over and that the current year will be a better season. It is interesting to note that seven of the last 10 droughts have been followed by years with above average rainfalls.

Robinvale (in north-west Victoria) has recently received almost one-third of its annual rainfall in the space of a couple of days. Whilst the main rainfall patterns occur in winter months, this early rainfall provides much needed relief to those in the Robinvale area and provides some optimism for the current season.

Agribusiness projects that are based on irrigation (e.g, horticulture) acquire rights to pump water from rivers. These rights provide varying degrees of comfort to a project that it can access the water it needs. In our view, one of the aspects that a financial adviser should consider is whether an agribusiness project focuses on higher certainty for water.

The right to draw water from rivers is always subject to the amount of water in those rivers. There is concern that the low rainfall levels over the past year may impact the level of water that right holders can take from the river.

The Goulburn Murray water authority has advised that, based on the assumption that there are average inflows in the current year, there is a nine in 10 chance that allocations to those with water rights will be greater than 40 per cent of the amount their rights allocate. They also note that there is a five in 10 chance that in the same circumstances there will be a 100 per cent allocation in respect of those water rights.

In our view, a project needs to plan carefully to deal with situations where water rights may be less than 100 per cent effective. For example, if a project requires 1,000 megalitres of water and only has water rights for 1,000 megalitres, it will be 250 megalitres short in the event that there is an allocation of only 75 per cent. In these circumstances, the project may need to find the additional water to meet its needs.

An effective way this can be done is to carry forward water that was not used in a previous year. The Macquarie Almond Investment team has developed innovative techniques to conserve water in the first year of operations without impacting the growth of its almond trees. The water that is saved will be available in the upcoming year, and this is part of Macquarie’s commitment to aiming to reduce the downside risk of investing in agribusiness.

In our view, projects should also have the ability to access additional water entitlements as another means of protection in the event they don’t receive 100 per cent of their water entitlements. As noted in the previous example, a project will still receive its required 1,000 megalitres of water if it has rights in respect of 1,334 megalitres and the allocation is only 75 per cent. Financial advisers should therefore review the promoter’s capacity to acquire additional water rights. This will generally involve an assessment of the financial strength of the promoter and its ability to fund the purchase of additional water for the project if required.

Finally, in our view, projects should be as efficient with water as possible. To do this, projects need to be able to draw from river systems in the most effective way to minimise waste. Large agribusiness projects typically have the most up-to-date irrigation technology and the economies of scale to do this. For example, the orchard for the Macquarie Almond Investment incorporates soil moisture monitoring equipment that ensures water is only delivered to areas where it is required.

With the end of financial year rush, take the time to consider the agribusiness project that fits well within your client’s investment portfolio and in line with their investment objectives. And always ensure your agribusiness review incorporates the ability to manage risks, such as the drought, as much as possible.

Risk mitigants to look for when evaluating agribusiness projects

In our view, advisers should consider the following when evaluating agribusiness investments for their clients.

- Is carry forward water available to the project? The Victorian Minister for Water confirmed on March 1, 2007, that unused water can be carried over to the 2007-08 season.

- Does the project have the capacity to purchase additional permanent water entitlements?

- Does the project have alternative ways of reaching their water allocations, for example, construction of a dam?

- Does the project have water efficiencies, soil moisture monitoring equipment for example, which ensures water is only delivered to areas where it is required?

Anthony Abraham is head of retail agribusiness for the investment banking group of MacquarieBank .