U.S. Drought: Worse than Most Realize

September 10th, 2012
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Article of the Week from Money Morning

Money Morning

This is an important update on the U.S. drought of 2012 and its impact on food prices, water availability, energy, and even U.S. GDP.

drought-cows-pondSMALLEven though the mainstream media seems to have lost some interest in the drought, all of us should continue to be aware of it since its ramifications are far-reaching.

As we discussed in this report, it's all connected to a larger pattern of exponential growth that is simply no longer sustainable. At stake is nothing less than the traditional American way of life.

This monumental drought has already led to sharply higher grain prices, increased gasoline costs (via the pass-through of higher ethanol costs), impeded oil and gas drilling activity in some areas (due to a lack of water), caused the shutdown of a few operating electricity plants, temporarily reduced red meat prices (but will also make them climb sharply later) as cattle are dumped in response to feed- and pasture-management concerns, and blocked and/or reduced shipping on the Mississippi River.

Follow up:

All this and there's also a strong chance that today's drought will negatively impact next year's winter wheat harvest, unless a lot of rain starts falling soon.  Hurricane Isaac certainly helped, but didn't go far enough.

Further, there will be a definite impact to U.S. GDP, which could add to pressures (excuses?) that the Fed may use to justify additional quantitative easing (QE) measures (otherwise known as 'printing more money').

Here's an in-depth look at why the U.S. Drought of 2012 is far from over...

Bigger Than Expected Crop Losses

Certainly the number one story around the U.S. drought centers on its impact on grain production, specifically corn and soybeans. In a minute we'll discuss the other impacts, but we'll start with the one that has the greatest potential to cause both suffering and strife over the coming months (and possibly years), especially for those on limited budgets.

In 2011, the U.S. reaped a corn harvest of some 314 million tons. In 2012, the USDA has estimated a harvest of 274 million tons - a shortfall of 40 million tons - despite record acreage being planted.

While the USDA has been steadily reducing their crop estimates, practically with every passing week, it seems likely that the USDA remains behind the curve today, as it has been every step of the way. A different source for information comes from the Pro Farmer Midwest Crops Tour, which is coming in slightly under the current USDA estimates:

Crop Tour Points to Sharper Drought Impact on Soy, Corn

Aug 21, 2012

Initial reports from the closely watched Pro Farmer Midwest Crop Tour suggested more crop damage than expected from the drought, raising the potential for diminished soybean production this fall and sending futures sharply higher.

The disappointing crop reports from scouts touring fields on the Pro Farmer crop tour in states such as Ohio and South Dakota make it hard to believe soybean yields will reach current U.S. government crop projections, said Don Roose, president of advisory and brokerage firm U.S. Commodities in West Des Moines, Iowa.

The market is in the "watch and worry" mode on all fronts as shrinking crop forecasts will further tighten supplies already projected to dwindle to precariously tight levels in 2013, Mr. Roose said.

On the annual Pro Farmer tour, analysts and investors walk corn and soybean fields in seven Midwestern states over four days to assess prospects prior to the fall harvest. Pro Farmer is an agricultural advisory firm. The Pro Farmer tour, which wraps up Thursday, reported diminished potential for the soybean crop in both Ohio and South Dakota.

The crop tour doesn't estimate soybean yields, but it reported an average 584.9 pods per 3-foot-by-3-foot square area in South Dakota, down 47% from a year ago. In Ohio, scouts reported soybean counts at an average of 1,033.72 pods per 3-foot-by-3-foot square area, down from 1,253.2 pods a year ago.

Soybeans entered their critical growing phases in recent weeks, and the crop has benefited in some regions from recent rains across the eastern Farm Belt.

Meanwhile, scouts with the Pro Farmer Midwest Crop Tour on Monday reported an average estimated corn yield in Ohio of 110.5 bushels per acre, down from the tour's estimate of 156.3 bushels a year ago. In South Dakota, tour scouts reported an average yield estimate of just 74.3 bushels per acre, down from 141.1 bushels a year ago.

While commodities traders and agronomists have braced for weeks for the prospect of a crop decimated by drought, the estimates were lower than many had expected.
The summary here is that the Pro Farmer Tour is reporting crop yields to be 2% - 3% lower than current USDA forecasts, which is a big deal when it comes to food. We're talking a few tens-of-millions-of-bushels' difference.

The somewhat sour note in this unfolding drama is the fact that 40% of the nation's corn crop goes to ethanol producers, which means that food will be burned in the nation's auto fleet instead of helping to keep prices down for consumers and animal feed. Another 40% goes to animal feed (chicken, cattle, hogs, etc.), and the remaining balance goes to direct human consumption.

However, the ethanol mandate is a congressional requirement for our fuel blenders, so they do not have a choice in the matter. It would literally take an act of Congress to even temporarily suspend the ethanol requirement - and in an election year, that's just not going to happen, given the powerful constituencies invested in preserving that mandate.

Of course, higher input costs will ripple through the entire chain, so perhaps Bernanke will get the inflation he seeks, although it won't be the one he wants. The inflation he wants is simple monetary-driven inflation. The inflation he will get is nothing more than a supply/demand mismatch.

Still, the USDA has a handy calculation for estimating the future impacts:

U.S.'s inferior corn crop has supply-chain ramifications

Aug 13. 2012

The USDA has provided considerable information about how the drought's effects were likely to percolate through the economy. Because of a smaller-than-expected corn crop, the USDA said it can make the general prediction that "we will see impacts within two months for beef, pork, poultry and dairy (especially fluid milk). The full effects of the increase in corn prices for packaged and processed foods (cereal, corn flour, etc.) will likely take 10-12 months to move through to retail food prices."

The USDA has a formula for predicting changes in the rate of inflation caused by gains in prices at the commodity level: if the farm price of corn rises 50%, retail food prices rise by 0.5% to 1% as measured by the Consumer Price Index (CPI).

The price of September corn futures from mid-June until early August advanced 55%, meeting the USDA's criterion for a measurable increase in the CPI Lapp presented a more extreme scenario than the USDA. He predicted that the damage to the 2012 corn crop will translate into a food inflation rate of 4% to 5% in 2013. In his view, the dollar cost of the drought already was $30 billion, which accrued rapidly over the summer.

"This is a cost that somebody has to bear," Lapp said. "Some price hikes are fairly quick and others take a while."

He said high feed costs will have to be absorbed by producers, who will likely liquidate part of their cattle and swine herds and poultry populations. At the retail level, the drought's effects will translate into narrower margins - and expected higher prices - for processed food and soft drink manufacturers among others.

Lapp offered his opinion that legislation that has effectively required 40% of the corn crop be used in making biofuels has made everything worse.

"The situation has been aided and abetted in a negative way by the biofuels mandates," he said. "Shame on us for having mandated so much to corn ethanol" without creating contingencies for a bad crop year.
Because corn is the base unit for so many things (especially in the form of high-fructose corn sweetener), and because it's a primary feed component for finishing cattle and raising chickens and hogs, it tends to have a pretty decent impact on food prices.

However, it takes time for those price hikes to work through the system. So it will not be until 2013 sometime that we really begin to feel it in the U.S. And for the rest of the world that lives more directly on grains? They're not as lucky. The price hikes hit them almost immediately.

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1 comment

  1. kalendjay Email says :

    We hear that there could be a ten year supply in in our corn reserves. Why not release them, let the ethanol production continue but take back the fermentation residue known as dry distillers grain (DDG or DDGS) which is even better as animal feed? And when corn prices are low enough, grow wheat, sorghum, even chick peas which can be used as feed or cereal, but which are easier on water and fertilizer requirements? USDA policy makes no sense except to lobbyists.

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