The prognosticators looked and sounded pretty confident when they were making their predictions at the start of 2012. I suppose they can be forgiven because nobody predicted a drought at least not one as sever or so widespread. Nevertheless, drought has become the defining driver in virtually all the agricultural markets in 2012, especially on the livestock and grain side of things.
This drought has proven to be one of the most unique of recent times, as it has grown to encompass the majority of the Corn Belt. From a historical standpoint in the grain markets the drought is most commonly compared to the drought of 1988. Record acres were planted and another record crop was expected until hot and dry conditions have caused yield estimates to be reduced significantly. The crop is expected to be as much as 30% smaller than anticipated and with a growing mandate for ethanol, ensuring demand prices have soared. At the time this was written December corn futures were atop of $8/bushel, and reasonable people are still predicting more upside to these historically high prices. The beauty of grain production is that drought means higher prices, and while some in particularly hard hit areas will capture nothing more than insurance payments, the majority of producers are facing a situation where decreased yields have roughly been offset by increased prices. Supplies are tight enough, and demand is strong enough that the market seems committed to ensuring supply and that means not only purchasing acres for next year’s planting but rewarding those who followed the market signals this year. As a result, many producers will see per acreage revenue figures exceed projections despite sharply lower yields.
While it is not difficult to see the downside to drought, some of the consequences are not so obvious. Projections for higher food prices and the devastation that feed prices will reek on the livestock industry, has led for some to call for a suspension of the ethanol mandates. Recent studies have indicated that a suspension of the mandate could result in a reduction of corn prices by as much as $2.50/bushel. However, the gasoline industry has structured itself around the mandates and there is simply not enough refining capacity to replace ethanol. The result is that with or without the mandate, ethanol will be more competitive with gasoline then what many people would expect, and the infrastructure of subsidized ethanol is such that it would be nearly impossible to rescind at this point. On another front, there is already a lot of discussion about whether there will be sufficient seed corn next year. Corn acreage plantings are expected to be as high as or higher than last year’s record, and the drought has reduced seed corn availability as well.
From a livestock industry standpoint, the drought has had far greater economic consequences with longer lasting effects. Drought equates to a perfect storm for the livestock industry. The market moves lower as liquidation increases, plus feed costs increase, reducing margins and cattle values at the same time. Additionally a producer sees reduced production for several years after a drought as they must rebuild their numbers and as their land resource takes time to regain its full production capabilities after a drought. Calf prices are inversely related to corn prices and producers are looking at increased input costs, decreased production, and reduced prices. Plus, they have the added “whammy” of selling inventory in a depressed cattle market, and when moisture conditions improve demand is expected to drive a significant bump in replacement prices. These trends are especially true in widespread droughts, which is certainly the case. Approximately 80% of the nation’s cowherd located in areas experiencing moderate to extreme drought conditions.
As a result drought mitigation has been the focus of 2012. They say hindsight is 20/20 and this drought has emphasized how important it is to have both a grass and drought management plans in place prior to a drought. It is those preparations that allow a producer not only to maintain their production capacity coming out of drought, but provides one with both the flexibility and tools to manage their way through a drought, rather being forced to simply react. The drought of 2012 has been especially challenging not only because of its severity but the market dynamics surrounding it. 2012 was supposed to be the first of 4-5 years of expansion and significant profits for the cow/calf sector. We entered the year with the smallest cowherd since the 1950’s and strong demand. The drought means that numbers will grow even tighter, expansion will take even longer, and that the period for record prices while delayed will also be extended by at least a year. So while the long term outlook for agriculture is extremely bullish, the short term outlook is equally exciting. Most importantly, producers must make the right decisions about how to maintain, liquidate or rebuild inventories. When moisture returns, bred cow prices are expected to see price levels never before attained, combine that with record calf prices and it becomes obvious that the one that emerges from this drought with the most cows and the most production capacity in tact will be huge winners. Throw in record feed prices and the uncertainty about when the drought will end and you have the makings for what is a very high stake game of poker.
Nobody at this point can say with any certainty whether 2013 will be a continuation of drought, or a return to more normal precipitation patterns. What nearly everyone agrees on is that both grain and livestock prices should be at or near historically high price levels. From a grain production standpoint, the course is clear, plant and hope for rain. From a livestock producer standpoint, it is a much more complicated dynamic. If the drought was to persist for another year, the livestock industry would likely shrink to the point that industry infrastructure would permanently be retired and the structure of the industry altered. The short term and long term prospects for agricultural land and agricultural production have never looked better on either a macro or micro level, which creates tremendous opportunities. The key question is how one positions there operation to take advantage of those opportunities in order to maximize short term profits and long term gains.
The drought of 2012 has created a situation where the opportunity to get in on the ground floor of what promises to be a golden era for agriculture has been extended, at least for those with the wherewithal and plan to take advantage of the opportunities that exist. A grizzly veteran of many cattle cycles and the whims of Mother Nature quoted Vincent van Gogh – “The fishermen know that the sea is dangerous and the storm terrible, but they have never found these dangers sufficient reason for remaining ashore.” He went on to explain that most of the success he had acquired was stepping forward boldly in times like these when others stand on the sidelines paralyzed by fear, or waiting for uncertainty to pass. He laughed and said I take solace in the fact that “it rains on the just and unjust alike.” The drought of 2012 will eventually end, and with it will fade the opportunities that have been created.