Why the U.S. Drought is Hitting Harder Than Most People RealizeCommodities / Agricultural Commodities Sep 06, 2012 - 09:14 AM GMT
Chris Martenson writes: 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.
Even 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.
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.
Here's an in-depth look at why the U.S. Drought of 2012 is far from over...
Bigger Than Expected Crop LossesCertainly 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:
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:
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.
It looks like the harvest in Russia will be below expectations as well:
Russia is still officially projecting 75-80 million tonnes but may only get 71 tonnes. If the projected exportable surplus is 10-12 million tonnes, but Russia actually harvests 9 million tonnes less than their hoped-for projection, then its exports will have to decrease to plug that gap.
Here's the kicker: Russia has already exported a good deal of that amount. That is, the prospect of another Russian export ban this year is quite realistic. If we get one, then we can expect a repeat of the turmoil in the grain markets that we saw in 2010.
But there's another much more fundamental reason why we can expect higher prices going forward.
Need for Even Higher PricesThe good news is that there's still plenty of supply to carry us through to the next harvest. However, demand is going to have to go down some, and the way we accomplish that is through the price mechanism.
Right now, physical grain traders are saying that prices are too low and that unless they rise, we're going to run out of grain before the next harvest. Obviously, that's not truly going to happen - increasing scarcity will cause prices to rise until current demand levels are reduced.
The idea here is that the cash market will have to lead the futures market higher, an odd situation because it is usually the other way around. With so many hedge funds now playing in the commodity space, one explanation is that they are simply playing paper games with each other - those playing the short side will get a lesson in the importance of keeping one eye on reality.
A truly shocking event would be if the U.S. ever gets to the position of limiting exports of corn or even soybeans. That is a very unlikely proposition to consider, but if the silos get drained because we have dysfunctional markets that saw fit to keep prices bizarrely low while our free trade agreements allow the too-low grains to be exported, threatening domestic supplies, then that possibility notches up a little bit.
Dairy, Meat, and Even Higher Gasoline CostsWhile it is clear that basic grain prices are heading higher, the knock-on effects into other soft commodities are a little less clear, but are definitely still important to consider.
The most obvious of these are higher grain feed costs that will hit both livestock and dairy producers especially hard:
Some are already turning to, shall we say, other means to keep their herds fed:
Yes, the higher grain costs are going to hit everything from big cattle feedlot operations to my own two-bags-a-month chicken-feed usage.
However, it will be the cost of and even lack of hay that will really create some big problems later this year. The drought not only harmed the range and pasture lands, forcing greater use of stored hay to offset the decline in forage, but it put a huge crimp in this year's hay production:
A doubling of hay prices is obviously going to create quite a bit of economic hardship for many farming operations, which tend to be marginal profit businesses even when everything is going well.
Here's another view on the hay situation:
The drought has done some very serious harm to the nation's hay supply that goes beyond the economics of higher hay costs. First there's the supply of the hay, and then there's the relatively poor quality of hay that was taken from non-irrigated, drought-stricken fields. All in all, it's not a good situation.
To add a bit more difficulty into the situation, it turns out that drought-stricken silage and even the corn itself can be harmful to animals:
The key here is that nitrates are safe below 2,000 ppm but toxic above 15,000 ppm, and the levels found in the stalks and how high it travels are a function of whether enough rain fell to allow the plant to take it up. Much of the corn crop was so desiccated that the plants could not even manage to draw up this nutrient, and therefore it is safe as a feed product.
While it's hard to get a read on at this early stage, there are enough warning signs here pointing to much, much higher grain, food, and meat prices in the future. The worry is whether there will even be enough feed to sustain the animal populations through the Winter and Spring. Given the damage to the harvestable corn, a lot of it is going to be turned into silage
Many ranchers and farmers are faced with a horrible choice here. Saving their herds may be economically unsound or even impossible where hay and safe silage are not available, and so they are selling their herds, one of the most heart-wrenching decisions anyone could have to make.
So many are doing this that recently the price for cattle has dropped, as everyone is selling into an increasingly soft market. My advice is to enjoy these low meat prices while they last, because the next stage of this story involves much higher meat prices.
The problem with understanding just how bad the hay situation might (or might not) be is that there are no national statistics collected that could tell us whether or not there's even enough hay available to sustain the current commercial and recreational livestock populations.
The Importance of Positioning Yourself
So, with all of these repercussions building during the current drought - to which there's yet no end in sight - what can you do today to minimize their impact on your budget and lifestyle?
Part II: Positioning for the Drought's Aftermath looks at the likeliest outcomes in food prices, food availability, energy prices, and macroeconomic consequences (of which there will no doubt be many from this drought). We have a national food distribution system that runs significantly on a just-in-time basis, which leaves it vulnerable to price and inventory shocks when there are supply disruptions. The reduced water levels caused by the drought are handicapping electrical power generation in growing regions in the country; electrical thermal plants are the number one biggest user of water in the U.S.
The global financial markets are similarly tenuous these days, as resources are already taxed in trying to stimulate the moribund U.S. economy and dig Europe out of its massive credit woes.
This is one of those moments where taking simple, prudent steps now can have an outsized effect on preserving your quality of life.The groundbreaking video I just recorded with the excellent team at Money May Press also addresses the heart the problems written about here.
It focuses on steps we individuals can take to decrease our vulnerability to the myriad of problems that threaten very our way of life. You can see this report by clicking here.
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