It seems every year we hear about water shortages, droughts, floods, and other natural catastrophes that impact farmers, ranchers, and food processors, as well as consumers. This year, 2021, is no different. In fact, the drought.gov website is showing this map from the National Integrated Drought Information System (“NIDIS”) effective June 22, 2021. The dark red colors represent the most serious drought impacts.
The water cycles impact farmers and ranchers from the perspective of the crops and animals the producers focus on growing during a given water and growing cycle. This in turn impacts food processors using the crops and animals as inputs, restaurants and foodservice providers delivering food to consumers, and eventually the consumers. The current water cycle appears more impactful than previous cycles, but it is important to understand that there are regular water cycles that businesses need to be considering in their planning and forecasting. NIDIS shows these cycles in the graph covering the period from 2000 to 2021.
This 2021 cycle appears to have more dark red than previous cycles, but also shows a similar total drought stricken area when compared to previous cycles such as those in the 2018, 2013, and 2002 time periods.
Another approach to viewing water cycles is to consider the data the US Geological Survey (“USGS”) collects on snowpack and lake levels. The graph below compares annual snowpack from 2015 to 2021, and provides an average snowpack level. The 2021 snowpack is below the average but not as bad as some years.
This data clearly shows there are cycles, and also shows 2021 is at least a below average year from a water availability perspective.
The NIDIS tells us drought and extreme weather threats have occurred in different regions at different times, with different impacts, since at least 1895.
Politics aside, the points mentioned above indicate that businesses who rely on water to produce their product, and businesses that rely on outputs from the producers, need to be aware of the impact of natural cycles on financial performance. While today’s data focuses on drought conditions, in May of 2019 the data shows 82.3% of the US was abnormally wet.
It is important to consider the average levels of expenses and resource availability, and then sensitize that analysis for the individual debt structure a business has in place. Using this approach a business is able to maximize the number of possible successful outcomes from a financial performance perspective given the uncertainty in weather and in water availability.
Examples to consider from a producer and processor perspective
Farmers and ranchers make decisions on which crops to produce or animals to raise on a growing cycle or an annual basis. In the Central Valley of California this year those decisions are based on availability of water – both from the reservoir systems and from ground water sources – and the cost of that water. The types of crops being produced have materially different water needs. In the table below, the Food and Agriculture Organization (“FAO”) of the United Nations shows the water needs of field crops compared to standard grass. Citrus, olive and grape plantings use 30% less water than standard grass. Clean cultivated fruit and nut trees use the same amount of water as standard grass. Rice, sugarcane, and nut and fruit trees with a cover crop use 20% more water than standard grass.
Each producer needs to consider the availability of water, the cost of the water, the cost of other production needs, and the potential sale price of the crop. This is not a simple linear analysis. A matrix approach needs to be developed to consider 1) varying yields, 2) varying costs to produce, and 3) varying sale prices. Using this matrix approach the number of opportunities for break-even performance or performance with a required fixed charge coverage ratio (“FCCR”) becomes clear. This type of analysis allows both the producer and the lender to assess risk and manage performance.
Water management for tree crops also requires an understanding of the impact on the current year crop and the future years crops, as well as the survivability during the immediate drought event. The University of California Davis produces information by crop addressing the timing of reduced irrigation on trees, and on crop production depending on the time during the growth cycle the reduced irrigation occurs.
Link here:
Producers make decisions to pull orchards, severely restrict water usage, or reduce water usage based on the availability and cost of the water resource. The matrix approach to understanding opportunities for break-even production is employed, with the added overlay of yearly tree crop management.
Impact on Food Prices
While there may be immediate impacts on pricing based on water conditions, there are also longer term impacts to consider. Supply and demand variables for seasonal crops impact consumer prices faster than longer term tree crop decisions. The United States Department of Agriculture (“USDA”) monitors and reports on crops expected to be planted, crops planted, and yield per acre from crops planted. The USDA Economic Research Service produces monthly reports to forecast changing food prices.
The June 2021 forecast is available at this link:
The June report anticipates food prices will increase in 2021 with beef and veal predicted to increase 2% to 3%, pork to increase 3% to 4%, and poultry to increase 1.5% to 2.5%. Overall the prices for these proteins are expected to increase 2% to 3% from 2020 to 2021. Fresh fruit prices are predicted to increase between 4% and 5%. Fats and oils are predicted to increase between 2.5% and 3.5%.
Commodity prices and food prices do not work in tandem. In this year, the impact for the producers of these proteins and crops is more significant than the immediate consumer impact. For example, wholesale beef prices are expected to increase between 6% and 9%, wholesale pork prices are predicted to increase between 14% and 17%, and wholesale poultry prices are predicted to increase 15% to 18%.
Those predicted price increases for producers and for consumers need to be compared to the feed commodity price changes. Contrast those expectations with soybean price predictions indicating an increase of 58% to 61%, and consider that corn has reached over $7.00 per bushel compared to recent $3.50 to $4.00 levels.
Also contrast those expected price increases in the protein, fruit and feed crops with farm-level vegetable prices, which are predicted to decrease 10% to 13%.
These predictions show that each part of the cycle from field to table is impacted differently. Sensitivity analysis is imperative to identify opportunities for success. Companies that require these various inputs in their production process will need to evaluate the impact of price changes, and their ability to pass those price changes on to customers.
For example, with this pricing outlook and the water availability risks in California, would a producer plant a vegetable crop? What will that do to supply and demand? Another example is the cost of feed to produce proteins, including eggs. Will producers be able to continue to operate egg laying operations in this price environment? How will normal seasonal business cycles for supply and demand of food products be impacted?
In summary,
Food producers and processors need to analyze their performance from a risk tolerance perspective – including pricing of inputs, sale prices of products, and availability of inputs.
Best practices continue to show the need to:
Prepare a matrix analysis – yield, input costs, and potential sales prices.
Develop a sensitivity analysis to consider the speed and magnitude of changes.
Evaluate vendor and customer contracts to consider the ability to change prices with market changes.
Prepare alternative strategies and develop decision trigger points.
It appears inevitable that inflation will occur in 2021. Food prices will increase. Water shortages may have immediate impacts on the availability and pricing of certain food products, but it is more likely water issues will have a longer term impact than just 2021.
The businesses operating in these food sectors need to implement the best practices and prepare to change as needed to increase the likelihood of survival. Risk cannot be eliminated, but planning for the risk factors and evaluating decision points helps companies, their lenders, and their investors rest easier during these difficult pricing periods.