Gauging The Effects of the 2012 Drought

2012 Drought

 

One of the worst U.S. droughts in 50 years is striking the Midwest, withering crops in their fields and sending corn and soybean futures to all-time record price highs.

The Midwest experienced some of the driest Junes and Julys in history and the abnormally high temperatures and low rainfall may continue into autumn. The National Weather Service said in mid-July that the normal temperatures and below-normal precipitation could persist from August through October. The worst of the adverse weather is in the eastern Midwest, but several market watchers said if the conditions persist, this could spread to the western Midwest, too.

That means farmers and traders will likely be dealing with the weather market for a while, possibly until harvest. That could mean volatile price action so both market users need to be nimble.

Ken Morrison, founder and editor of online commodities newsletter, Morrison on the Markets, remembers the last big weather market for grains was the year most people use to compare to this year – 1988.

“The behavior is similar,” he says. “I was trading. I was in charge of Cargill’s minor grains trading – oats, grain-sorghum and barley. In 1988 it was just as volatile. That year, oats went premium to corn. It was one of the wildest summers we had. In that degree (minor grains) it was wilder and more volatile than even this market.”

That volatility means traders need to be cautious. He explains: “Most traders are just trading smaller sizes, not changing their strategies. Whenever volatility gets like this it happens. If you usually trade a 50-lot before, now you trade five lots. That’s pretty common.”

 

What Now?

Mike Zuzolo, president, Global Commodity Analytics and Consulting, advises farmers how to hedge their agriculture production. Zuzolo is in Lafayette, Ind., in the heart of the worst of the drought for that state. Because of the intensity of the dryness, he urges his clients to focus on their local cash basis and be in contact with their grain elevator. Specifically, he tells them not to be in a hurry to lock in basis, especially if their test yields are coming in lower than expected. Basis is the difference between the futures price and local cash grain prices.

“First call your wife, then call your elevator, because everyone is probably going through the same scenario… If the reports are as bad … the elevator is going to have to raise basis calls in order to get grain,” Zuzolo says, adding that farmers need to review their crop insurance options to help limit downside risk.

He says in a ballpark estimate, some Indiana fields may see 70 percent to 80 percent loss.

Iowa farmer Pam Johnson, who farms 1,200 acres with her husband in Floyd, Iowa, divides her acreage between corn and soybeans. While not nearly as damaged as some crops east of the Mississippi river, her fields are under stress. Johnson, who is also first vice president for the National Corn Growers Association, says since June, Iowa corn crops have received a fraction of the one inch per week rain that corn needs to have optimal yield.

In June, Iowa crops received 1.55 inches for the month and as of July 19, they received seven-tenths of an inch. Her corn crops are done pollinating – and they pollinated under severe heat stress – so there’s little that can help boost yield at this point. Johnson said she’s expected yields to be down at least 10 percent this year.

“The beans, too, they’re suffering, but if they get rain soon they could recover,” she says, adding that soybeans have not pollinated yet. Pollination is when crops set yield.

 

“No Bowl of Cherries” for Livestock

Grain farmers have been the focus of this year’s drought, but cattle farmers are facing more problems – both high grain prices and stressed animals because of the heat.

“It’s really hard on them (the cattle),” says Lester Aldrich, a broker at Zia Commodities, a private ag consultancy with cattle clients in Texas and Kansas. “You can just see it on them when they get off the trucks. They’re hot, they’re tired, they’re thirsty.” He adds that heaviest-weight cattle can sometimes fall ill just before slaughter. So far, though, there are few reports of death losses, he says.

Feedlot operators who have no hedges are likely losing anywhere from $150 to $250 per head because of the price of corn has jumped nearly 50 percent from mid-June to mid-July. “The breakevens for cattlemen are just awful,” Aldrich says. “It’s just the pits. There’s no bowl of cherries for them at all.”

For farmers looking to hedge 2013 production or for traders looking to put on longer-dated trades, Morrison says, wait: “Fundamentally I find it difficult to short the back months because of the big discount to the front months. You never know how the front months will correct.”

About the Author

Debbie Carlson has focused on commodities for much of her writing career. She spent more than a decade at Dow Jones covering the Chicago-based futures exchanges. As a Dow Jones editor, she worked closely with The Wall Street Journal and Barron's in planning commodities coverage.