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The long & short of the '12 drought

Grain supplies were already tight heading into this summer's drought. And now, they're expected to stay near record-lows for the foreseeable future.

But, it won't last forever; high grain prices will eventually lead to demand destruction, specifically on the export market as foreign trading partners look to other regions or their own domestic production to meet grain needs. That's just one way that current market conditions forged by the drought could do a 180 in the next few months, according to a report issued Friday by Federal Reserve Bank of Kansas City vice president and Omaha branch executive Jason Henderson. In some ways, today's drought-fueled grain price boom could ultimately spawn a massive slide in prices and boom in supply around the world.

"High prices could also spark a strong supply response from foreign crop producers. Rising crop prices in recent years have spurred an increase in global production," Henderson says in the Fed report. "High prices could entice further expansions in global production that could lead to lower prices. The best cure for high prices might be high prices."

Then there's the livestock sector's influence on the grains. Right now, many cattle producers, for example, are taking on massive herd liquidation in an effort to simply be able to afford to keep all their animals fed. That's eventually going to result in a lot less feed demand, taking away more upside potential for the grains, Henderson says.

Then, there's the hot topic of the ethanol mandate. Right now, its future is the subject of a lot of debate in the farm community, and whether or not it's left in place or temporarily trimmed back could, in the short term, go a ways to helping determine how the corn price/demand situation unfolds in the next few months. But, added on top of the potential demand cut from the livestock and export sectors, a smaller ethanol mandate could, in the longer term, have an adverse effect, Henderson's research shows.

"Surging prices are likely to cut grain demand. Livestock herd liquidations could curtail feed demand next year. The drought has been just as devastating with steep short-term losses projected to give way to a price rebound

if livestock supplies shrink next year" he says. "Reduced ethanol production could trim corn demand."

All-in-all, Henderson says it's going to be the producer who can bear the financial brunt of the drought and make it out the other side who's going to make it through the drought. It's important to remember that the decisions made now could ultimately have altogether different effects once the drought breaks.

"Although the immediate challenges of the drought are expected to disappear over time with improved weather, there are concerns about whether some producers can endure these short-term losses," he says.

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