HOT AND DRY ECONOMICS
BY NEIL TOWNSEND
There are two variables that dictate prices and are out of farmers’ control. First, governments everywhere have long meddled with agriculture and trade policy. The net impact has been to create enormous externalities—barriers that inhibit the laws of supply and demand from dictating prices. Canada, a large net exporter, has often struggled for market access and suffered diminished competitiveness against subsidized farmers. Countries such as China, India and the U.S. as well as the EU continue to restrict market access and some also offer farmer supports that distort the market. There is no indication this will fade.
Second, farmers are at the whim of the weather. Final production results, both quantity and quality, rely on rainfall and temperature patterns during the growing season. The 2021 western Canadian growing season has been detrimentally impacted by hot and dry conditions.
Weather is different than climate. Climate extrapolates over many decades. Weather is a shorter term phenomenon. In 2021, weather conditions have significantly compromised production potential across large parts of Western Canada and the U.S. Great Plains. Farmers are faced with diminished yields and smaller overall production. Prices, for crops whose production is heavily concentrated in this region, have risen precipitously. In some cases, like canola, prices have reached record highs.
Modern farming is expensive, and no commercial farmer undertakes the activity to obtain tax breaks. The cost of machinery, seed, chemical, fertilizer, labour and land have all trended higher. At the same time, relatively low interest rates have allowed farmers increased leverage to build their landbase or expand access to time-saving, production-enhancing technology. Recent years have seen relatively good prices and average or better yield results. This had farmers coming into the 2021/22 marketing year in relatively good financial shape.
For many years, a topic of discussion on the farm show circuit was the prospect of higher interest rates. Farmers, the argument went, were woefully unprepared for a central bank rate of five per cent or higher. Interest rates remain close to historical lows. Farmers remain relatively leveraged. This leverage is not whimsical but necessary. Labour is hard to come by. Economies of scale have become the modus operandi of 21st century farm practice. The message has been to get bigger and to mechanize, but more land and better equipment have one thing in common: higher cost. Thus, while interest rates have not yet caused disruption, many farmers rely on positive production results to reach break even. The colloquial term to describe this is “yield your way to profit.”
Then along comes a year like 2021. Farmers have faced adversity before, but the scale and scope of 2021 weather adversity harkens back to the historically bad drought of 1988. Many farms will be hard pressed to pull off 70 per cent of an average yield. Others will struggle to get close to 50 per cent. Will prices rise enough to compensate for decreased production? Overall, probably not. Total western Canadian farm receipts (the value of all products farmers sell in a marketing year) will be down in 2021/22 relative to recent years. This will create financial stress at the farm level.
This financial stress will percolate up the supply chain. Western Canada has shifted firmly towards bulk handling. Line companies have invested in high-throughput facilities. The railroads have added larger capacity rail cars and run longer trains. Port facilities have been upgraded and new ones have been built. Billions of dollars have been spent to increase capacity. The means by which these facilities are amortized is through fee for service. The reality is that the western Canadian agricultural supply chain is one really big logistics play. A lack of volume hurts everyone and will be a bottom line problem for rail and line companies alike.
Farmers sit at the very start of the supply chain and recent weather has reduced their capacity to feed the beast. Reduced farmgate receipts will harm their financial health. Moreover, inflation is real and costs for 2022 will be higher. Hopefully, Mother Nature will have wrung the hot and dry out of her system by then. A return of such conditions, even on a lesser scale than in 2021, would push many farm operations to the point of no return.
Neil Townsend is chief market analyst with FarmLink Marketing Solutions.