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Published September 24, 2012, 10:40 AM

Worst drought in decades

Given the widespread drought in the Midwest, the U.S. Department of Agriculture’s late August release of the 2012 Net Farm Income Forecast contained a big surprise.

By: Daryll E. Ray and Harwood Schaffer, Agweek

KNOXVILLE, Tenn. — Given the widespread drought in the Midwest, the U.S. Department of Agriculture’s late August release of the 2012 Net Farm Income Forecast contained a big surprise.

According to USDA, “U.S. net farm income is forecast to exceed $122 billion in 2012 and net cash income is expected to exceed $139 billion, both record nominal values. The expected increase in income reflects large price-led gains in corn and soybean receipts, as well as large increases in crop insurance indemnities.

“Extreme hot and dry conditions in the Plains and Corn Belt are drastically cutting projected corn and soybean yields. With corn and soybean supplies for the 2012 marketing year expected to be the lowest in nine years, prices are increasing dramatically, resulting in higher expected 2012 calendar-year receipts for many crops.”

If that income were spread evenly over all farming operations, one could sit back and heave a sigh of relief, after two months of worrying about the effect of the drought. But as a look at the numbers shows, the income is not evenly spread across all farms.

As a sector, the value of livestock production decreased $200 million from a year earlier. The big loss in value of production came in the dairy sector, which is forecast to see a decline of $4.3 billion (10.9 percent) while both meat and eggs are slated to see increases. Over and above changes in the value of production in the livestock sector, USDA forecasts the price of feed to increase by $7.2 billion (13.2 percent). That means that after taking feed costs into account, the livestock sector is forecast to see numbers well below last year.

And those numbers are for the sector as a whole. The experience of individual livestock producers is likely to vary widely. For dairy farmers in drought areas who depend upon on-farm feed production, the picture is likely to look a lot worse with income on their farm heading toward deep red. Farmers who have both crop and livestock income may see a wash. Even cow-calf operators in areas with adequate pasture are likely to see some loss in income as the market for their calves takes a downturn as a result of lower profit expectations by feedlot operators.

The surprise is that the crop sector is projected to “weather” the drought better than one would expect. Corn yields and production are arguably hit the hardest by the drought, so let’s focus on corn.

Since corn planting this spring, USDA has dropped its corn production projection from 14.8 billion bushels to 10.8 billion bushels, a decline of 27 percent. During this same time, the price of corn has increased by about 40 percent.

This is a rough illustration of what economists would expect. Why? Because it is well known that the corn market is price inelastic. (Stay with us here, it’s easier to see this than you might think.) The -27 and 40 percent numbers are consistent with a demand elasticity of -0.675 or a price flexibility of -1.48. What this simply means is that for each 1 percent drop in output, the price increases by 1.48 percent. So, in this illustration for the 27 percent drop in output, the price increases by -1.48 times -27, or 40 percent.

How this affects farmers’ bottom lines depends on how much yield reduction they experience. Farmers whose yields decline by, say, 25 percent or less will see higher revenues than expected at planting. Farmers lucky enough to have trend or even higher yields could have their best revenue and net income years.

The profit or loss of farmers whose yields drop by more than the percentage decline at national level will depend upon whether or not they bought crop insurance and what options they chose.

At one end of the spectrum, farmers with substantially reduced yields but who purchased a high level of coverage with the harvest-price adjustment could see per-acre corn revenue greater than what they expected at planting (

print.html). For those who bought low levels of coverage and did not purchase the harvest-price adjustment, this year could be a financial disaster.

While crop insurance provides a safety net for farmers, the net is somewhat leaky, guaranteeing profit for some while leaving others with significant losses.

Editor’s Note: Ray holds the Blasingame Chair of Excellence in Agricultural Policy, in the Institute of Agriculture at the University of Tennessee in Knoxville, and is director of the university’s Agricultural Policy Analysis Center. Schaffer is a research assistant professor at APAC.