Thursday, August 13, 2009

Grain, Drought and Systemic Risk

The global supply of grain is more vulnerable than most of us realize.

Knowledgeable reader L.K. recently sent me this disturbing report:

I just read your article The Royal Scam. I wanted to tell you about something that 99% of America does not realize but which could cause more problems than any of the things in that article. Nobody realizes that only 1% of the US population are real farmers. 70%+ of our food supply is grown by them in a relatively small area of the Midwest between Southern Minnesota to Texas and Eastern Nebraska to Ohio. So most of our food, the only thing we need every day to survive, is grown by 1% of the population in the middle of the country whereas most of the rest of the population lives within 20 miles of the coasts.

Also, the crops in that area are not irrigated. So they are unusually susceptible to cyclical droughts. If a garden-variety drought were to hit that area of the US, that part of the population that depends on it for survival have no solution and they are armed to the teeth.

There used to be a lot of grain stored up courtesy of the government, but that was all gotten rid of in the '80's so that the money used for it could be spent on social programs. So now we have no contingency plan for this occurrence. Currently we are long overdue for a drought in that part of the US. If we get one there you can make your own conclusions as to what will happen.

An interesting sidelight to this is that Goldman Sachs, the only surviving investment house in the US with a trillion dollars in assets, just became a bank and moved their headquarters to Salt Lake City, Utah. Many people wonder why they would do that. However, all the cropland in that area is irrigated making that region drought-proof. Also there's not much of a population there to freak out as will happen within 20 miles of the coasts.

The way I know about this is that for thirty years I was a grain trader and feed ingredient buyer for several large US agribusinesses whose business it is to know about and follow closely these sorts of things. All of the statistics that prove what I said is correct are freely available on the internet but 99.99% of all people are not interested in where their food comes from or how much of it is out there. Strange since that's the only thing they really need to survive.

But if this scenario (drought-induced grain shortage) were to occur things would happen relatively quickly and nobody would warn the public about it until it was too late. This event is set up like your financial one. The pieces are already in place and there is no contingency plan to stop it.

One solution I know of is to NOT live in a big city. The bigger the city, the worse it will be. And, as I mentioned, living in an area where the crops are irrigated will also be a solution. But getting to that area from a big city when there's no fuel to get out with and rioting going on there will make it hard to make it to an irrigated area once the disaster hits. So a prudent person should do that ahead of time, IMHO.

Thank you, L.K. This report fits into a theme many have observed: the global supply chains for the two necessities of industrialized civilization--oil and grain--are precariously balanced on a few large suppliers, a situation commonly termed as "systemic risk," meaning it is not temporary but an integral feature of the supply chain.

No other alternative supplies are available if, say, Saudi Arabia stops pumping oil or a severe drought devastates the U.S. wheat crop. Yes, there are "strategic reserves" but these are not as deep as many seem to think.

The entire U.S. Strategic Oil Reserve is 600 million barrels, or about one month's supply. (20 million barrels a day X 30 = 600 million barrels). It will be useful in filling a brief gap in supply (say, 5 MBD) but it is simply not large enough to maintain consumption in the event of a serious, lengthy disruption.

The canniness of Goldman Sachs seems to know no bounds....

Frequent contributor Albert T. recently sent me these links and comments on the drought in India. Currently there is a severe drought in grain-producing regions of Australia, and both Texas and California are suffering from near-drought conditions. Nobody can predict the weather but to dismiss drought as a threat would seem to be foolhardy.

Here is Albert's report:

Impact of weak monsoon on Kharif

Rice Drought

Agriculture Minister Sharad Pawar told parliament the June-September monsoon had been deficient across India, delaying sowing and planting in key agricultural states like Punjab and Haryana. "Monsoon this year has been weak and erratic in its progress, resulting in late sowing of (paddy) crops," Pawar said during a debate on agriculture output.

The minister said rainfall nationwide was down 19 percent on the previous year, with a shortfall of 38 percent in the northwest and 43 percent in the northeast."

Meager Monsoon Threatens Indian Growth

After India's driest June in 83 years, four of 28 provinces have declared drought, and many farmers don't have enough water to grow a full crop. More than half of Uttar Pradesh, the most populous state and a key rice and sugar cane-growing area, is suffering from drought. A poor crop yield could push up food prices, straining the government's budget and complicating the central bank's efforts to revive the economy without letting inflation get out of hand.

"If overall rainfall deficiency falls to 20%-25%, India's gross domestic product growth could be pared to sub-5% this fiscal year," said Mridul Saggar, chief economist at Kotak Securities.

India was sort of improving last week or two but apparently not so. The impact of food going to a larger % of income from say 10 to 20 is hardly ever mentioned:

1 yr old graph on food % spent by Americans.

Food CPI and Expenditures (USDA)

Basically the supply chain for food processors/producers (bakeries/pastry plants) eats the manipulated higher prices while the farmers and others who produce or participate in grain elevators etc. in the market eat the lower price in the cash market for holding/producing grain. It makes production less attractive for farmers and higher costs pass through the the food processors to end users (us) due to futures being higher. So we take it on both ends with risk amplified in the now for lower production and in the future for higher costs. Thats my take on it. (The first article below tries to say something similar).

CFTC chief: agency 'seriously considering' index trading limits amid concern over wheat prices

How Commodity Indices Broke the Wheat Futures Market

DJ Kraft Slams CBOT Wheat Plan, Questions Value Of Contract

What will happen is we will pay more and more for bread while farmers get less and less. (This is all my opinion btw).

Grain markets we've never witnessed before (2/15/08)

However, one key factor makes the current market environment different. That's the influence of the very well-funded index funds, which trade only from the long side and are sold as a hedge against inflation.

This makes farm markets more of a money game. Who has the cash and what do they want to do with it. For now, the supply and demand fundamentals have a lessened impact on prices.

Here's an example of what I'm talking about. As I write this in early February, the index funds hold long positions in corn futures that total nearly 2 billion bushels. That's more bushels than the expected carryover of 1.4 billion bushels.

Their long position in soybeans is just under a billion bushels, compared to an expected carryover of only 175 million bushels!

Their long position in Chicago wheat is approximately 1 billion bushels, which represents about 270 percent of the entire soft red winter wheat market!

Regulating commodities speculation: normative and fiscal means(Institute for Agriculture and Trade Policy)

Thank you, Albert, for this wealth of resources on a critically important topic.Here is a book Albert recommended some time ago which I also recommend:

Merchants of Grain

These titles are also highly relevant:

The Paradox of Plenty: Hunger in a Bountiful World

Paradox of Plenty: A Social History of Eating in Modern America

The Nine Nations of North America

Diet for a Small Planet

The Omnivore's Dilemma: A Natural History of Four Meals

Gardening When It Counts: Growing Food in Hard Times

Storey's Basic Country Skills: A Practical Guide to Self-Reliance

Just in Case Kathy Harrison

The Urban Homestead: Your Guide to Self-sufficient Living in the Heart of the City

Depletion and Abundance: Life on the New Home Front Sharon Astyk

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