Field Equations

Prairie Drought Creating Hardships and Opportunities for Farmers

For the first time in years, North American farmers are grappling with major growing challenges. In both Canada and the United States, exceptionally dry weather across the prairies has curtailed crop yields and is weighing heavily on wheat and canola production. But there is a silver lining: after years of excess supply, expectations of a smaller harvest have helped provoke a large increase in crop prices. Strengthening demand has also helped. Food demand not only held up well through the coronavirus recession, it increased—and grocery volumes have remained high even as the restaurant industry has reopened, which has provided an additional lift to crops and livestock. But costs are rising too, with farmers across the continent facing higher prices for equipment, fertilizer, feed, and energy.

Farm Prices at Multi-Year Highs

From a big-picture standpoint, North American farmers are enjoying the strongest pricing environment in years (Chart 1). In the United States, the farm product price index—an all-encompassing measure of agricultural prices—has reached a seven-year high after rebounding more than 30% from last year’s pandemic-induced low. The Canadian index has fared even better, and has posted a string of new records thanks to the relative affordability of the Canadian dollar. At the beginning of the pandemic, a plunge in the loonie helped to prop up the domestic value of internationally priced farm products. And today, even with its subsequent recovery, the Canadian dollar remains far lower than during previous periods of strong global farm prices (it was actually above parity against the U.S. dollar during the commodity boom in the mid-2000s and the Midwest drought in the early 2010s). These aggregates necessarily gloss over a diversity of experiences within the sector, but from ten thousand feet, there is no denying that farmers are enjoying a solid marketing environment.

The largest gains have been posted in the crop space. Although most crop prices were not highly affected by the pandemic, major benchmarks were already weak when it started, due a string of solid harvests and a drop in exports stemming from the China-U.S. trade war. Fortunately for producers, all of that has changed. With production and inventories easing, trade challenges largely resolved, and domestic demand in good shape, wheat, corn, and soybean prices all reached eight-to-ten-year highs this year, while canola hit an all-time record (Table 1). Livestock prices have also rebounded impressively after plunging at the onset of the pandemic, when meatpacking closures created a glut of animals on farms. With processing capacity back online and consumer demand strong, benchmark cattle prices have reached a five-year high this summer after dropping to a ten-year low last spring (after adjusting for seasonal patterns). In the hog space, prices have jumped from a seventeen-year low last year to a seven-year high this summer. Like many commodities, crop and livestock prices have taken a step back over the past few months, but they remain well above recent norms.

Higher farm prices are also filtering down to the grocery store (Chart 2). At the onset of the pandemic, food inflation accelerated on both sides of the border, but jumped most dramatically in the United States, where outbreaks at large food processors had a big impact on supply. Since then, food prices have actually decelerated in Canada. On a two-year basis, Canadian food inflation was a moderate 2.1% annualized in August, tempered by the recovery of the Canadian dollar from its pandemic-induced lows. This stands in stark contrast to the United States, where two-year food inflation reached a ten-year high of 3.8% annualized in August. Prices are now rising rapidly across most of the food products used to construct the U.S. consumer price index, which is adding to concern about inflation in the broader economy.

Supply Suddenly Shrinking

The coronavirus pandemic has had a large impact on many sectors of the economy—but the direct impact on grain, oilseed, and livestock production has actually been fairly small. Not only are these activities essential, but they are relatively solitary, which has limited the potential for virus outbreaks and work stoppages. As a result, the agriculture sector was one of the few industries to register real GDP growth in 2020, and it did so in both Canada and the United States.

But this year, crop production in North America is being undermined by a searing drought spanning the Canadian prairie provinces, the U.S. Northern Plains, and the Pacific Northwest. The U.S. Drought Monitor estimates that 58% of the continental United States is grappling with abnormally dry conditions, while in Canada, 79% of agricultural land has faced the same. The hot, dry weather has had a major impact on crops grown in these regions—most notably wheat and canola. As of mid-August, the U.S. Department of Agriculture (USDA) rated only 11% of the country’s spring wheat crop in “good” or “excellent” condition, compared to 70% last year. Conditions north of the border are not much better. In Alberta, only 21% of the province’s spring wheat was estimated to be in “good” condition or better as of late August. The dry weather also pulled forward the harvest, so at this stage, rainfall would be too little, too late.

It has been apparent for months that crop yields across the prairies would be weak this year, but the latest estimates are eye-opening (Table 2). In the United States, total wheat yields are likely to be around 12% below trend this year—and that incorporates a decent winter wheat harvest earlier in the summer. In Canada, which primarily grows spring wheat, yields are projected to be 33% below trend this year. The drought on the prairies has also devastated yields for Canadian canola—typically the country’s largest revenue-generating crop—which are likely to be 37% below trend this year. U.S. canola yields are also extremely weak, though the crop is not grown intensively south of the border. Although wheat-producing regions overseas have generally fared better this year, the hardships in North America have still pulled global wheat yields well below recent norms. And because Canada is by far the world’s largest producer of canola, global canola yields have been hit especially hard.

North American corn and soybean yields have held up well this year by comparison, reflecting generally accommodative conditions in the Midwest, but stockpiles of all major crops are getting extremely low (Chart 3). Across North America as a whole, inventories of wheat, canola, corn, and soybeans are all projected to fall near decade-lows, or lower, relative to consumption by the end of the current marketing year. The breadth of the scarcity partly reflects that wheat shortages are encouraging greater use of corn and soybeans. Strong demand is also at play. Fortunately, global crop markets are not as tight—with the exception of canola, given the importance of the Canadian crop. In the wheat space, the world stocks-to-use ratio is actually estimated toward the upper end of its recent range, which has yielded more moderate overseas crop prices.

Livestock supply has also tightened after years of herd expansion (Chart 4). In the cattle space, the North American herd actually turned lower before the pandemic, but declined further in 2020 as meatpacker closures kept farmers in herd reduction mode. This year, the overall headcount of the cattle herd has remained under pressure, as producers in drought-affected regions have been making the difficult decision to cull their herds, driven by the reduced quality of grazing land, the higher cost of purchased feed, and in the hardest hit areas, shortages of drinking water. The fact that cattle prices have trended higher despite such culling—which has temporarily increased the supply available for slaughter—is a testament to the strength of the demand environment. Overall, the North American cattle herd is on track to end this year around 2% smaller than at the end of 2018.

The hog segment has experienced similar supply dynamics. After a period of rapid expansion, last year’s meat processing shutdowns saw hog producers significantly reduce the size of the pig crop. This year, higher feed costs are yielding a record rate of slaughter, which is keeping pressure on the herd. Overall, the North American hog herd is on track to end the year around 2% smaller than its recent high at the end of 2019.

No Shortage of Demand

Farm prices are also benefitting from strong demand, but the experience since the beginning of the pandemic has been mixed. In the crop space, demand for most products was not highly affected by pandemic-related restrictions, but corn demand plunged as reduced travel and extremely low oil prices caused biofuel production to drop. In the food space, some parts of the processing industry struggled to retool away from bulk products normally sold to food services establishments, which temporarily reduced demand for farm products. Some processing segments also grappled with coronavirus outbreaks directly, but fortunately, such closures have become rare as businesses have adapted their operations to the reality of the pandemic.

Since the start of the pandemic, lower demand through the food service channel has been offset by a major increase in spending at grocery stores (Chart 5). In both Canada and the United States, real grocery spending soared during the first half of 2020 as consumers rushed to stock their pantries, and remained well above pre-pandemic levels even after panic buying subsided. Grocery volumes have also remained strong this year despite the reopening of the restaurant industry. In the United States, real grocery spending trended even higher during the first half of 2021 and was roughly 12% above pre-pandemic levels in Q2. In Canada, grocery purchases took a step back in Q2 but remained 8% above pre-pandemic levels. The outlook for consumer spending remains strong, with the economy largely reopened, employment rising, and households sitting on substantial new savings.

Robust overseas demand is providing additional support to North American farm prices. Across the continent as a whole, net exports of most major products have taken a meaningful step up from recent norms (Chart 6). The stronger trade situation has been driven in part by the Phase One trade agreement reached in early 2020 between the United States and China. As part of the agreement, China committed to significantly increase its purchases of U.S. agricultural products, which it had targeted during the trade war. Under the terms of the deal, China almost doubled its purchases of U.S. agricultural products last year. Soybeans, corn, and pork have all been beneficiaries. This year, China’s purchases are on track to increase even further—and while U.S. farmers are benefitting most directly, producers across the continent are enjoying the positive impact on pricing. North of the border, China’s restrictions on purchases of Canadian canola remain in place, but producers have managed to divert more product to other markets.

Revenue Rising, but so Are Costs

Today’s stronger pricing environment is providing a significant lift to farm revenue. Even in the crop space, where the drought is weighing on production, the disproportionate jump in pricing should buoy revenue this year. The financial impact on crop producers in the most drought-affected regions should also be tempered by insurance coverage and government relief initiatives. The stronger pricing environment has also put livestock producers on track to enjoy higher revenues this year, though the impact will be partly offset by a reduction in pandemic-related government transfers.

Unfortunately, higher revenues are being absorbed—at least in part—by higher costs. With global demand for goods running hot, supply chain problems curbing product availability, and non-agricultural commodity prices at elevated levels, farmers are facing higher prices for some of their key inputs (Table 3). Energy and fertilizer costs have escalated particularly sharply—and not just compared to last year’s pandemic-induced lows. In the United States, the cost of refined petroleum products has vaulted 29% over the past two years (i.e. since before the pandemic) and fertilizer prices have jumped 25%. The numbers facing Canadian farmers are similar. The cost of agricultural equipment and industrial building construction has also increased significantly over the past two years, and while pesticide prices have declined, they have done so from the artificially high levels caused by the China-U.S. trade war. Livestock producers are also facing significantly higher feed prices.

Fortunately, financing costs remain extremely low. Since the onset of the pandemic, the Bank of Canada and the Federal Reserve have kept short-term policy rates at their effective lower bounds while purchasing bonds to bring down longer-term market rates. In a capital-intensive industry like agriculture, this provides significant cost relief. The low rate environment has also supported asset valuations and, together with higher agricultural prices, has put farmland prices back into high gear. In the United States, where market data are timelier, farmland prices jumped 7% in the year to June 2021 after increasing around 1% per year over the previous five years. Of course, the ultra-low rate environment won’t last forever. Both the Bank of Canada and the Fed are likely to begin raising rates around the turn of 2023, give or take, as the economy gets back to capacity. Approaching policy rate hikes, together with a reduction in central bank bond-buying and faster inflation, will also put longer-term rates on an upward trajectory.

Productivity to Remain Key

With costs on the upswing, it is as important as ever for farmers to maintain a focus on efficiency. Fortunately, the agriculture industry has an impressive track record on that front. Setting aside year-to-year fluctuations in growing conditions, crop yields have trended ever higher over the long run, thanks to steady advances in plant genetics, land management practices, and most recently, precision farming. Overall, wheat production in North America has increased by almost 70% over the past half century, even as the amount of acreage devoted to the crop declined by around 20%. Livestock producers have also made major strides over the long run. In the United States, the average finished beef steer weighs almost 350 pounds more at the time of slaughter than it did fifty years ago. A broader view of industry-wide efficiency is captured by estimates of multi-factor productivity, which attempt to measure the increase in output attributable to improvements in technology and management, as opposed to more intensive use of labour and capital (Chart 7). By this measure, the farm sector has posted a truly exceptional performance over the past few decades. Since 1980, multi-factor productivity in Canadian agriculture has soared by more than 170%, against less than 10% for the business sector as a whole. The fact that productivity gains in agriculture have actually accelerated over the past few years bodes well for the industry’s ability to grapple with current and future challenges.