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Markets watch the weather

Rain makes grain, and it’s one of the most volatile variables for Prairie farms

Price and yield are the two biggest determinants of farm revenue.

Using farming software to run simulations and what-if scenarios shows that even a modest change in commodity prices or crop yields can have a big impact on gross margins and the bottom line.

This makes sense, given revenues are top line 100-cent dollars. While I usually talk about market and volatility in these articles, I thought it would be interesting to look deeper at the other biggest influence on revenue: weather, and more specifically, precipitation.

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Just like commodity prices and market volatility, weather factors have certain parameters and often fluctuate within a range as well. Like most things in the markets and in nature, it’s the extremes we have to be aware of and pay attention to. Whether it’s precipitation figures or commodity prices, numbers are numbers and crunching this data gives a better understanding of all the factors that affect crop yields, commodity prices and ultimately farm revenue.

We all have heard the ancient adage that “rain makes grain” and it really is the main weather factor that drives crop production. While temperatures during the important growing months can change 10 per cent from year to year, precipitation levels during the key May to August months can vary as much as 30, 40, to over 50 per cent annually.

Using precipitation data from the National Oceanic and Atmospheric Administration (NOAA) for the U.S. Spring Wheat Belt shows not only that levels fluctuate dramatically from one year to the next but also, in some cases, for lengthy periods of time.

During the dust bowls of the 1930s, there were several years in a row when all years were well below the long-term average of 8.2 inches (see chart — grey line) with many having extremely low levels of precipitation.

It gets even more interesting, when you compare precipitation levels with yields. Crop yields will vary by as much as 10 to 30 per cent, or more from year to year and usually in sympathy with very high- or very low-precipitation years. It’s no surprise that some of the worst-yielding spring wheat crops in the past 20 years have coincided with low-precipitation years.

It’s nothing new that precipitation will impact yield, but it does remind us just how volatile it can be. This is of course all tied in with grain prices and how much it ultimately affects revenues.

Indeed, grain prices can fluctuate up or down 20 to 30 per cent in a 12-month period, very similar to precipitation changes as well as yield changes. Once again, it’s usually in the low-yield years that prices are higher and the high-yield years that prices tend to be lower. Again, nothing new, but there is a strong connection here and a reminder of the influence of good-old-fashioned supply and demand.

Bottom line, precipitation, crop yields and grain prices go hand in hand. A better understanding what all these effects have on revenue can assist in putting in place both operational and financial strategies to better manage through all conditions.

There are few things you can do to control Mother Nature. Today’s equipment technology, though, like variable rate, aerial imaging and zone mapping, can mitigate some of the effects of weather to help improve production at the farm level even if weather doesn’t always co-operate.

Likewise, the proactive use of financial hedging technology, like options and futures, is all the more important to fine-tune pricing, storage or delivery decisions and manage overall farm revenue. Risk management technology can help manage prices just like farming equipment technology can help manage the effects of weather.

Both are becoming a greater reality in our advanced, high-tech world.

About the author

Columnist

David Derwin is a commodity portfolio manager with PI Financial Corp. The views here are his own, presented for educational purposes, rather than as specific market advice. For a copy of the complete research study “Farming Big Data — Myths, Misperceptions & Opportunities in Agriculture Commodity Hedging” contact him at [email protected]

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