Wednesday, November 26, 2014

Managing Drought Risk on the Ranch

Finances and Drought

Financial Benefits of Drought Planning

Drought comes with both direct and indirect costs. Whatever actions are taken to mitigate drought, there is always an associated cost, whether it be physical or psychological.

From the economic perspective drought mitigation is managed from two main objectives – demand management and supply management.

Demand management options include decreasing the demand for inputs such as selling livestock, weaning calves early and moving them to a drylot or sale, and decreasing the grazing time in various pasture.

Supply management includes options that increase the supply of forage and/or water by digging a well, trucking water to livestock, renting additional pasture, grazing alternative forages such as crop residue, and trucking livestock further distances to obtain additional pasture. 

With rare exception, all of these options incur cost either by increasing expenses or decreasing future revenues. While it may not be possible to incur no cost as the result of drought, it is possible to prepare. The more prepared you are, the more options you will have to mitigate drought, and hopefully, that will lead to a smaller impacts to you, your family and your livelihood and way of life.

Drought and cattle markets

Seasonal and Cyclical Behavior in Livestock Markets
Seasonality in Choice Boxed Beef Prices (below)
Chioce boxed beef cutout values, 2008-2010
Seasonality in Slaughter Steer Prices (below)
Nebraska direct slaughter steer prices
Cyclical Pattern in Real Calf Prices (below)
Real calf prices 500 pounds or less from the early 1900's

Market prices for cattle and beef fluctuate both seasonally and cyclically. When you combine such phenomenon with local conditions, such as drought, the amount of risk may be amplified. 

Using drought management strategies, a producer may be able to exploit the market fluctuations and use them to alleviate heavy financial losses. 

For example, it is commonly observed that cull cow prices generally bottom out in late fall, say November. If this seasonality effect is preceded by prolonged drought in your area, you could expect that your local market may see a flood of more cull cows than is normal for the season. This even further dampens local prices, and makes a very poor time and place to sell cull cows.

If, however, you had culled heavily in the spring, you would probably have gotten a better price for your culls, and you would have conserved more pasture or range.

The earlier you can anticipate drought and be prepared to manage it, you are more likely to avoid unfavorable market conditions and decrease your loss. In essence, early drought management provides greater flexibility and enhances your capability to avert unfavorable market conditions and "must sell" situations.

Risks associated with a drought

The two kinds of risk generally associated with a drought are production risk and market risk. 

Production risk naturally emanates from the fact that drought limits forage production and availability, which directly limits the total productivity of the operation. 

Increased market risk is realized when those affected by drought act in unison and dump animals on the market in an untimely manner.

To mitigate as much of this risk as possible, producers should have a viable drought management plan. Such a plan will not only specify all the options of demand and supply management strategies but may also use some form of insurance product where offered.

A viable plan needs to have several characteristics. These characteristics include being able to identify key decision points. As will be shown in the section titled “Before a Drought Section- Financial Considerations" a series of smaller decisions can be effective in mitigating drought impact on the operation.

Drought conditions occur over time sometimes making it difficult to take immediate action. A viable plan will provide a method of making decisions in a timely manner and in a less stressful way.

The key factor to remember in building a plan is that all of the options need to be carefully evaluated based on their cost of implementation and then use the combination of least cost options. In addition to the demand and supply management strategies one generally thinks about, insurance products and marketing tools should also be integrated where they can help mitigate risk.

Resources

Grazing Lands Economics (from NRCS National Range and Pasture Handbook)

A Good Drought Plan may Save your Ranch and Improve you Bottom Line (Stockton and Dhoubhadel, 2011)

The National Drought Mitigation Center | 3310 Holdrege Street | P.O. Box 830988 | Lincoln, NE 68583–0988
phone: (402) 472–6707 | fax: (402) 472–2946 | Email Us

University of Nebraska-Lincoln
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