The Unexpected Consequences of the 2012 Drought

On my way to Fool HQ Monday morning, I hadn't been outside of my apartment for more than two minutes before I started sweating through my shirt. Unless you're from Maine, Florida, or the Upper Northwest, you're likely dealing with an equally uncomfortable situation. And along with the excessive heat has come unusually dry conditions.

As you can see below, the vast majority of America is in the middle of the worst drought since 1956. The darker the color -- orange, red, or purple -- the worse the drought is.

anImage

Source: NOAA

But the effects of droughts don't necessarily play out as you'd expect. Take corn, for instance -- the crop is used in a dizzying array of products, from corn syrup to livestock feed to ethanol. One look at where our corn belt is located and you'll see that supply is going to be far tighter than in a normal year.

anImage

Source: USDA, data for 2010.

Though certain sections of Minnesota are actually getting a steady drizzle, the same can't be said for the rest of the Midwest or Great Plains states. On a very basic level, one would assume that this would spell disaster for farmers.

But that's not actually the case. Farmers can buy insurance from private companies like ACE Limited (NYS: ACE) , and almost universally participate in the Federal Crop Insurance Program. Therefore, farmers are saved from the brunt of the lower yield, and because crop insurance only covers a portion of revenues for private insurers, they will avoid severe punishment as well.

But that doesn't mean there won't be losers. As the corn yields lower, the price for a bushel of corn has skyrocketed, increasing 30% since Jan. 1 and 50% since just June 15.

anImage

Source: CNBC

When an input cost rises that much, someone is bound to feel the pinch. Again, it would seem to make sense that consumers at grocery stores would be the main losers.

But once again, that's just not the case. As Ricky Volpe, an economist with the USDA, explains, "A 50% increase in the price of corn tends to raise total shopping bills by about 1%." No one likes to see food prices rise, but it seems like the average U.S. consumer is dodging the drought bullet as well.

If you're looking for who loses from rising corn prices, there are two places to look: livestock producers and corn processors. Morgan Stanley recently downgraded Archer Daniels Midland (NYS: ADM) , one of the country's largest corn processors, over concerns that margins for high-fructose corn syrup would be pinched.

And whereas farmers can rely on insurance to provide a safety net in uncertain times, livestock producers have no such protection. Bill Tentinger, president of the Iowa Pork Producers Association, predicts that "high corn prices ... will force many pork producers out of business."

For the average American, that means meat prices may increase more than the average 1%. And companies like Chipotle (NYS: CMG) may see a disproportionate increase in input costs to serve up their burritos.

What about water?
There are several ways that the lack of rain will affect the water industry, as well. But in the interest of examining how consequences may not be what they seem, let's investigate the toll on the natural gas industry.

Take a look at where the majority of natural gas wells are located, and you'll see that they are centered in some of the hardest-hit areas in the country.

anImage

Source: EIA, U.S. Department of Energy

Fracking, a process that revolutionized the industry by making previously inaccessible resources open to exploration, uses tons of water. The drought has caused some states, like Pennsylvania, to suspend fracking operations.

Again, it would make sense to assume that natural gas companies would stand to lose from reduced output. But America's largest natural gas producers, like ExxonMobil and Chesapeake Energy (NYS: CHK) , may actually benefit from the drought.

As it is, we have built up a vast oversupply of natural gas in the country. That has led to rock-bottom prices for natural gas, and reduced earnings for several companies. If production decreases, then supply can tighten, and prices can rise to levels where natural gas producers can remain sustainably profitable.

Instead, companies like Heckmann (NYS: HEK) stand to be bigger losers. The company is building out the infrastructure to meet the water demands of the fracking process. But if fewer companies are paying Heckmann to use its water system, the company will be collecting far fewer fees.

As you can see, it can sometimes be difficult to predict who will be most affected by major world events. Let The Motley Fool help you in navigating such occasions. Our analysts have issued a special free report to help you with a different major event on the horizon: the presidential election. The report shows how you can benefit no matter who the winner is. Get your copy today, absolutely free, and you'll be the one celebrating come November!

The article The Unexpected Consequences of the 2012 Drought originally appeared on Fool.com.

Fool contributor Brian Stoffel owns shares of Heckmann. You can follow him on Twitter, where he goes by TMFStoffel. The Motley Fool owns shares of Chipotle Mexican Grill, ExxonMobil, Heckmann, and Chesapeake Energy. Motley Fool newsletter services have recommended buying shares of Chipotle Mexican Grill, and creating a bear put spread position in Chipotle Mexican Grill. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Introduction to Value Investing

Are you the next Warren Buffett?

View Course »

Investing in Emerging Markets

Learn to invest in a globalized world.

View Course »

Add a Comment

*0 / 3000 Character Maximum