Drought and small revenues – do they always go hand in hand?

June 5, 2017
By Sonia A. Hall

The conditions the Northwest experienced in 2015 have received a lot of attention, because we saw drought even though precipitation was close to normal. So the drought was due to higher temperatures, which meant snow didn’t accumulate anywhere near as much as it does on average. With less water available for irrigation in summer (see our earlier articles on the 2015 drought here and here), we’d expected irrigated crops to suffer, and we’d also expect growers’ bottom line to suffer.

Drought (and other stresses) can have a significant impact on crop production—see this comparison of the size of an ear of corn in Missouri during the 2012 drought to its “normal” size (space between hands). The expectation is that decreases in production will lead to drops in revenue, but is that always the case? Photo: Malory Ensor/KOMU News under CC BY 2.0

But when the National Agricultural Statistics Service’s Annual Statistical Bulletin for Washington State came out in October 2016, it was followed by an article in Capital Press discussing the apparent paradox that agricultural production values hit record highs in 2015, even though the region was under that newsworthy “snow drought.” Though I did not personally fact-check the Capital Press article, it’s an intriguing paradox. A presentation I heard at the recent (January 2017) Climate Impacts to Water Conference provided some insights. Ballav Aryal, a graduate student in the School of Economic Sciences at Washington State University, presented research that highlighted two factors that might explain this apparent paradox.

Factor number one: price elasticities. What’s that? Say, for example, that wheat production is very low this year. If there’s nothing consumers can really replace it with, the wheat that’s available becomes very valuable, and its price will likely go up significantly. That’s what economists call an inelastic demand. If, on the other hand, consumers could just shift to eating oats or corn instead, then that wheat would not be as critically valuable, and its price might not increase much at all. That’s an elastic demand.

Figure 1. The price is set where demand (D line) meets the supply line (S1 and S2 show two different production situations). If wheat production is low this year (S2 line, rather than the normal S1 line), prices will rise more if demand is inelastic (left panel – compare P2 to P1) than if demand is inelastic (right panel – compare P2 to P1). Figure courtesy of Ballav Aryal, Washington State University, modified with permission.

 

Price elasticity is a factor that growers have little control over. But if the crops that are impacted by drought (and so have lower production) also happen to have inelastic demands, then their prices might increase significantly when production is slow. Those increases in the price might more than make up for the decreased production. That is, total agricultural revenue could increase even if the amount produced decreases.

Factor number two: water allocation. In contrast to the price factor, water allocation may be a factor that growers can control, at least to some extent. This of course is focused on irrigated crops. If in any given year growers apply their available water to an array of different crops, when their water availability is curtailed due to drought they will make decisions on what crops to favor with the water they do have. If they are able to direct their water to those crops of highest value, then their revenue will suffer less (maybe much less) than if they can’t and irrigation water to all of their crops is reduced about equally. Water leasing or otherwise trading water among producers—or even irrigation districts—can have the same effect on the overall collective value of a region’s production in a drought year (see the 2016 Columbia River Forecast for more on this). This factor also argues for a diversity of crops across the region, as having a variety of crops acts as a hedge against drought risk.

 

References:

Hall, S.A., J.C. Adam, M. Barik, J. Yoder, M.P. Brady, D. Haller, M.E. Barber, C.E. Kruger, G.G. Yorgey, M. Downes, C.O. Stockle, B. Aryal, T. Carlson, G. Damiano, S. Dhungel, C. Einberger, K. Hamel-Reiken, M. Liu, K. Malek, S. McClure, R. Nelson, M. O’Brien, J. Padowski, K. Rajagopalan, Z. Rakib, B. Rushi, W. Valdez. 2016. 2016 Washington State Legislative Report. Columbia River Basin Long-Term Water Supply and Demand Forecast. Publication No. 16-12-001. Washington Department of Ecology, Olympia, WA. 216 pp. Available online at: https://fortress.wa.gov/ecy/publications/SummaryPages/1612001.html.

 

This article is also posted on the Agriculture Climate Network blog

Filed under Climate Change

2 comments on “Drought and small revenues – do they always go hand in hand?”

  1. Jeff said on June 5, 2017:

    Sonia, what do you think the public policy implications are of this paradox? Does it suggest that fears of agricultural losses during drought years are overblown? And that public money is better spent on preparation and long term resiliency measures than “disaster” relief?

    • Sonia A. Hall said on June 6, 2017:

      Hi Jeff, Thanks for your questions. You may be in even better position than myself to response on policy implications. Your point is based on the fact that drought impact analyses that do not account for how prices respond to changes in demand will tend to overestimate the negative economic impact of drought, especially for those crops for which there is a large price elasticity. This is really part of the bigger point highlighted by this study: it’s important to focus on the complexity of the issue. In addition to crops where the drought-but-still-high-revenue paradox is at play, there are also crops in our region with elastic demands, where low production does lead to low revenues. So it is important that policies – whether focused on disaster relief or focused on improving resilience – give consideration to those complexities. There is also the need to better understand when, where, and how water allocation can help mitigate drought impacts on revenues, to inform policies that favor water allocation programs that help that along. Ballav’s work does not point to either resilience or disaster relief as a policy answer that fits all crops in the region, but rather points to what we should explore further to better support any resilience and disaster relief policy decisions.

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