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Drought affecting food costs

Question:

Every day brings more headlines about the drought in Midwestern farming areas. How is that going to affect food costs?

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Answer:

The 2012 U.S. corn crop is officially forecast to total 10.8 billion bushels, a decline of 13% from a year ago. While planted area is pegged at a modern day record of 96.4 million acres, yields are forecast to decline to 123.4 bushels per acre, a decline of more than 20% from trend levels.  The decline in yields reflects the most adverse weather in more than 20 years to face growers.

Corn is the largest crop produced in the U.S. – equal to more than 50% of total crop production (by volume) in a normal year.  As a result, corn prices are an extremely important driver of food costs for the restaurant industry.  A few products, such as fructose and starch, are directly impacted by corn prices.  And other grain prices (wheat, rice, and oats) are impacted by an increase in corn prices because of the effect on demand.  But the most important impact for restaurants is the eventual impact upon the price of proteins (beef, pork, and poultry) and dairy products.

Because corn prices have risen so dramatically (up 60% since mid-June), the restaurant industry will begin facing higher costs for a broad range of inputs by late 2012 and through 2013.  Previously consumer food prices were expected to rise by roughly 2.5% during 2013. Because of the drought’s impact on corn supplies, the 2013 rate of consumer food inflation is now expected to be 4-5%.

This impact upon the cost of proteins and dairy products reflects the importance of corn as a feed ingredient.  Corn is the dominant feed for cattle, hogs, chickens and dairy cows.

Historically, when feed costs (i.e., the price of corn) increase, livestock producer margins are reduced or become negative.  Currently the estimated margin for each of the protein groups, as well as the dairy sector, is negative.  Ultimately this means production cutbacks and higher prices for beef, pork, chicken and dairy products.

The weather-related run-up in price of corn and other key ingredients is a good reminder of the value of employing solid and consistent principles in the management of commodity risk.  Managing food input costs requires restaurateurs first to identify their risk management goals, and then develop hedging and procurement strategies to meet those goals.  While the ability to avoid higher costs due to the 2012 drought may be limited, restaurants should use this as an opportunity rethink their risk management goals and strategies employed in the years ahead.

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