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Retail Trends

All Dried Up

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The most severe drought in nearly 60 years has devastated the nation’s corn, soybean and wheat crops, and some food manufacturers are already looking at passing price increases along to consumers before the end of the year.

The real impact of the drought — which covered nearly two-thirds of the country — is still to come, however. The worst corn crop since 1988 has some observers forecasting price hikes on everything from beef and dairy to cookies and peanut butter. And since a significant amount of corn is used in ethanol production, higher gasoline prices may be in the offing as well.

The situation has global implications. The United States exports more of these commodities than any other country, and a cutback in shipments could lead to a global food crisis, according to some economists.

“This drought is really going to be felt for a year to a year and a half,” Corinne Alexander, agricultural economist with Purdue University, said in a recent interview. “You can’t have a short-term impact from a drought that’s this severe.”

Projections by the U.S. Department of Agriculture’s Economic Research Service agreed, noting that the full impact of prices on a wide variety of foods containing corn, flour and cereal would take more than a year to show up on grocery shelves. As such, higher U.S. food prices may not have an impact on the upcoming holiday season, but could result in cutbacks on everything from food to apparel and deal another blow to an already fragile economic recovery.

Craig Rosenblum of Willard Bishop Consulting fully expects consumers to indulge a bit during the upcoming holiday season. “But looking ahead to the first quarter of 2013, recession-weary consumers could cut back in spending, according to some retail executives and economists,” he says.

“I think consumers will be in a conundrum in the first quarter. We could have a new president and we don’t know what will happen with the government. The question among retailers is whether to take a hit on margins and try to drive top-line sales or wait until we’re seeing 4 percent inflation and the top line drops.”

He notes that retailers who continue to struggle in a higher cost environment could also end up ratcheting down capital expenditures for renovations and investments next year. “The one place where I don’t see people trimming a lot is IT spending. It’s holding steady,” Rosenblum says. “People know they can drive efficiency with the right technology.”

Meanwhile, with crops — particularly corn — yielding 40 or 50 fewer bushels per acre, food price inflation will be double what many thought it would be in the final quarter of 2012. Safeway CEO Steve Burd and Kroger CEO Dave Dillon “have acknowledged that they thought inflation would be in check at 1 or 2 percent, but would probably run 4-6 percent in the back half of the year,” Rosenblum says. “Few if any [retailers] will be able to absorb cost increases or margin compression, so they are going to pass along those prices increases to shoppers.”

Double-digit declines
Not everyone agrees on the gravity of drought-related price increases.

The USDA said in mid-August that the drought was peaking and that steadying weather conditions might limit food inflation next year to between 3 and 4 percent. However, the agency concedes it has just started to assess the consequences for next year’s crop.

The National Oceanic and Atmospheric Administration (NOAA) reported that drought conditions would persist through November across much of the Corn Belt and Great Plains states. Final harvests don’t get underway until September, but a 13 percent year-over-year decline in the corn crop and a 12 percent decline in soybeans are feasible, the USDA said.

Meanwhile, government agencies and industries like beef and poultry are battling over a suspension of U.S. ethanol rules that would allow more corn to be used for food and livestock feed. By mid-August, some 180 members of Congress had requested an ethanol waiver on what’s been called the “fuel vs. food debate.”

With the low yields increasing the prices of corn and hay bales as much as 150 percent, some livestock ranchers have reportedly been forced to look for other sources of feed. Most, however, are simply bringing their herds to market sooner. This could mean a larger supply of beef and lower prices at retail for the next several months, but prices are likely to jump 4 or 5 percent in 2013. Diminished herd sizes will reduce the beef supply and it may take several years for ranchers to rebuild them.

Smaller cattle herds will also bump up milk prices next year, according to the USDA, with an immediate 30-cent-a-gallon increase in the offing. The USDA also predicts that poultry and egg prices will rise 3-4 percent and pork will increase 2.5-3.5 percent.

Even estimates by the most conservative food industry observers have overall food prices rising 3 to 4 percent in 2013, leading to concerns about cutbacks in consumer confidence and spending in a wide range of product categories.

Frank Galgano, an environmental expert and chairman of the department of geography and environment at Villanova University, says, “Possibly we will see some items disappear from the grocery shelves.” However, few food industry observers mention shortages. The real issue is when price increases will be passed along to consumers.

Kraft Foods CEO Irene Rosenfeld told the Financial Times that low single-digit price increases will take effect this year, but there will be a lag before the effect of the drought is really felt. “You won’t see an immediate impact, but without a doubt it will have an impact on some of our key commodities,” she said.

Insurance costs
An interesting sidelight to the drought is the effect on insurance companies, which are now facing their largest-ever agricultural losses. Overall, industry sources are estimating underwriting losses of $18 billion, but the federal government reinsures approximately $14 billion of that, in addition to subsidizing premiums that farmers pay to private insurance companies. The bottom line is that private-sector insurers will likely have to shoulder about $5 billion, according to Wall Street insurance analysts.