3 Steps for Effective Drought Risk Assessment in Agriculture
Drought risk assessments are a key mitigation tool in an agricultural investing or lending portfolio. According to FEMA, an effective drought mitigation plan should include a “description of the type, location, extent, past occurrences, probability of future events, and impacts of all natural hazards to which they are vulnerable.”
When it comes to agriculture, a true drought risk assessment requires more than just a report of which areas are currently in drought or at risk of future drought. It requires a close look at both the direct and indirect impacts that drought can have on a farming operation. This includes immediate impacts like higher water transfer costs, as well as long-term impacts such as aquifer depletion and land subsidence.
This article will provide three steps that ag lenders and investors can take to perform a drought risk assessment and understand the overall risk to their portfolio.
1. Monitor Trends and Seek Out Credible Data
Drought risk factors can turn on a dime, and vary from one basin to the next. Droughts are expected to become even more unpredictable in large part due to climate change, and a megadrought that lasts for two decades or more is a real possibility.
Keeping track of changing weather patterns and being vigilant about drought risk is imperative for all stakeholders in the agricultural sector – good business decisions depend on it.
Some of the trends to look out for include:
- Drought declarations by regional bodies. As of 6/4/21, California Governor Gavin Newsom declared a drought emergency in over 40 counties, while Marin County officials call the current period the “worst we have seen in over 140 years.” For many residents, this will be the first official drought warning they receive.
- Reduced water allocations and delivery cancellations. As of 6/4/21, the CA State Water Project has reduced 2021 water allocations to 5% of what was requested. This mirrors what happened in 2015, and can help to inform the decisions that ag professionals are making about the current growing season. Additionally, the Central Valley Project updated their allocations last week and won’t be delivering any water to agricultural contractors north or south of the Delta and cut urban deliveries to 25%.
- Increased water prices. Water prices are also likely to rise in times of drought. While access to a water market can be a lifeline for growers, they may have to pay more for water in a dry year than in a wet year. By monitoring water cost trends and other potential price indicators, ag finance institutions can factor these metrics into their drought risk assessments and lending decisions.
- Reduced farmland value. A recent review by AQUAOSO Technologies and the CA Chapter of ASFMRA found that “during times of regulation-provoking water stress, high-value farmland must have access to a viable source, quantity, and quality of water.” Lenders and investors must take these factors into account when assessing the overall drought risk of their portfolios.
These are just some of the key indicators to look out for when performing a drought risk assessment. Ag professionals should take care to assess the credibility of a source and use a logic-based approach to understanding drought risk.
This means reading scientific studies firsthand and following opinion pieces back to the source to see which reports they’re referencing. Broad claims should be substantiated with verifiable data.
The emotional stakes of water stress are high and impact various communities differently. This is not to be discredited; the social impacts of drought (some expressed in opinion pieces) are incredibly relevant and should not be overlooked.
Rather, fact-based reports – many of which account for these social impacts – and data-driven intelligence should be the foundation upon which agriculture professionals build a more resilient agricultural industry.
2. Use Data-Driven Intelligence to Assess Drought Risk
While nationwide resources such as the U.S. Drought Monitor can be a useful overview, portfolio-specific data the most value. That means understanding drought risk at a local, granular level, by taking into account each farm’s unique attributes and access to water resources on a parcel-by-parcel basis.
For example, two farms may have a similar likelihood of experiencing drought but may be located in two different basins with different water allocations, water rights policies, reporting requirements, and access to water markets. Even within the same state, the vulnerability of nearby farming operations can vary considerably, as watersheds take different approaches to mitigate drought risk.
Because of this variability, drought risk assessments are most powerful when the focus is on unique parcels in a portfolio. With data-driven intelligence, lenders and investors can determine whether a farming operation can withstand extended drought, and what risk mitigation strategies can be implemented to reduce risks.
3. Ask the Right Questions About Drought Risk
Finally, lenders and investors have to be able to ask the right questions in order to learn from drought history and stay ahead of future water shortages. These include questions about water supplies, water rights, and water banking, which can help to illuminate both the physical and temporal pressures of drought. After all, even a moderate drought can have severe impacts if it goes on long enough.
Ag professionals who have completed the first two steps on this list will be better suited to take on the third because they can use the information they’ve found in the research and data collection process to tailor the questions to their portfolio.
The risks posed by water stress, drought, and climate change can harm an agricultural lending portfolio if not addressed properly. By answering these questions in advance of a pending drought, lenders and investors will be in a better position to make educated decisions about water risk and maintain a competitive advantage.
Ag professionals can download the full list of questions here, as part of the free white paper, “Is California Agriculture Prepared for Another Drought?”
The Bottom Line
Performing a drought risk assessment is one of the key steps that ag professionals can take to ensure that the operations they invest in are prepared to withstand an extended water shortage. But many risk assessments stop at the state or regional level and don’t lead to an understanding of the specific physical, transition, and social risks that are relevant to each parcel of land in a portfolio.
By using portfolio-centric, data-driven intelligence, lenders and investors can make more informed decisions about drought risk at a local, granular level.
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