Drought Risk Management Comes from Understanding Impact Data

Drought risk management has always played a role in agriculture but is taking on new importance as climate change disrupts historical weather patterns and increases overall water risk. As the World Bank explains on The Water Blog:

“Societies have long struggled to prepare for and respond to floods and droughts…. Worldwide, it is difficult to point to a region or country that will not face more challenges managing these extremes in the years to come.”

As drought risk increases, however, there will be opportunities to reduce this risk with more efficient farming methods. While drought risk represents a challenge to the agricultural industry, new tools and technologies will provide ways to mitigate and manage drought risk in the years to come.

Drought blankets the West, but drought does not impact everywhere equally. In fact, it is quite the opposite: water is a hyperlocal issue. Because there are many moving levers in agriculture, such as water rights per parcel of land, water deliveries per parcel, local regulations, topography and natural resilience, and countless more parcel-specific qualifications of drought resilience, it is not an option for ag finance professionals to lack access to granular data.

This post will look at ways that ag lenders, Farm Credits, and other ag professionals can improve drought risk management by better understanding drought impact data.

Why Drought Risks are Material to Ag Finance

Material risks in agriculture are those that have a real-world impact on an agricultural sector, farming region, or even a specific parcel of farmland. Some impacts of climate change, such as sea-level rise, may not be a material risk to all farming regions, but drought risk is almost universally a concern, regardless of crop or growing region.

According to a report on “Drought Risk Assessment and Management” in a European research journal: “Due to the wide-ranging direct and indirect, often cascading impacts, drought risk assessments need to include information tailored to specific sectors and oriented to the needs of specific users.” By pinpointing risk using data acclimation and geospatial data technology, ag lenders, investors, and Farm Credits can create more effective drought risk management strategies tailored to their portfolios.

Financial Impacts of Drought

Drought risk is a material risk because it has long-term impacts on the bottom lines of borrowers and the financial institutions that lend to them. The Institute for Agriculture & Trade Policy estimates that as droughts become longer and more severe as a result of climate change, the U.S. agricultural industry could lose $10-14 billion every year.

Ag professionals don’t have to rely on projections to anticipate these losses. Looking back at recent disasters, actual agricultural losses include:

• “$14.5 billion in production loss payments from the federal crop insurance program” due to the 2012 drought
• Over $1.175 trillion in losses due to extreme weather events between 1980 to 2020 (according to research by NOAA)
• $931.6 million in agricultural damages due to the 2020 wildfires in Colorado, California, Oregon, and Washington

In addition to direct financial losses, extreme weather events take a toll on those who work in the agricultural industry, with an estimated 18,600 full- and part-time jobs lost due to drought in California in 2015 alone.

Having a drought risk management strategy based on real-world data won’t eliminate these impacts entirely, but it can mitigate the financial risk to farming operations and employees alike by making it possible to remain viable in times of water scarcity.

Increased Risk of Loan Defaults

According to Federal Reserve Economic Data, these risks aren’t limited to the growing season or the year that extreme weather events take place. Because several years of increased costs due to drought can accumulate, there is a trend of higher delinquency rates two or three years after a drought (based on previous droughts in CA).

The American Farm Bureau Federation (AFBF) reports that small farm delinquencies and defaults rose by 2.5% in 2019 – their highest rates since 2013. In the first quarter (Q1) of 2021, they were a bit lower, at 1.95%, but are edging upwards.

This diagram shows how drought can have a cascading effect, resulting first in water allocation cuts, followed by lower crop yields due to a lack of alternative sufficient water sources.

Next, this leads to borrowers defaulting on loans, reduced farmland value, and harm to disadvantaged communities who may depend on the same water resources, or on agricultural jobs for their livelihoods.

Ag finance institutions have several opportunities to mitigate these risks, such as factoring in water sources during due diligence.

Click here to view the full infographic.

Addressing the Impacts of Water Scarcity

The University of California found that water scarcity in 2014 – 2016 resulted in “losses in crops ($2 billion) and dairy and livestock ($553 million), as well as additional groundwater pumping costs ($1.3 billion).” Reduced water availability can have negative impacts throughout a farming community and will impact different growers uniquely.

Some farmers will have no choice but to remove crops they’ve already planted. The New York Times reports that, in the San Joaquin Valley, farmers may lose more than a tenth of productive farmland, or 535,000 acres, between now and 2040.

Because different groups have different water needs, the World Bank makes the case that drought risk management must take a “whole of society approach” that strives to be “inclusive and representative of the needs of all of society… especially those who are systematically underrepresented, such as women, minorities, elderly, and the poor.”

Ag finance professionals can play a role in this process by using granular data-driven intelligence to inform their lending decisions and work with their borrowers to reduce water risk.

How Granular Data-Driven Intelligence Can Help With Drought Risk Management

Lenders can use parcel-specific data-driven intelligence in several ways. First, they can factor in viable water sources during the due diligence process. While having two water sources may have been sufficient in the past, that’s no longer enough in a time of increased drought risk and regulation.

Next, ag professionals can use GIS tools to identify which parcels of land are most at risk from wildfires. While drought conditions may exacerbate wildfire risk, even in the absence of drought, wildfires can damage crops and lower crop yields. By tracking wildfire threats, ag professionals can put risk mitigation measures in place.

Thirdly, lenders and investors should become more aware and act on the knowledge of how water is allocated in specific farming regions, specifically in regard to disadvantaged communities, Tribes, and People of Color. Not only is this the right thing to do, but it may form a key part of future ESG (Environmental, Social, and Governance) reporting requirements, which disclose an organization’s commitment to socially responsible practices.

Water and climate data must be granular in order for an ag finance professional to effectively understand the parcel-by-parcel risk in a portfolio. Overall regional risk, such as the fact that the Western U.S. is in a dire drought, is not enough. In ag finance, data must be parcel-by-parcel.

By asking themselves these questions now and using geospatial datasets to answer them ag professionals will be better able to put a drought risk management plan into place before the next extreme weather event catches them by surprise.

The Bottom Line

Effective drought risk management depends on data-driven decision-making informed by parcel-specific data. By using tools like GIS Connect to understand drought impacts on a parcel-by-parcel basis, ag professionals can make better lending decisions in the future and assist existing borrowers who may already be at risk.

AQUAOSO’s GIS Connect platform is built specifically for agricultural professionals to help them better understand water risk. Users can integrate existing financial data and third-party datasets to put their lending decisions into a geospatial context. By reviewing land and water rights, water delivery information, and more – all in one place – users can save time and money and bring their decision-making into the 21st century and future-proofing their business.

Contact the team at AQUAOSO to schedule a demo, or download this free white paper to determine whether a farming operation is prepared to face another drought.

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