Sunday, June 7, 2015

How to make money off of California's drought

The image above is from the USDA website and shows the current drought conditions in California. you will note that the almost half the state is classified as being in the D4 range. D4 is classified as extreme drought conditions. The state, which is a historically dry place, is struggling under one of its periodic droughts.People are having to cut back water consumption by up to 25% and the drought is wrecking havoc on the states agricultural industry. 

California’s agricultural economy is contracting.

Facing another severe drought year in 2015, farmers are going to be taking more losses. According to a new study from the UC Davis Center for Watershed Sciences, this year California agriculture is estimated to use 2.5 million acre-feet less in water, employ 18,600 fewer people, and contribute $2.7 billion less to the state’s economy than it would in a normal water year. 


Crop plantings may have to evolve if the drought continues, too.

It’s all the rage to claim that California farmers just need to stop growing water-guzzling almonds, but the global specificity of California’s soil, along with high commodity prices for certain crops, suggests these are decisions that need to be made with the assistance of economic and scientific data, not emotion.

The key word for me in the above snippet is "almonds". This interesting article from the NYT highlights just how much water goes into various agricultural products. 

Which consumes the most water?
A) a 10-minute shower.
B) a handful of 10 almonds.
C) a quarter pound hamburger patty.
D) a washing machine load.
The answer? By far, it’s the hamburger patty. The shower might use 25 gallons. The almonds take up almost a gallon each, or close to 10 gallons for the handful. The washing machine uses about 35 gallons per load. And that beef patty, around 450 gallons.

The article goes on about how unsustainable our current agricultural system is and how this is an opportunity to change the way we do things, at least until it rains again. Anyway, the point I am making is that one persons tragedy is another's opportunity. If one is looking at things on a global scale one would note that although the almond growing areas in California are under extreme pressure, with yields down and farmers actually taking out almond trees by the thousands of acres, the almond growing areas in Australia are thriving.

The company I am investing in is called Select Harvests and trades in Australia under the symbol (SHV) and in the US (SHVTF). The company is the largest vertically integrated nut grower in Australia. The company is a big exporter of almonds to the EU, Asia, and the Middle East. China and the rest of Asia has been steadily increasing its demand for almonds as per capita GDP continues to increase. 

So here is the investment thesis. California is the largest grower of almonds in the world. The state is in the fifth year of a drought. This is causing lower yields and will certainly not lead to further expansion of almond growing. In fact, farmers are beginning to rip out their water guzzling almond trees. As it takes seven years for a almond tree to fully mature this will lead to supply constraints for years even if the drought lifts.The agricultural sector in California is being used as a whipping boy and scapegoat for the failed water policies that go back decades. If the drought continues the farmers in California will come under even more intense pressure to curtail their activities. 

On the demand side the consumption of almonds is growing at 8% per year. Using the rule of 72 this means almond consumption will double in nine years if the rate of consumption growth stays the same. This will not be possible because of the fact that it takes years for the trees to fully mature. Therefore price will rise to ration demand. This is happening just as many of Select Harvests almond trees are reaching prime production age. So we have growing demand, no or low supply growth, higher then historical pricing, and a company that is positioned to take advantage of  the situation. 

Eventually the drought in California will end as these things cycle (see recent weather in Texas). The higher prices will draw in capital and the supply/demand situation in almonds will resolve. In the meantime this is an opportunity to take advantage of a situation that will last for several years. I am adding Select Harvests to the investment portfolio. 

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