The ‘El Nino’ phenomenon and its impact on global commodities
As of May 15, 2023, there was an estimated 90% chance of an El Nino weather phenomenon happening later this year. El Nino is the biggest fluctuation in the climate system of the Earth and will potentially have consequences across a wide range of geographical regions around the globe. The term ‘El Nino’ is often employed to characterise the warming of the sea surface temperature that occurs every 3 to 7 years typically off the Pacific coast of South America and lasts for about two years, thereby causing large climatic upheaval across the globe. It is declared when sea temperatures in the tropical Eastern Pacific increase 0.5 degrees Celsius above the long-term average. El Nino is felt strongly in the tropical eastern Pacific with warmer than average weather, and its effects are felt most strongly often in December. Climate experts have been monitoring the effects of El Nino since 2016 when the last severe El Nino occurred, the largest since the 1997-98 episode, and it led to disruptions in the world’s food, water, health, energy, and disaster response systems. It led to the highest-ever global temperatures and it is predicted that this year temperatures could increase even further.
According to the International Monetary Fund, the extreme weather conditions caused by El Nino would constrain the supply of rain-driven agricultural commodities, lead to increased food prices and inflation and may lead to social unrest in commodities-dependent counties which rely primarily on imported food. El Nino could potentially cause even more supply disruption to already volatile global agricultural and energy markets, supporting weak commodity prices and increasing inflation.
El Nino’s effects vary across geographical regions and in their intensity. Often we see high temperatures and less rain across the Northern US, Asia and Australia and increased rain in the Southern US and Argentina. Importantly, this current fast warming of the Pacific Ocean comes after a near-unprecedented three back-to-back years of the opposite cooling La Nina weather disruption. The IMF took into consideration the economic interlinkages and spillovers between countries and analysed the macroeconomic transmission of El Nino shocks between 1979 and 2013 both on national economies and internationally, focusing on its effects on real GDP, inflation, and commodity prices. It found that El Nino has a large but quite varied economic impact across different regions. Australia, Chile, India, Indonesia, Japan, New Zealand, and South Africa face a short-lived fall in economic activity in response to a typical El Nino shock. However, in other parts of the world, the El Nino phenomenon actually improves growth, in some countries directly, for instance the US, and in others indirectly through positive spillovers from major trading partners. Many countries that the IMF analysed experienced a short-term inflation increase following an El Nino shock, its magnitude increasing with the share of food in the consumer price index, while energy and non fuel commodity prices also rose around the world. The inflation that could be caused in the aftermath of the ongoing El Nino, when potentially interacts with the high-inflation environment caused in the aftermath of the Covid pandemic and high energy prices due to the Russian invasion of Ukraine, would reduce people’s purchasing power and could lead to quite high levels of inflation.
It's important to break down any potential effects of the El Nino across the different commodity markets. A significant El Nino would potentially support many but not all agriculture markets. Firstly, it would reduce the supply of wheat, sugar, rice and cocoa, thereby increasing prices. Due to less rain available and higher temperatures to pivotal Indian and Thai sugar and rice producers, we would see less yield. It’s expected that major cocoa producers, in Ghana and the Ivory Coast, would experience drier weather and therefore lower yields. Moreover, it is expected that Australia’s wheat crop would experience dry weather and thereby bring an end to a series of three bumper crop cycles. Conversely, in the case of the USA and South America, this may be a positive change from the droughts and thereby boost yields and decrease prices. For instance, a wetter and warmer winter season would help the US corn and soybean belt and the currently drought-hit Argentina.
Breaking down El Nino’s potential effects across the energy markets, we need to understand the potential effects would be different access markets for different geographical regions. We would generally expect that in light of increased temperatures, it would boost the demand for oil and especially increase the demand for natural gas and depress the heating outlook. As Asia is the world’s biggest importer of oil and natural gas, hotter and drier conditions could boost their demand, especially if the droughts hit their hydroelectric capacity. In Northern Europe, El Nino would often cause colder winters and increase the demand for energy; in the north-west USA, a typically milder winter could potentially reduce demand for heating oil in its biggest market and finally, it would typically see a less severe June-November Atlantic hurricane season, thus the demand for energy would potentially decrease in the season due to less severe weather conditions. Thus, the effects on the overall demand for energy would differ across the different regions which face varying weather conditions due to the El Nino. The direction and magnitude of the overall impact on energy markets would be contingent on how people and markets change their demand for various commodities in light of changing prices and how intensive the varying weather conditions are in light of the El Nino.
Since growth, inflation, and commodity prices are sensitive to El Nino, governments should take into consideration the likelihood and effects of El Nino episodes when they construct and implement macroeconomic policies that could help to mitigate the adverse effects of such shocks. For instance, the IMF corroborated that in India changing crop varieties, rainwater conservation, judicious release of food grain stocks, and changes in import policies and quantities would help increase agricultural production in low-rainfall El Nino years. Such policies could include the rate of interest rates that the countries’ central banks would implement in light of inflation and any measures of forward guidance and quantitative easing/tightening in light of economic conditions in light of the El Nino. Moreover, on the macroeconomic policy front, countries’ central banks should closely monitor any increases in inflation coming from El Nino shocks and alter their monetary policies accordingly to avert second-round inflation effects. In the longer term, investment in the agricultural sector mainly in irrigation, as well as building more efficient food value chains, would serve as valuable insurance against future El Nino episodes.
In conclusion, the ongoing El Nino phenomenon would lead to temperatures never seen before and could have varying impacts on different community markets to a great extent. It would not spell doom for all economies and markets, as in certain markets and countries, it would boost demand for energy and other commodities as explained above, owing to varying weather conditions. However, to counter the adverse impacts of the El Nino on respective economies, governments and their central banks need to devise macroeconomic policies that ensure that the distributional consequences caused by increased commodity prices would be less disruptive to the lives of people, and countries need to make contingency plans to make sure that their economies have the resilience to face the economic disruptions caused by these weather conditions in the future. Moreover, there is a need for cooperation on the international front, as due to the globalised nature of the world economy, most countries would face the effects of the weather conditions and policies on the multilateral level could counter the negative economic consequences more effectively.