Founder: Turnaround Talk
When I was younger (not that I am old), you could set a timer that at 15h00 during summer, you would get a thunderstorm that would bring significant rain. Fire and brimstone for a few hours, and the deep blue African sky would return. Winters were greeted with periodic cold snaps with a generous layer of frost gracing our brown fields. The climate was mostly predictable.
It is no secret that the impacts of climate change are visible for everyone to see. We swing between El Niño and La Niña conditions in summer, and this winter brought snow to Johannesburg, even if it was for a morning. We are currently seeing excessive heat conditions in Europe, where some countries are experiencing the hottest summer on record. The climate has moved from mostly predictable to highly unpredictable.
Like load shedding, climate change is an external risk factor that can have a significant impact on a company’s ability to avoid or enter into financial distress. I recently read an article on News24 which discusses the economic impact of El Niño.
How El Niño can affect economies
The article points out that there are several direct and indirect ways that El Niño can impact EM economic activity.
There are already reports that low rainfall has caused the level of the Panama Canal to fall, forcing ships to carry lighter loads to avoid running aground. At the margin that could cause some disruption to supply chains, which caused goods price inflation to balloon during the Covid-19 pandemic.
The article adds that El Niño is also expected to impact the supply side of the global commodities market. There are already reports of heavy rain disrupting copper mining in Chile. However, in Asia, drier weather and shorter monsoon seasons can be positive for the extraction of other metals and ores such as bauxite, nickel and tin.
EL Niño may also exacerbate natural disasters, which have had an increasingly devastating impact on global activity and insurance markets in recent years. Many parts of Asia including China and India have already been suffering heatwaves, and drier conditions due to El Niño would add to the risk of drought and wildfires, which have been increasingly prevalent in recent years due to climate change. Heavy rainfall can lead to flooding and landslides.
The article points out that drier conditions also affect energy generation in those countries, notably in Latin American countries such as Brazil, Colombia and Venezuela, that rely heavily on hydroelectric power generation. That can lead to power shortages, pushing up prices and stifling activity.
Hydroelectric generation may be disrupted in parts of EM that rely on it heavily.
Image By: Craig Manners via Unsplash
El Niño effect on food prices
The article points out that changes in weather conditions are a clear threat to agricultural output. Drought conditions can stunt production, while excessive rain can also cause problems if it washes crops away. All other things equal, disruption to agricultural output would cause food prices to climb.
At first sight, there does not appear to be much relationship between the risk of El Niño and global food prices.
For example, the Oceanic Niño Index (ONI) produced by the National Oceanic and Atmospheric Administration of the US Department of Commerce, which measures changes in water temperatures in the Pacific Ocean, bears virtually no resemblance to movements in global food prices. An ONI score of 0.5 is consistent with weak El Niño conditions, 1 moderate, 1.5 strong and 2 very strong. As the chart shows, spikes in the ONI, representing more severe El Niño conditions, have only occasionally been accompanied by significant increases in global food prices. More recently, while the ONI score has picked up, food prices have been heading in the opposite direction in year-on-year terms.
The article adds that it’s worth bearing in mind that weather conditions and expectations for supply are only one factor that drive food global prices. Expectations for demand, along with production costs – notably energy – are equally, if not more important. This explains why there has historically been a close correlation between movements in global oil and food prices. Higher energy prices often reflect improved sentiment about future economic growth (and thus demand for food) and directly increase the cost of production in the agriculture sector. The opposite is also true for lower energy prices.
An obvious recent example of this was seen when food prices spiked in the wake of Russia’s invasion of Ukraine. While higher food prices were in part due to concerns about the loss of supply of exports of wheat and other products from the region, much of the impact was due to higher energy prices as sanctions on Russian exports turned the global oil and gas market upside down. That increased the cost of producing food and also forced up the prices of fertiliser. Energy prices have more recently declined, reflecting downbeat sentiment about the global economic outlook, weighing on food prices.
The article points out that it makes sense to try and eliminate the impact of changes in the cost of energy on food prices. And by doing that, we find that there is a better relationship between measures of the likelihood of El Niño such as the ONI and movements in food prices that are not due to energy. On the face of it, this suggests that the increasing likelihood of El Niño has begun to affect food prices, and that they trade roughly in line with a “moderate” weather pattern.
Using this relationship as a guide, we can think about what might happen to food prices in the event of more severe El Niño conditions. Keeping oil prices stable, this suggests that in the end of a strong El Niño the S&P GSCI agriculture and livestock indeed might be around 40% higher from current levels around the turn of the year, while a very strong El Niño could lift prices by more than 50%. Feeding these figures into our inflation models, it seems that while a moderate El Niño would not significantly alter the outlook for inflation, anything more severe would be worrisome. Indeed, it is feasible that, after steep declines into year-end, average EM food inflation could quickly rebound into double-digits during 2024.
Which economies would be most impacted?
The article adds that the impact of any disruption to agricultural output and prices would be felt unevenly across EM. After all, poorer countries rely more heavily on agricultural output for local sustenance and economic growth. Higher food prices and shortages of goods can have a devastating impact on poorer EMs and even be the trigger for social unrest.
Meanwhile, those EM economies that are major net exporters of food can suffer from a loss of export revenues if production losses are worse than any increases in prices.
Image By: Supplied
For example, in Brazil, net food exports are equivalent to around 5% of GDP, and it is notable that swings in the ONI have become well-correlated with GDP growth. This would suggest that while bumper agricultural output ensured that Brazil’s economy grew more quickly than expected in the first of 2023, that support may go into reverse in the months ahead if El Niño conditions intensify.
The article points out that net importers of food will face higher prices and face the choice of funding wider trade deficits or cutting back imports of other goods, requiring a reduction in domestic demand and therefore overall GDP growth. Food inflation would also increase.
However, the impact on inflation would be felt unevenly across EM. After all, food accounts for a varying proportion of consumption in different countries. For example, whereas food accounts for about half of the CPI basket in India, the weight is much lower in other EMs.
A potent cocktail of disruption
If we add the Ukraine War into the mix, we have a potent cocktail that massively disrupts global supply chains and the cost of doing business.
As the article points out, the economic impacts of El Niño is particularly harsh on developing countries. South Africa saw the impact of a disrupted food supply chain during Covid and the impacts that this had on the country.
While the impact on the business environment is not immediately visible, it does not mean that there is no impact. Addressing this issue is paramount and needs the focus and dedication of a Government that is not already dealing with a crisis of significant magnitude.
We harp on about the urgency of dealing with the Energy Crisis and the urgency to address it. Some people may even be sick of reading about this in every article developed in the media. But take careful note of the following:
- experience shows us that the current South African Government does not cope well when it is dealing with multiple crises at the same time; and
- when warned about the propensity of loadshedding becoming a major crisis in 2008, the Government chose to ignore it. The impact is that we are currently dealing with a larger crisis than necessary had the situation been addressed 15 years ago.
And make no mistake, if we do not address the climate change issue urgently, it can grow and become a beast the size of the Energy Crisis.
