Traders are rubbing their hands. Just this summer, extreme weather is detonating commodities?

wallstreetcn ·  May 31 21:43

Under the worst heat in history, everything from agriculture to energy to shipping may be seriously adversely affected, and commodity market fluctuations will increase dramatically.

2024 is expected to be the hottest year ever, and as the northern hemisphere enters summer, the world will be plagued by extreme heat caused by global warming. Extreme weather not only caused huge problems in people's lives, but also had an unprecedented impact on the commodity market, intensified fluctuations in commodity prices such as energy and food, and continued to push up inflationary pressure.

Global temperatures in the first 4 months were the highest in 175 years. If the situation continues to deteriorate, 2024 is likely to replace 2023 as the hottest year since weather records were recorded. Furthermore, the risk of droughts and wildfires will further increase due to the possibility of record tropical cyclone activity and the impact of the El Niño phenomenon.

Institutional investors have been keenly aware of the potential impact of extreme weather. Since the beginning of the year, Invesco's$Invesco DB Agriculture Fund (DBA.US)$Since the beginning of the year, it has risen by more than 23%, not only surpassing the S&P 500's increase of about 11%, even surpassing the 15% increase in the S&P Technology sector, but also surpassing the increase of about 13% since the beginning of the year.

Under the influence of extreme weather, the world's major commodity markets are facing the possibility of huge fluctuations, and the market is already pricing uncertainty:

Natural gas: supply and demand are tightening, and prices are likely to soar by up to 60%

Demand for fossil fuels such as natural gas is likely to increase significantly due to rising demand for refrigeration. Tradition Energy anticipates that US gas futures prices could soar to $4 per million British thermal units in the second half of this year.

Citi also predicted in April that “perfect storms” such as extreme heat, hurricanes, and increased droughts may cause gas prices to soar by about 50% to 60% higher than current levels.

Petroleum: Production may be disrupted by a variety of extreme weather

Extreme heat disrupts refinery operations, puts pressure on process equipment, and affects the ability to maintain stable internal temperatures. If the grid is overloaded and the refinery loses power, the refinery will shut down completely. Hot weather can also cause steam to build up, which can damage crude oil pipelines.

Frequent hurricanes may also disrupt refinery production. Edward Morse, senior consultant at Hartree Partners and former head of Citigroup's product research department, told the media:

This summer, for the entire (oil) world, the biggest risk is not the Russian-Ukrainian-Palestinian conflict, but the hurricane season in the Gulf of Mexico.

The risk of large-scale fires is also looming.

Last year, the worst wildfire season in Canada's history caused oil and gas drillers to shut down production, which had a negative impact on production capacity of up to 300,000 barrels. In 2023, the fires largely did not affect Canada's major oil and gas producing regions, but the impact this year could be huge. According to data from the North American Drought Monitoring Agency, as of the end of April, 63% of the US region was abnormally arid or arid.

Investment institutions' net bullish bets on US gasoline futures and options had previously reached their highest seasonal level since 2019, and have now declined somewhat.

Electricity: The grid is pressurized at high temperatures

Hot weather may cause frequent situations such as power plants being forced to shut down and construction projects to stop. It will also further increase inflationary pressure and hinder the pace of economic recovery.

In August of last year, electricity prices in Texas in the US climbed by more than 800% under the heat.

agricultural products

Taking wheat as an example, major exporters such as Russia are facing ongoing droughts, and analysts have had to drastically lower their production estimates.

The main wheat producing area in Kansas, USA, is also suffering from extreme droughts. Currently, there is still more than a month until the wheat fields are harvested. If the weather is drier or the heat is unbearable, production will drop from what was predicted.

High temperatures may also cause tropical agricultural products such as coffee and cocoa to be hit hard. Citi believes that if severe weather and production problems are common in Brazil and Vietnam, the price of Arabica coffee futures, a high-end coffee bean favored by Starbucks and other companies, may jump by about 30% to $2.60 per pound in the next few months.

supply chain

Extreme weather can also disrupt global shipping. Water levels in important waterways such as the Suez Canal and the Rhine will drop due to droughts, hampering the flow of goods. Coupled with the impact of a possible hurricane attack, it will have a huge impact on the global trade and logistics supply chain.

Take the Rhine River, Europe's most important commercial waterway, as an example. The Rhine River is the busiest commercial waterway in Europe. It transports all kinds of goods from diesel to coal from the Dutch Palembang in Rotterdam to the inland, but in recent years the water level has continuously hit record lows.

In June 2023, the water level at Kaub (Kaub), a key route point of the Rhine, was at its lowest level in the same period in 30 years. At the time, the carrying weight of barges from Rotterdam in the Netherlands to inland Europe dropped from about 2,000 tons to about 1,200 tons.

Extreme weather could drive higher commodity prices and exacerbate inflation

Overall, extreme weather may drive up the entire line from shipping prices to the prices of natural gas, oil, electricity, and agricultural products, hinder the decline in inflation, and force the Federal Reserve to keep the interest rate policy “higher and longer.”

As mentioned earlier, electricity prices may double in some regions due to a surge in demand for air conditioning use at high temperatures, compounded by risks such as fires disrupting power grids. Crops such as wheat and coffee may also cut production due to droughts, driving up food prices at consumer terminals. Meanwhile, oil and gas prices will rise simultaneously as demand for refrigeration rises.

Furthermore, according to a study by the Federal Reserve Bank of San Francisco, extreme heat will limit the productivity of construction workers and curtail capital investment, thereby stifling the US economy. The paper points out that if large-scale measures are not taken to reduce carbon emissions, an increase in future hot weather will reduce capital stock or cumulative investment value by 5.4% and annual consumption by 1.8% by 2200.

Addressing extreme weather shocks brought about by climate change has become a global priority in energy, agriculture, and trade. Governments and businesses need to ensure the resilience of supply chains to weather extremes to avoid serious negative impacts of supply cuts on economic operations.


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