El Niño: Key Implications For Commodities

BMI View: The high probability of El Niño returning in H214 poses downside risks to production of key commodities in 2014/15 in large producing countries. We believe palm oil, rice and sugar will be the most affected should El Niño develop this year. The impact on other commodities, including wheat and cocoa, will be less acute.

Meteorologist departments across the globe forecast a return of the El Niño weather phenomenon in H214. Although the slowdown in warming of the tropical Pacific Ocean over the past several months will most likely delay its return, meteorologists estimate the probability of El Niño occurring this year at between 60-80%. In late June, the United Nation's World Meteorological Organization estimated that there is a 60% chance El Niño will set in by the end of August, and the probability of its return by December reaches 80%. Assuming El Niño forms, forecasters tend to predict a moderate-strength event rather than either a weak or strong occurrence. Although at this time the likelihood of a return of the phenomenon is relatively elevated, there is still uncertainly regarding its timing, location and magnitude.

El Niño refers to the extensive warming of the central and eastern tropical Pacific that leads to a major shift in weather patterns across the Pacific. It is typically associated with below-normal rainfall across Asia Pacific, including South East Asia and Australia, and with above-normal rainfall across North and South America, mainly during the second half of the calendar year. However, the relationship does not always hold, as there are examples where weak El Niño events have resulted in severe dryness, while at other times strong events have resulted in a relatively modest impact.

Significant Impact On Production
Palm Oil - Global Production Growth (% y-o-y) & El Niño Events

BMI View: The high probability of El Niño returning in H214 poses downside risks to production of key commodities in 2014/15 in large producing countries. We believe palm oil, rice and sugar will be the most affected should El Niño develop this year. The impact on other commodities, including wheat and cocoa, will be less acute.

Meteorologist departments across the globe forecast a return of the El Niño weather phenomenon in H214. Although the slowdown in warming of the tropical Pacific Ocean over the past several months will most likely delay its return, meteorologists estimate the probability of El Niño occurring this year at between 60-80%. In late June, the United Nation's World Meteorological Organization estimated that there is a 60% chance El Niño will set in by the end of August, and the probability of its return by December reaches 80%. Assuming El Niño forms, forecasters tend to predict a moderate-strength event rather than either a weak or strong occurrence. Although at this time the likelihood of a return of the phenomenon is relatively elevated, there is still uncertainly regarding its timing, location and magnitude.

Selected Meteorology Departments' Forecasts For El Niño
Meteorological agency Date of latest forecast Forecast
UN's World Meteorological Organization 6/25/2014 60% probability El Niño will set in by the end of August; 80% chance it will return by December.
Australia Bureau of Meteorology 6/17/2014 At least a 70% chance of El Niño developing in 2014.
Météo France 6/15/2014 Weak to moderate El Niño this year, highest intensity in autumn.
Indian Meteorological Department 6/11/2014 70% probability of an El Niño occurring in 2014.
US Climate Prediction Center 6/5/2014 70% chance of El Niño occurring during the Northern Hemisphere summer; 80% chance during the fall and winter.
Japan Meteorological Agency 6/1/2014 Forecasting a return of El Niño this summer. No specific probability.
Brazil Instituto Nacional de Meteorologia 4/1/2014 80% chance of El Niño occurring this year.
Source: Services' websites, BMI

El Niño refers to the extensive warming of the central and eastern tropical Pacific that leads to a major shift in weather patterns across the Pacific. It is typically associated with below-normal rainfall across Asia Pacific, including South East Asia and Australia, and with above-normal rainfall across North and South America, mainly during the second half of the calendar year. However, the relationship does not always hold, as there are examples where weak El Niño events have resulted in severe dryness, while at other times strong events have resulted in a relatively modest impact.

A high probability of El Niño this year implies there is a greater than normal chance of below-average yields and output of key commodities in 2014/15 in large producing countries. We believe downside risks to production are the most acute for palm oil, rice and sugar. As a result, El Niño will cause prices of these commodities to rise and be volatile in H214 and over 2015.

The phenomenon will hurt crops being sown or under growing and harvesting stages when it sets in. The impact of El Niño can be felt for some time after its start, as it also leads to below-average runoff into irrigation storages, resulting in negative consequences for irrigated agricultural production (such as rice, cotton, horticulture and dairy) for several quarters after the event has occurred.

Impact Of El Niño On Crops
Commodity Country Risk To 2014/15 Production Risk To 2015/16 Production
Palm Oil Malaysia, Indonesia Downside - Medium Downside - High
Rice Thailand, India, Vietnam, etc. Downside - High Downside - Low
Sugar Australia, India, Thailand Downside - High Downside - Low
Wheat Australia Downside - High Downside - Low
Oilseeds India Downside - High Downside - Low
Coffee Vietnam Downside - Medium Downside - Low
Brazil Upside - Medium Upside - Low
Cocoa Côte D'Ivoire, Ghana, indonesia Downside - Medium Downside - Low
Source: BMI, FAO, MPOB, ICO, ICCO

Due to the concentration of the global palm oil production in Malaysia and Indonesia, two countries which are affected by El Niño, we believe palm oil will be the commodity most impacted by El Niño. The Malaysian Palm Oil Council (MPOC) estimates fresh fruit bunches (FFB) yields can be affected by up to 20% by a severe event, significantly reducing production. As a result, El Niño could tighten further the global supply of palm oil in 2014/15 and 2015/16, which is already forecast at the lowest levels since 2009/10, as measured by the stocks-to-use ratio ( see 'Palm oil to average MYR2,650/tonne in 2014', May 30). We believe palm oil prices will rally significantly if El Niño develops.

Significant Impact On Production
Palm Oil - Global Production Growth (% y-o-y) & El Niño Events

Sugar and rice production is also largely concentrated in countries that would see a change in weather from El Niño, as around a third of sugar production comes from Australia as well as South East and South Asia, while over 50% of global rice output comes from these regions. El Niño could further weaken the summer monsoon, key for agricultural production in India, Pakistan and Bangladesh and which is below par so far this year. In particular, monsoon in India was 43% below average in June 2014, the weakest first month of the season in five years.

Heading Up Due To El Niño
Global - Three-Month MDE Palm Oil, MYR/tonne (LHC) & Front-Month CBOT Rough Rice, USD/cwt (RHC)

Cocoa production will also be negatively impacted. However, we already expect tight global supply in 2014/15 and higher average prices in 2014 and 2015, which will dilute the potential impact of El Niño. Wheat production in Australia and oilseed output in India could also be affected by El Niño, as output of these commodities is particularly vulnerable to dry weather in these countries. However, given the existence of large alternative producing countries for wheat and soybean, the risk of upside pressure on international prices is limited. Moreover, these two markets are relatively well supplied at present, especially in the case of soybean, which we forecast will record a five-year high surplus in 2014/15.Coffee is much less affected, as wet weather in Central and Latin America will help production, while trees in Vietnam may experience stress due to the lack of rain.

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