Path Dependencies Between The Atmosphere And The Economy: Introduction
When analyzing the influence of weather and climate volatility on business performance and global commercial activity, most financial analysts typically go directly to the obvious headlines that capture attention - like the impact of higher or lower temperatures on the demand for seasonal retail products, how home energy demand for air conditioning and heating is influenced by periods of extreme heat and cold, or how acute flooding episodes affect transportation routes to local businesses. But these are just a few of the examples that sit on the surface. When examining the data more deeply and connecting with the primary and secondary links in the global economic system, we find that the relationship is far more integrated and wide reaching than many realize. Looking at the weather-climate-commercial system as a network, rather than as a one way cause and effect driver, patterns emerge so that it becomes difficult, if not impossible, to separate the economy from the environment.
The examples below highlight some of the links between weather, climate and economics.
First Order Effects
We know that drought impacts food supply. There is no shortage of current news stories that link, for example, drought to higher coffee and cocoa prices, and consumers are now seeing some of this relationship reflected in the products they purchase. But the reality is much more complex than simply less water equals smaller crops. A drought in South America that leads to lower agricultural production and yield impacts corn and soybean prices, which will tighten margins for food companies and spill over into higher prices for the food products utilizing these raw materials.
The relationship does not end there. Higher corn and soy prices also impact the cost to feed livestock, so chicken, beef and dairy will also see increased price pressure. Again, this eventually is reflected in higher consumer prices for these staples.
Another topic that is current is the price of eggs. While the source for some of today’s egg shortage is avian influenza, weather parameters govern the spread of this disease both by enabling the survivability ranges of the pathogen, while also expanding the migration routes of the vectors. When we stack the costs of living, eggs tend to be a lower percentage of spend when compared to other food products and energy prices, however, this always seems to grab the attention of the consumer markets during periods of volatility.
Moving away from the more obvious examples, weather volatility also impacts the construction industry. First, through the raw material commodity prices themselves (think lumber). Weather also dictates when and where the seasonal housing starts behave - a key driver of the economy that receives attention as an economic barometer.
Second Order Effects
The examples above point to microeconomic cases. The impacts are perhaps even more significant when we examine the relationship on a macroeconomic scale.
There is a growing body of research that correlates weather and climate volatility to macroeconomic indicators, such as currency strength, foreign exchange rates, and foreign direct investment, to name a few. (Future articles will examine this topic more deeply.)
When prices for commodity products are high, depending on the origin, this will indirectly influence currency strength as most liquid commodities are traded in US dollars. As a result, relative purchasing power can cause producers to flood the market with product, or store until more favorable economics return. In both cases, this leads to arbitrage opportunities with foreign exchange markets.
There are relationships between commodity categories that drive fundamental macroeconomic behavior. Let’s go back to the Brazil drought example. Assume that during a period of high oil prices there is a price spike in world sugar futures resulting from drought in key production regions in South America (Brazil is typically among the world’s largest producers of many agricultural commodities; #1 for sugar). The increase in sugar prices will also drive domestic Brazilian growers to divert more of their harvested sugarcane to ethanol production, as cane derived ethanol will be in higher demand as a blend. This becomes particularly useful in a country like Brazil where Flex Fuel Vehicles continue to capture automobile market share. On top of the energy and soft commodity dynamics, this will indirectly influence the strength of the USD vs the Brazilian Real, so the exchange rates and capex decisions that are currency dependent are also indirectly influenced.
Short range weather forecasts are a commodity. The real value-add when it comes to weather and climate patterns lies in the seasonal to subseasonal space. Astute investors and capital allocators that have a longer-duration investment horizon can and should be incorporating longer range weather and climate volatility analysis and scenario planning into their research.
These are just a few examples, but by examining the linkages and visualizing how the global supply chain is still the conduit for the flow of goods and capital around the world, it allows us to visualize the path dependencies between the atmosphere and the economy.