El Niño: What it is, and its effects on commodity markets

Our specialists explain this climatic phenomenon and its consequences on the global balance of agricultural commodities. 

May 10, 2023

hEDGEpoint Global Markets

Weather plays a key role in the supply side of agricultural commodities. That’s why—when phenomena such as El Niño occur—changes in weather patterns can impact production and the market in turn. 

There are several ways in which climatic aspects affect production, such as crop yields, plant growth cycles, and agricultural product quality. It’s estimated that up to 80% of the variation in productivity in the field results from climate seasonality. Economic, political, and social issues take up the remaining 20%. 

Thus, one of the key climatic phenomena that affects agricultural crops the most is El Niño since it generates significant changes in temperature and precipitation. One of its main characteristics is that it can cause both torrential rains and severe droughts. 

According to the Oceanic Niño Index (ONI), a model developed by the National Oceanic and Atmospheric Administration (NOAA) in the U.S., there’s a 60-70% chance of El Niño becoming active in the May-July quarter. Heading into the last quarter of the year, the chances increase to 80-90%. 

With this forecast, producers can start preparing to face this sensitive moment. Even so, there’s still no strong agreement on the dates or how the effects will be this time. 

In this article, we’ll try to better explain what exactly this phenomenon is, how it affects commodity markets, and how you can better manage financial risks caused by climatic instability. 

What is El Niño, and how does it affect commodity markets? 

Under normal conditions, prevailing winds blow from east to west over the tropical Pacific Ocean, carrying warm waters to Southeast Asia and Australia. Sometimes these winds (also called trade winds) weaken. If this weakening event is intense enough, warm water stops accumulating on the Asian side of the Pacific, and then moves eastward, reducing the upwelling of cold water on the South American coast. This scenario, which features above-average sea surface temperatures in the eastern part of the tropical Pacific Ocean, is better known as El Niño. 

The El Niño-Southern Oscillation (ENOS or ENSO) is a recurring weather pattern related to winds and sea surface temperatures in the tropical Pacific Ocean. ENOS oscillates in three phases: from warm (El Niño), to neutral and cold (La Niña). For each one of these, weather patterns are different and impact the development of crops around the world. 

 Which commodities could be affected by El Niño in 2023? 

It’s clear that such a sudden climate change can affect any agricultural crop. But, according to the period, regions, and weather forecasts, our specialists can suggest some of the commodities that should be affected. 

As the ENSO forecast points to a higher probability of El Niño forming between May and August, concerns about total sugar production in the 23/24 cycle (October-September) have increased. Typically, Asia is the region most affected, as weather patterns (if they’re extremely strong) can reduce monsoons and impact sugarcane development. Brazil, the globe’s main sugar supplier, could also suffer: a more humid winter could harm the concentration of sucrose and disrupt the pace of milling. 

Regarding coffee production, it’s known that the phenomenon historically leads to a warmer climate during the vegetative growth and flowering windows in Brazil. This year soil moisture levels are adequate and thus the outlook is currently less vulnerable. But this could still change over the winter. El Niño has also impacted Central American arabica production in the past, as it leads to warmer weather during the flowering and fruit set phases. 

When it comes to soybeans and corn, regions of interest include the U.S., Brazil, Argentina, and the Black Sea. Given the large size of these countries and the differences in crop timing, the effects of El Niño vary widely. In the U.S., El Niño tends to be weaker during the summer. As a result, its effects on productivity in that country should be slight, although generally positive. 

In South America, El Niño is known to bring warmth to most of Brazil, and above-average rainfall in southern Brazil and Argentina later in the year. Hence, the event is usually neutral or negative for winter corn, but positive for soybeans and corn in southern Brazil and Argentina during the summer. 

As for wheat,, Northern Hemisphere countries dealing with spring crops and Southern Hemisphere growers will be the most affected. This year, Canada’s spring wheat production should be the most impacted in the Northern Hemisphere, while in Russia, good prospects for the winter crop and high carryover stocks may reduce the influence of El Niño on the total supply. 

Argentina and the U.S. could benefit from El Niño effects. On the other hand, Australia could see reduced rainfall and lower crop yields, causing a bullish impact on wheat markets. 


How can we mitigate the financial risks that El Niño could cause? 

With aspects of climate and weather so strongly influencing commodity prices, it’s vital to have planning that provides more financial predictability. 

Using hedging products is an ideal solution available to avoid unpleasant surprises in the financial planning of those who work in the commodity chain. 

hEDGEpoint’s specialty, this mechanism serves as a kind of insurance against market price variations, reducing transaction risks. 

hEDGEpoint combines the knowledge of specialists, who know the field and its many variables well, with risk management products, to always offer you the best experience in future operations. 

We’re globally present and always prepared to help you use the best hedging strategies for your business. Contact a specialist today to learn more about using this unique instrument. 


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