The Impact of El Nino on Softs Markets: an ICE Webinar

By Kristina Zurla Landgraf ISSUE 811 | November 2009

An “El Nino” weather event took shape this year, and what that might mean as we head into winter has caused speculation among weather forecasters and traders alike. As this event can influence weather patterns in unusual ways, traders in agricultural markets are taking particular notice. ICE Futures U.S. recently hosted a webinar on the impact of El Nino, and what it might mean for key softs market growing regions this year and into 2010.  You can view the full webinar here, along with other ICE webinars.

Judy Ganes Chase, president and founder of Judy Ganes Consulting, a leading provider of softs research and other advisory services, said there are a lot of misconceptions about El Nino. The markets often react just on the word El Nino, usually based on ideas there will be some sort of loss of production due to weather conditions, said Ganes.

An El Nino weather pattern generally occurs every three to four years, and this is the first one we’ve seen since 2006, said Ganes. An El Nino is a naturally occurring part of the tropical Pacific Ocean cycle. Warmer waters result in changes in the jet stream pattern, with more rain in the tropics and other regions more dry. Ganes added no two El Ninos are alike, and each El Nino has to be monitored as it develops. She analyzed the past 16 El Nino events in key coffee and cocoa growing regions, and noted weather patterns in the following table. The countries highlighted in red had the greatest percentage of dry years, with the greatest statistical significance.

While there are typically no “wet signals” for most of the coffee and cocoa regions, Ganes said there are other factors that could cause that to change. She said we’ve seen the quietest, longest solar minimum, or sunspot activity, in 200 years. This factor could override the impact of El Nino, said Ganes. Low sunspot activity tends to create colder winters, and wetter activity in Vietnam and central Brazil. India tends to see an erratic wet monsoon and longer dry monsoon. The next table shows countries with a percentage of heavier-than-normal rainfall during low solar years.

 

Ganes emphasized it’s important to take all factors into account when analyzing the potential impact of El Nino. She gave some “fast facts” in terms of the potential impact of El Nino on key softs markets.

• Sugar: Reduces India’s monsoonal rains
• Sugar: Drought in Thailand, Indonesia
• Cocoa: Warmer, dryer West Africa (Dec-Feb)
• Cocoa: Dry Indonesia, Malaysia (Jun-Aug)
• Coffee: Warmer Brazil winter

 

Cocoa
Based on average production losses during prior El Nino years, Ganes said maximum cocoa output losses in Ecuador could be more than 35 percent, Indonesia just under 15 percent, and in the Ivory Cost, output could drop as much as 7 percent. She said total world cocoa output could potentially fall as much as 300,000 tonnes in 2009 – 2010 if it turns out to be a very strong El Nino year. However, she added that this was an aggressive, worst-case type of forecast. “I do not think this is going to happen…but this possibility causes traders to react strongly. The analysis shows this, but the likelihood of this loss occurring is actually fairly small,” she said.

Nonetheless, she said the path of least resistance for market prices is likely to be higher until further data suggests otherwise. Cocoa production could remain in deficit for back-to-back seasons, she said.

Sugar
This year, the top-two global sugar producers, Brazil and India, faced weather issues. In Brazil, it’s still unknown how much of the crop will be used for food versus fuel (ethanol). On a global basis, world sugar stocks are being reduced, and prices have been surging. Gaines said she sees a possible drop-off in consumption occurring due to these high prices, which is fairly rare for sugar.

“My biggest concern is what is going to happen to production next year. We could turn from a deficit to a surplus,” she said. Ganes said sugar traders should focus on conditions in India and Brazil. There has seen a sharp drop in production in India, where the monsoonal rains were late this year, delaying sugar planting. There were also planned reductions in sugar cane plantings last year, as a result of a surplus and lower prices relative to competing crops.

“I would think in 2010 – 2011, assuming a return to more normal weather, India is going to pump their production up to substantially higher levels. Whatever rally we have now in sugar I think should come to a quick end,” said Ganes. In Brazil, production estimates were pared back this year due to too much rain, delaying harvesting and leading to a possible 2 to 2.5 million tonnes in lost production.

It’s possible that because of the high prices, sugar that had been earmarked for ethanol could move into production for human consumption, said Ganes. Even though supplies will be large in Brazil, there won’t be enough to make up the shortfall in India, she said. That means sugar is looking at possible back-to-back deficits, which rarely occur in this market.

Coffee
Rainfall is also a major factor for coffee; when there is too much in Brazil can impact the flowering of the crop, said Ganes. The Columbian crop is expected to recover from this year’s devastatingly low production, but that remains to be seen.

This year, the market has been in an uptrend, and traders are questioning whether another of its “famous” spikes is coming. Ganes said it is too early to pin a figure on the Brazilian crop output, as it has to move through the flowering period. The range of general expectations for the 2010 – 2011 crop, which is now flowering, is 50 - 60 million bags. Her own estimate was in the middle of that range at 55 million bags, but she said that target wasn’t likely to be met. She said if there is too much rain, the flowers won’t set properly and a greater amount of fruit drop could occur. The coffee market is notorious for its spikes, she said, which are generally tied to weather events in Brazil.

“There is zero tolerance for any (coffee) production difficulties…and if there is a problem, this market would be justified to rise sharply,” said Ganes.

 

 

This year, El Nino seems to have kicked in about April or May, peaked in July and has weakened in recent months, said Ganes. She said El Nino should strengthen again and peak in November/December, and if it follows typical historical tendencies, should die down a bit during December and January.  

In sum, Ganes said the impact of El Nino depends on the country and commodity, as well as when and how the El Nino develops. Throughout the year, the relative strength of the El Nino could impact various stages of production.

You can view the full webinar with comments on other softs markets, including cotton and orange juice, on the ICE Futures Exchange Web site.

Kristina Zurla Landgraf is editor of Lind eWire. She can be reached at editor@lind-waldock.com.

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