Traders Are Bracing for a Record-Smashing Summer That Will Roil Commodities

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(Bloomberg) — Around the world, people are already experiencing the chaos caused by record-breaking global temperatures. It's about to get a lot worse.

The chances that 2024 will become the hottest year in history are increasing as the Northern Hemisphere enters summer. Prices of some of the world's most vital commodities — natural gas, energy and staple crops like wheat and soybeans — are rising. The shipping world, already in chaos from the Red Sea to the Panama Canal, is likely to be rocked once again by drying waterways. The possibility of devastating forest fires is increasing.

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The forecast is a grim reminder of how extreme weather caused by climate change will exacerbate inflation, driving up the cost of energy, food and fuel. Recurring natural disasters also increase the risk of devastating damage and insurance costs, while making it more difficult to predict market movements. Last year, extreme weather and earthquakes caused global losses amounting to $250 billion, according to Munich Re.

Some experts expect US natural gas prices to jump by more than 50%, while wheat and coffee markets are also expected to rise.

Globally, the first four months of 2024 were the warmest in 175 years, according to the National Centers for Environmental Information. This year is certain to be among the five hottest years on record, and has a 61% chance of knocking out 2023 from the top spot, based on the US agency's analysis.

Adding to the misery is the fact that warming oceans threaten to generate “explosive” tropical cyclone activity. La Niña, a weather pattern expected to take hold in August, will lead to an increase in hurricanes in the Atlantic Ocean, while also unleashing dry conditions in the western and southern United States.

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The biggest risk to the global economy and oil markets “is not Russia and Ukraine, it is not Iran, it is not Israel’s Hamas,” said Edward Morse, a senior advisor at Hartery Partners LP and former head of commodities at Citigroup. research. “The biggest threat to the summer, for the world as a whole, is hurricane season in the Gulf of Mexico.”

Read more: What is a heat dome? Are we in for more of them?: QuickTake

Here's a look at the markets that have the potential for the most volatility.

Gas prices have been on the rise

Gary Cunningham, director of market research at Tradition Energy, said U.S. natural gas futures could rise to $4 per million British thermal units later this year if hot weather boosts air conditioning use enough to erode currently abundant inventories. . At the same time, producers are reducing production from shale basins in response to relatively low prices, paving the way for a tighter market.

Europe, which can no longer rely on Russian supplies following the invasion of Ukraine, is now competing with Asia for LNG shipments from exporters such as the United States, Qatar and Nigeria. The funds were the most optimistic about European natural gas since before the energy crisis, indicating growing concern about scarce supplies.

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“This summer will almost certainly bring with it a series of debilitating heat waves, especially in the central United States and Europe,” said Jennifer Francis, a senior scientist at the Woodwell Center for Climate Research.

Extreme heat in Southeast Asia starting in April prompted traders in the region to buy large quantities of gas cargoes. Hot weather has also descended on Egypt, forcing the North African country, typically an exporter, to resort to buying liquefied natural gas. Hot conditions sweeping India are increasing demand for fuel from the energy sector, according to Petronet LNG Ltd CEO Akshay Kumar Singh.

In Europe and Asia, a “perfect storm” of extreme heat, disruption to U.S. exports due to hurricanes, and a worsening drought that wipes out hydropower in Latin America could push gas prices up about 50% to 60% above current levels, analysts at Citi said. Group in 2018. April.

Possibility of power outage

Energy markets face a similar risk from rising demand. Rising temperatures across Texas are putting a test on the state's grid, with August electricity prices recently rising above $200 per megawatt hour, the highest level since 2022 for this time of year. The upside risks are huge: prices rose more than 800% last August amid extreme heat. The state has repeatedly teetered on the brink of widespread power outages over the past two summers.

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“When it's bad, it's really bad,” said Sean Kelly, CEO of Amperon Holdings Inc., which forecasts electricity usage in Texas and other grids.

Read more: Power outages threaten large swaths of North America this summer

In Europe, extreme heat may force some French nuclear plants – which provide about 70% of the country's power generation – to close. That's because many reactors rely on rivers for cooling, and when water temperatures get too high, environmental rules to protect aquatic wildlife can force facilities to temporarily close.

Inflation threat

Expectations of stubbornly higher commodity prices will continue to frustrate the Fed's inflation battle and amplify the risk that interest rates will remain high for longer. Expectations are also a source of concern for Joe Biden before the US presidential elections, in which the cost of living will be significant for voters.

Meanwhile, extreme heat is expected to stifle the U.S. economy by restricting the productivity of construction workers and limiting capital investment, according to a study by the Federal Reserve Bank of San Francisco. The study found that without large-scale efforts to reduce carbon emissions, future increases in extreme heat would reduce capital stock, or the value of accumulated investment, by 5.4% and annual consumption by 1.8% by 2200.

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Supply shocks

For agricultural markets, supply shocks represent the greatest threat.

Wheat futures reached their highest levels since July, and funds trimmed bearish bets they had held for nearly two years. Dry conditions in Russia, a major global exporter, are prompting analysts to cut harvest estimates. Field work in Western Europe has been slowed by heavy rains, while attacks on agricultural infrastructure threaten exports in Ukraine.

In North America, a large portion of large farmers in Kansas are suffering from severe drought. So far, this year's crop tour estimates that the state's wheat fields will produce more than they did in 2023, when the drought was so bad that many fields were unable to harvest. However, with more than a month to go before the fields are ready to harvest, more dry weather or scorching heat could cause yields to fall below these forecasts.

“It better get the rains started pretty quickly to get these numbers,” said Dave Green, executive vice president of the Wheat Quality Council and crop tour leader.

Extreme weather was one of the driving factors behind the astonishing rise in cocoa prices, and coffee markets now face similar risks. Futures for Arabica coffee, the high-quality bean favored by companies like Starbucks, could jump 30% to $2.60 a pound over the next few months if bad weather and production issues prevail in Brazil and Vietnam and money managers continue their policy. A buying spree, Citigroup analysts said this month.

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Options trading

Extreme heat can affect every corner of the oil market, from production to shipping and refining.

Last year, Canada's worst wildfire season on record prompted oil and gas exploration companies to halt up to 300,000 barrels per day of production. In 2023, the country's main production region was largely spared the fires, but the impact this year could be massive. At the end of April, 63% of the country was abnormally dry or in drought, according to the North American Drought Monitor, creating conditions ripe for fires.

Extreme heat can disrupt refining operations, placing stress on processing units and impacting the ability to maintain consistent internal temperatures. A complete shutdown of the refinery would come if the grid was overloaded and power to the facility was cut. Hot weather also threatens to disrupt crude oil pipelines by causing steam to build up. Some traders are bracing for what is expected to be an unusually active hurricane season, another threat to oil refineries.

Money managers' net bullish bets on US gasoline futures and options have fallen from their peak after hitting a seasonal high since 2019.

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shipping

Tanker shipments may also be affected, with drought likely to cause transit problems in major waterways such as the Suez Canal.

The Rhine River – Europe's busiest commercial waterway, transporting everything from diesel to coal inland from the giant port of Rotterdam in the Netherlands – has seen record low water levels in recent years.

In the coming months, the threat of wild weather is expected to keep commodity traders on their toes, said Carl Neal, senior energy analyst at StoneX Group Inc.

“With uncertainty comes volatility,” Neal said. How will heat affect summer crops? To what extent will cooling demand compete with natural gas storage injection? The market begins to price in this uncertainty.

-With assistance from Brian K. Sullivan, Elizabeth Elkin, Anna Shiryevskaya, Steven Stabczynski, Ruth Liao, Noreen S. Malik, Eamonn Farhat, Michael Hertzer, Tarso Veloso, Celia Bergin, Megan Durisin Albery, Anuradha Raghu, Devika Krishna Kumar, Lucia Kasai, Barbara J. Powell, Robert Tuttle, Gerson Freitas Jr., Jordan Fitzgerald, Julia Vanzeres, and Rachel Graham.

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