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Natasha Kaneva: Welcome to Research Recap. I'm Natasha Kaneva, and I head global commodities research here at J.P. Morgan. Today I'm joined by my colleague, Tracey Allen, agriculture commodities strategist at J.P. Morgan, and we're here to discuss El Niño and its impact on agriculture and other commodities. Tracey, thank you for being here.

Tracey Allen: Thanks for having me, Natasha.

Natasha Kaneva: Tracey, before we start, could you please give us a quick introduction of what markets you are covering here?

Tracey Allen: Indeed. I cover the agricultural commodities complex, forecasting the outlook for prices and the fundamental production consumption outlook and trade flow outlooks across everything from the wheat, soybean, corn, sugar, cotton, palm oil markets. And the myriad of other agriculture commodities, which feed into the global commodity inventories. I have a very close eye on the weather, on the flows across our global commodity markets, and, of course, the inventories that we all rely on. I must say, Natasha, I am an agricultural economist. I'm not a meteorologist. But it is a topic very close to our space, of course, and one that we follow very diligently.

Natasha Kaneva: So Tracey, after three consecutive years of La Niña, the world might be transitioning to El Niño. Can you give us a quick overview of what the El Niño phenomenon is?

Tracey Allen: Thanks, Natasha. The El Niño phenomenon is very much part of the natural El Niño-Southern Oscillation phenomenon. It oscillates from a warm to a cool phase every few years. The climate models and the current conditions throughout the tropical pacific are indicative of an El Niño state emerging rather imminently where we typically under an El Niño condition see warming of the sea surface temperatures, certainly in the tropical and the eastern tropical Pacific Ocean, and that’s also combined with a number of atmospheric conditions that combine forces to essentially shift rainfall patterns through the region, and also temperature patterns, which is quite impactful for world crop production. And I think this is such a topical point at the moment, Natasha, because we are dealing with a lot of other weather-related risks across other regions of the world, along with geopolitics. And, of course, we've just started to see the core inflationary pressures across a number of key markets throughout the world start to subside slightly. And so the risk of potential increases in food price inflation bumping up that headline figure is gaining quite a lot of attention and concern right now.

Natasha Kaneva: Mm-hmm. Thank you, Tracey. So far, El Niño has not been declared yet, yes? So what are the forecasts, and what conditions are expected to intensify?

Tracey Allen: That's right. We're getting very close. It appears as though the global meteorological departments are very close to declaring the El Niño phase. We do need a number of conditions to be met for multiple months, certainly, atmospheric and oceanic conditions. The majority of which have been evident and have been observed by NOAA and the Global Meteorological Organization over recent months. And it does appear as though those conditions are currently in play. Everything from the likes of sea surface temperatures, certainly, warming through the key El Niño regions of the tropical Pacific there rising above 0.5 degrees Celsius, relative to normal there. The Southern Oscillation index moving into critical bands. And the cloud cover and atmospheric conditions have also been met. So it looks like a declaration of this particular state is relatively imminent. And what is gaining attention, importantly, is the forecasts and the climate models are really quite suggestive of a very intense event as we progress into the end of 2023. It does look like this event is one that's at least of a moderate intensity. Certainly, sea surface temperatures in those key El Niño regions are suggestive of a moderate event right now. And the longer-term projections, as I mentioned, moving in the Northern Hemisphere winter, the Southern Hemisphere summer, are moving into more intense phases. Very similar, Natasha, to the events of, say, 2015-16, and also the very intense El Niño period of 2007, 2008. So, you know, with those kind of model projections, it does suggest to us that this event specifically could be quite impactful from the point of fewer crop production, particularly throughout much of Asia and Australia, on the detrimental side. But equally, quite supportive of South American agricultural output. And I should note that there is also a coinciding impact here from a potential positive Indian Ocean Dipole. So this is a separate but somewhat related climate development, and the models are projecting this positive Indian Ocean Dipole to be declared at a similar time to El Niño. And what this does is typically bring more rainfall to India and improve the likelihood of an above-average Indian monsoon. Of course, when we have an offsetting condition from El Niño, which typically brings drier conditions, there is a possibility that both of these climate drivers could essentially mitigate one another. So from the point of view of impacts on, you know, a key country with a very high composition of inflation derived from the food price basket, it is possible that, actually, the southwest monsoon across India turns out to be average to slightly above average this year. Which is in line with the government's projections there. But it also looks like quite an intense drought is certainly ahead for much of the year across Australia and moving into the Southern Hemisphere summer period, Natasha.

Natasha Kaneva: Mm-hmm. So Tracey, you covered a couple of the El Niño regions that will be impacted, or expected to be impacted. So can you walk us across different regions globally and what kind of weather conditions could be expected?

Tracey Allen: So we've touched on some of the more impactful regions from the point of view of declining rainfall. I think it's really important to note that there typically is an improvement in rainfall across parts of South America, thinking specifically here about the very frequent improvement in rainfall that we start to see particularly across Southern Brazil from September, October, typically through the course of the year. At the moment, we are seeing drought-breaking rains fall across much of Argentina. Very important, of course, for farmers' ability to plant the next season crops and certainly improve the volumes of production of everything from wheat to soybeans and corn. And with respect to Southern Brazil, whilst the rainfall appears net positive, it does also have the potential to stall the sugarcane harvest in that really pivotal center-south region of Brazil, which is the largest export region for sugar in the world. There are a number of severe implications for the fishery sector, of course, South American fisheries, and specifically thinking about Peruvian fisheries here as well. But I think also important to note that very often, once El Niño's actually declared, we do start to see improvements in rainfall conditions across California. It can be quite impactful for an improvement in agricultural cotton production particularly there. At the moment, El Niño isn't yet to be declared, so it hasn't had as strong an influence across the U.S. And for the time being, it does appear as though we're seeing more of an impact across Asia, Australia, South America, for that matter. In Thailand, we have a drought that appears to be intensifying. And, of course, more recently, we've had the Indian government ban the export of non-basmati rice as a result of the slow pace of plantings. An immense concern for yield potential going forward. So Natasha, a lot to watch out for here across the agricultural crop space.

Natasha Kaneva: Thank you for setting up the background. Focusing now more on agriculture commodities, and in particular, crops, how will this extreme weather conditions impact your markets?

Tracey Allen: When I look across the periphery of the agricultural space here, the main implications that I see going forward for this specific El Niño appear to be one where the production of wheat out of Australia is likely to decline by about a third year-on-year. And with that, lower exports. And it's occurring at a time of very tight milling wheat supplies in the global market. Equally, we are very aware of the dry conditions that appear to be getting quite entrenched across Thailand, reducing the sugarcane production and sugar exports from the country. Equally, thinking about output of cane and sugarcane specifically from Southern Brazil, from the center-south. The rainfall has been very helpful in terms of improving cane availability since coming out of that drier phase of La Niña. But it does look like these could get quite wet and potentially delayed in terms of harvest progress later in the year. So that's a really key area. And again, just thinking about the implications from a market point of view, we're most concerned here about tightening global wheat supplies. So seeing this as an upside risk for world wheat prices and also for world sugar prices. Particularly thinking also about other commodities grown through much of Southeast Asia. Palm oil is one that's very susceptible to drought conditions across Indonesia and also Malaysia. This typically plays out in the second year of an El Niño. And so we are quite cautious on palm oil and output and potential upside risks from the point of view of palm prices moving into the end of this year and into 2024.

Natasha Kaneva: Mm-hmm. Thank you, Tracey. So in light of this developments what is your view and what is the forecast for key crops, and why?

Tracey Allen: So moving forward, Natasha, there's a lot of play across agricultural markets. These weather-related risks are outside of El Niño. A lot's happening, of course, across very dry conditions across the central Midwest of the U.S., as well as this El Niño, which is more impactful for commodities across the tropical Pacific. And then we have a lot of geopolitical risks at play there as well. So, overlaying these all together, I do see upside price risks ahead for the world wheat market. We're seeing close to a 30% appreciation in wheat prices just over the last six weeks or so. It's been a rather significant increase in a very short space of time. And I wouldn't be surprised if we were to see that continue through much of this year as a result of the reduction in production and ongoing geopolitical risk in the market. The markets that appear most sensitive, specifically to El Niño, as I discussed, the ICE No. 11 sugar market, looking for prices to rise to around 26 cents per pound through much of this second half of the year. As we are seeing a lot of key exporters potentially having production constrained by this particular phenomenon. Also, more of a risk for 2024 in my view, but one that we should start to see being priced ahead of that is the burst of palm oil contract, which has been subdued for quite a reasonable portion of this year. And looks like it's going to start to rise into the key export window of the fourth quarter, moving to around 4,800 ringgits per ton. But in the background, of course, we still have weather-related issues across the U.S. Midwest, the key heartland of the corn belt and soybean growing belt. And very formative reports and [inaudible 00:13:50] evolution to come out through the middle of August there, Natasha. So, to be honest with you, across the agri space, we are bullish across the row crop markets going into year-end on a combination of demand side improvement. Of course, China buying record import volumes of agri commodities there, but particularly these weather- related supply risks that are just unfortunately not abating any time soon. But Natasha, I wanted to turn back to you and ask about the potential impacts to other commodity markets, from a shift towards El Niño.

Natasha Kaneva: Thank you, Tracey. Well, clearly, from the conditions you described, the weather phenomenon can significantly affect global commodity prices. It is associated with droughts and water scarcity, particularly in Asia and the Pacific. Those are very big mining regions. It increases the prices of non-fuel commodities, but also boosts demand for coal and crude as the lower output is generated from the hydroelectric power plants in those regions, thereby driving up the prices. So, for example, El Niño-induced droughts and low river currents in Indonesia will affect the mining equipment in the country that relies heavily on hydropower to produce nickel. Nickel is being used in batteries for electric vehicles, but also in stainless steel to protect from rusting. In our opinion, most of the region actually in Indonesia, the nickel-producing capacity uses coal rather than hydropower, so because of that, we don't believe the impact will be that large. But just imagine if it rains a lot, nickel already has about 35% water. With a lot of rain, it's an even higher water content. So clearly, there will be impact on production there. Moving to China, China produces about half of the world’s aluminum production, and previous periods of El Niño have coincided with significantly lower than average monthly rainfall levels in the province of Hunan. So Hunan is a province with a lot of hydropower, and it's used to smelt about 10% of the country's aluminum. That's about 5% of the global aluminum production. So clearly, lower hydropower will impact production there as well. In Latin America, across the globe, El Niño also typically brings stormy winters to Central and Northern Chile, where large copper mines are located. And the weather pattern also tends to disrupt supply chains, the stormy weather hinders operations at the ports. Yes, when you produce copper you need to move it down to the port. You need to put it on the boats. And after that, ship it to your port or Asia. So every single time we have those weather patterns this supply chain is being disrupted. And in the United States, El Niño typically brings wet weather to California, as you described, benefiting lime, almond and avocado crops, among others. But warmer winters in the Northeast and increased rainfall in the South. This is diminishing tornado activities in the Midwest. It decreases the number of hurricanes that hit the East Coast, and all of which tends to lead to overall higher production without that much impact on the demand.

Tracey Allen: Thanks so much, Natasha. Really interesting implications for the wider commodity complex there.

Natasha Kaneva: So to sum it up, El Niño can have significant implications for commodity markets as it can cause more extreme weather in some crop-growing regions and lead to droughts in Asia and extreme rains in South America, leading to higher fuel demand and lower metals production. Thank you, Tracey, for joining me today.

Tracey Allen: It's been a pleasure, Natasha. Thank you.

Natasha Kaneva: And thank you all for listening to Research Recap. We look forward to continuing the conversation as El Niño develops.

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