Super El Nino - A Risk Markets Aren’t Pricing

What is El Nino?

El Nino is the name used by scientists to describe a recurring climate phenomenon where the tropical region of the Pacific Ocean warms up. It’s cyclical, and tends to occur every 3-5 years, with a La Nina event usually occurring between El Nino’s with the opposite effect - a cooling of the same region. Although it occurs in the Pacific Ocean, close to Peru, El Nino and La Nina events have broader climate and weather impacts that reach around the world.

The frequency of El Nino means we have good records of how it impacts weather systems and climate. More flooding on the west coast of South America, more heat on the West coast of North America, droughts in Australia, heavy rain in East Africa, etc.

Predicting A Super El Nino

The National Oceanic and Atmospheric Administration (NOAA) defines the strength of El Nino events by benchmarking peak sea surface temperatures against a Relative Oceanic Nino Index (RONI). Essentially, they strip out long-term warming trends from climate change, then measure the temperatures in the central pacific against the long-term average.

Strength / RONI Anomaly:

• Weak / +0.5 to +0.9°C

• Moderate / +1.0 to +1.4°C

• Strong / +1.5 to +1.9°C

• Very Strong / > +2.0°C

Although not officially defined, most scientists consider a Super El Nino to be anything over 2.5°C. Historically, only the 1982 El Nino event was this warm. 1997 and 2015 hit +2.4°C, so this year could see us move into completely unprecedented territory.

The impact of the 1982/83 El Nino was so severe it directly led to most of the research now used for predicting future El Ninos.

So, how accurate are our models usually, and what are they predicting?

NOAA’s CFSv2 shows the average of the 40 most recent models at around +2°C with some members hitting +2.4°C (But remember, this number removed the impact of warming oceans due to climate change, so this is very significant).

The European Center for Medium Weather Forecasts (ECMWF) uses a slightly different system to RONI so is not directly comparable, but their forecasts are equally concerning, and 7 of the 10 major forecasting models globally are signaling a record breaking El Nino event is now likely.

Predicting El Nino events is not as accurate as broader climate change predictions, but accuracy increases significantly as the event draws closer. More specifically, there is a well documented phenomenon known as the “Spring Predictability Barrier”. Forecasts made before or during February - May are significantly less reliable than forecasts made during the rest of the year. We are just now exiting this period, and most major models are still forecasting a Very Strong/Super El Nino.

El Nino’s Impact: When

Although the ocean temperatures are likely to peak in November/December this year, the tangible weather impact will take 3-6 more months.

The impact is significantly more pronounced in the southern hemisphere, and while storms, floods and heat can be extremely disruptive and damaging locally, it’s the pressure on agriculture that will affect most people. Droughts especially can have a prolonged effect on farming for several seasons, potentially creating supply shortages for some crops into 2028.

El Nino’s Impact: Where

A recent Food and Agriculture Organization of the UN (FAO) report released earlier this week provided more depth on where El Nino will most dramatically impact agriculture.

“The findings point to a high probability of agricultural drought across major producing regions during key growing periods”.

The risks are greatest in Southern & Western Africa, South and Southeast Asia, Australia, Central America and the Caribbean, and Western South America.

Western Africa

In Southern and Western Africa, El Nino typically causes a decrease in rainfall. The Ivory Coast to Cameroon belt is a key region of the world for Cocoa. During the 2015/16 El Nino, global Cocoa production fell by 6.1%. Finding specific numbers for these countries is difficult, but Ivory Coast and Ghana are the world's two largest producers of Cocoa, so they undoubtedly played an important role. El Nino could hit both countries hard while they are still recovering from weaker yields from 2023/24 droughts.

Southern Africa

The most recent El Nino cycle brought the worst droughts to Southern Africa in over 100 years, pushing millions into food insecurity as water systems and livestock came under strain. FAO is currently forecasting over 50% chance of agricultural drought across most of the region. One of the biggest risks here is not only food insecurity, but a sharp reduction in hydroelectric power output. The water level at Lake Kariba on the Zambia-Zimbabwe border fell so low in 2023 that electricity generation fell to below 15% of normal output.

South Asia

India is probably the dominant story of this entire thing. El Nino poses a genuine threat to the arrival of the much needed monsoons. India has been undergoing extreme heatwaves with temperatures soaring beyond 46°C in many parts of the country in recent years.

Monsoons deliver around 70% of India’s annual rainfall, cooling the country after heatwaves and sustaining its farmers. Strong El Nino phases have historically cut India’s rice production by as much as 7%. Cotton and sugar are also huge crops for this region.

The extreme heat in summers is already responsible for productivity losses that could hit 4.5% of India’s GDP by 2030. The Indian Meteorological Department has already forecast a 35% chance of a deficient monsoon season, meaning a 10% drop in rainfall overall, with some regions of the country getting significantly less.

Southeast Asia

Indonesia and Malaysia produce around 85% of global palm oil - an ingredient found in the majority of supermarket items around the world. It survives droughts well, but the yield falls a lot with a time lag of around a year. The increased risk of fires is another risk, especially for palm oil plantations and peatlands.

Indonesia, Vietnam and Thailand are all huge rice producers, a staple food item for the region that relies on standing pools of water. Sugar from Thailand is also extremely water sensitive.

Australia

In Australia they understand the risks posed by El Nino very well, and there are already estimates that Wheat production could fall by 20% or more, huge when we remember that Australia is one of the world's biggest producers. Droughts from El Nino are also heavily correlated with bad bushfires across the country. Home insurance in Australia has been a major issue since the large bush fires of 2019/2020 when billions of dollars in damages mounted up. The droughts also hurt Australian meat and dairy and potentially some mining operations in the country as well.

Something I’ve barely mentioned thus far is coral, the warmer oceans combined with acidification are likely to lead to accelerated bleaching, which in term has a huge impact on marine life and eventually fish stocks.

Central America and Caribbean

In Central America and the Caribbean, there is a 70% chance of below normal rainfall. The Island nations will be thankful that the hurricane season should be weaker than normal, but the lack of rain will reduce sugar yields. In central America Coffee is the key crop in the firing line.

The Panama canal is also at risk, it runs on freshwater, and the previous 3 major El Nino events in 1997, 2015 and 2023 all caused delays and increased shipping costs.

South America

While most of the global south face drought risks, much of South America faces the opposite problem, especially on the west coast. Peru, Ecuador and Northern Chile could face massive flooding and landslides. Northern and Southern areas of the continent still face drought risks that could lead to forest fires. Overall, while there are significant risks to crops, it’s broader disruption and repair costs that are more likely to be the story here.

The Big Picture: Market Risks

There is no guarantee that all of these events will unfold as I’ve laid them out here. Some could be worse, some could be better. The big picture is clear: we are looking at simultaneous supply squeezes across a wide range of commodities.

In many cases, markets are already supply constrained, so the shortage could cause another uptick in global inflation, mostly through food inflation.

Energy is another concern in regions that rely heavily on hydroelectric power, mostly in southern Africa and northern regions of South America. This could be worsened by infrastructure damage from extreme weather and the reduced productivity those localized weather events could cause.

Finally, there’s supply chain disruption. Much like we saw from the recent conflicts in the middle east, companies and countries will be jostling for position to secure supply constrained goods and commodities.

This is all unfolding against a backdrop of rising water scarcity, food and energy security concerns, and a more confrontational trade environment - a combination that makes pricing the risk accurately essentially impossible.

The big takeaway for me is not that the market isn’t pricing in all of these events accurately, it’s that it isn’t pricing in the potential severity and duration of disruption that could occur. This is not an event that unfolds this year, it’s one that unfolds over the next 2, maybe even 3 years, during which we will likely see stagflationary pressure right as central banks are struggling to control bond yields.

My Portfolio and Approach

At its core, my portfolio is built around a few key themes, the transition to clean energy, electrification, AI & semiconductors, and climate change resilience. I believe these are the most structurally significant investment themes of the next decade.

El Nino for me isn’t just a risk to manage, it’s potentially a stress test of my thesis and my portfolio.

Like everyone, I am of course exposed to the downside risks. It’s especially present in my mining names - $FCX, $ANTO.L, $BOL.ST. I own them for their exposure to copper, but that exposure means they have mining operations in several of the regions that could face flooding or droughts, both of which could impact operations.

A lot of my portfolio is neutral. Companies that largely operate in and sell to North America and Europe, with little direct exposure to what might unfold over the next few years.

A sizable chunk of my portfolio is positioned to actively hedge the risks posed by El Nino, or structurally benefit.

On the infrastructure side I have $XYL and $VIE.PA - Xylem is a position I built specifically for exposure to water infrastructure and flood/drought adaptation. Veolia is more subtle, but could also benefit.

$ETN $SU.PA $ABBN.ZU $PRY.MI $NKT.CO and $NEX.PA will all benefit from increased demand for grid management and grid infrastructure rollout, both as a response to damage, and as countries look to improve their infrastructure.

$TT and $6367.T produce HVAC systems that will benefit where heat is a problem.

$VRSK is a climate risk analytics platform that is perfectly positioned to grow as adaptation and resilience rise up the global agenda.

Finally there’s $TRMB and $NTR. The former is an agri-tech business providing hardware and software solutions to make farming smarter and more efficient. The latter is my exposure to the fertilizer world, which could benefit for reasons that likely don’t need explaining.

While I have already slightly adjusted weightings as the likelihood of a Super El Nino increased in recent weeks, the protection in my portfolio is largely passive. If we escape the worst case scenarios, these companies are still positioned for long-term growth. If the worst happens, my portfolio should hold up much better to the turmoil than most.

Closing Comments

This post is the result of weeks of extensive research and years of analyzing broader climate risk. It’s a difficult topic to write about - the scope is so vast and ultimately these events can cost lives. Please understand that this is not about profiteering from disasters, or trying to make everyone depressed. It’s about resilience, adaptation, and preparation.

I don’t take the subject matter lightly, I’m not trying to scare anyone, nor convert them to a hippie green view of the future. I’m following the science and data, positioning the portfolio to help contribute to solutions, while protecting our savings.

I’d love to hear your thoughts on this, especially if you’re into commodities or climate science. I’m open to questions, criticisms, suggestions and ideas, so if you have any - please share them.

As always, please give the post a like and share it if you found it insightful. If you like the way I’m thinking and positioning, consider looking through my profile and copying my portfolio.

Thanks for reading!