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UK exposure to volatile commodity prices to intensify on climate change

UK exposure to volatile commodity prices to intensify on climate change

Commodity price volatility is likely to intensify and become more widespread due to climate change according to new research from PwC with potentially significant costs for UK businesses.  Extreme weather in the US and many other agricultural producing countries resulted in high and volatile food prices during 2011/12. As climate change intensifies a much wider range of commodity prices may experience heightened levels of volatility. Disruptions to trade and logistics, energy shortages and food production will affect UK businesses directly transmitted rapidly though supply chains. Volatile and rising prices will increasingly affect profitability for those companies with resource intensive, climate change exposed supply chains and those less able to manage and control their input costs.

According to the IPCC Fourth Assessment Report (2007) the 2020s show an increase in impacts from climate change globally. Although there are some positive impacts projected, the impacts are overwhelmingly negative, especially in South America, Africa and Australasia. By the 2050s the severity of impacts is projected to increase in most cases. Indeed, water scarcity and quality are projected to become worse in almost all regions with these trends likely to continue into the 2080s.

Disruptions to shipping may cause shortages of raw materials and more volatile prices

Future growth in trade with emerging economies may expose the UK to regions more vulnerable to climate impacts. For example with a significant proportion of commodities and resources transported by sea freight, coastal infrastructure such as ports, are likely to be impacted by sea level rises and increasing intensity and frequency of extreme weather events which could cause temporary or permanent closures or damage. Shortages and uncertainty over supplies of raw materials could lead to higher and more volatile prices, potentially disrupting UK businesses.

As to where the disruption will come from, predicting trade flows beyond 5-10 years becomes increasingly difficult but with China and other parts of South East Asia projected to experience more cyclones and higher sea levels the potential for disruption is high. You only need to look back to the Thai floods of 2011 to see the scale of the potential impact. Back then flooding resulted in the shutdown of at least half of the country’s hard disk drive (HDD) capacity, one quarter of global capacity resulting in a tripling in HDD prices.

Climate change could cause more volatile energy prices and short term shortages

The report identifies three countries identified which are critical to the UK’s current energy supply - Norway, Qatar and Russia. Nearly half of the UK’s imports of oil and 30% of gas are supplied by Norway, Qatar supplies nearly half of gas imports and Russia accounts for 30% of UK’s coal imports. If climate impacts affect these primary energy suppliers the UK could face volatile prices and/or need to find alternative supplies.

Norway could experience lower energy demand as the need for winter heating reduces. This could free up more gas for export markets, including the UK. Qatar (and other Middle Eastern countries) is projected to be one of the most exposed regions (in terms of proportion of land and people) to sea level rise. Liquefaction plants located in coastal regions may therefore be affected by sea level rise. Finally, climate impacts projected for Russia include increasing summer heatwaves which can impact on the operational efficiency of production and thawing of permafrost which can affect gas pipelines.

Related article: On its Own Obama’s Climate Plan will Not Save the World

More extreme weather to result in more volatile prices

Recent food price spikes are attributed to a combination of short term shocks and structural issues. Analyses of the recent price volatility suggested that weather-related shocks triggered price increases but that the policy and political decisions (panic buying, export restrictions) amplified these increases. Currently global production, and as a consequence UK imports, of certain foodstuffs tend to be concentrated in a few countries. In the short-term (to the 2020s) extreme weather events, exacerbated by climate change, are highly likely to increase volatility of prices and cause disruptions of supply.

Over the longer term (to 2050s and 2080s) the increasing impacts of average climate change could lead to more pervasive systemic changes to trade in food and other physical commodities resulting in higher prices. While nominal prices of key agricultural produce is expected to trend upwards over the next decade to average 10%-30% above those of the previous decade, trend prices in real terms (i.e. after adjusting for inflation) are projected to remain flat or decline from current levels.

The EU has been a major exporter of food to the UK and according to the report is expected to experience water stress in some areas and increased frequency of extreme weather events (including prolonged drought and flooding) impacting the agricultural sector through impacts on yields and the type of agricultural crops that can be harvested. In South East Asia climate change may also impact UK food supply chains. The US, Brazil and China are important trading partners which may experience reduced crop yields or shifts in agricultural zones in the next 10-20 years, leading to reduced production and potential availability of imports to the UK. It’s important to note that the impact of climate change may vary by agricultural commodity with Arabica coffee identified as particularly vulnerable by the report.

Which raw materials and industries are most at risk?

The volume and product composition of a country’s commodity trade determines its vulnerability to commodity price volatility. The chart below summarises the UK’s exposure to climate change impacts for the top 5 suppliers based on the top 15 products imported into the UK. A higher magnitude score means that the top 5 suppliers are expected to experience climate change impacts, while a greater concentration of supply means that the UK is less able to switch to alternative suppliers. PwC’s analysis highlights gas and apparel and clothing as key products at risk from climate change. Gas imports face the threat of disruption to supply because UK supplies are concentrated in a small number of countries making it difficult to find alternative in the short term sources if those countries are impacted (whether from climate change or other threats). Apparel and clothing imports threatened as key suppliers are particularly vulnerable to climate change (for example cotton uses large volumes of water).

Imports Climate Change

Related article: Nuclear Energy Innovation is Vital for Slowing Climate Change

Although all UK businesses are in some way affected by changes in commodity and energy prices, some will be more affected than others. Analysis by Trucost calculated the potential impact on earnings for 186 FTSE 350 companies from a 10% rise in commodity prices (particularly oil, coal, wheat and cotton). The most exposed sectors are food producers and utilities which would see a drop in earnings of 13% and 5% respectively.

As climate change intensifies a wider range of commodities are likely to be affected resulting in increased volatility. With supply chains increasingly integrated the impact of commodity price volatility will be transmitted more rapidly. Volatile and rising prices will increasingly affect profitability for those companies with resource intensive, climate change exposed supply chains and those less able to manage and control their input costs.

By. Peter Sainsbury

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