Global Oil Production Could Be Impacted by Instability
The ongoing “Arab Spring” in the energy-rich Middle East has been fueled by rising food prices and economic stagnation – two factors that continue to play a major part in political developments in that part of the world. High and rising food prices led to the 2007-8 food crisis sparking riots, export restrictions, and instability – not something which would benefit the global economy or the global energy markets.
Food prices have moderated over the last year but a major new threat has arisen. Weather patterns suggest a serious drought in the U.S. Midwest could occur this year – with a Purdue agronomist noting this could develop into one of “the so-called great droughts we’ve had in the last 30 years.” Because the U.S. is the world’s largest exporter of corn, soybeans, and wheat the impact could spread to global commodity prices very quickly.
Benner Climate Cycle
We noted last month that Samuel Benner, a farmer who was wiped out in the panic of 1873, developed a thesis that a drought pattern for Central North America exists and is governed by a 18 to 19 year cycle. Others proposed a cycle closer to 22 years. Some questioned if a cyclical pattern existed at all, or if these were just random events.
Dr. Elwynn Taylor, professor at Iowa State University, examined existing weather data as well as growth rings from trees living in the area over the past 800 years and found that a drought cycle exists. Taylor’s data indicates an average 19 years between drought events – confirming Benner’s premise. Weather patterns in the Midwest are driven in large part by ocean temperatures and weather patterns according to Taylor, and 85% of the moisture that falls in the Midwest comes from the Gulf of Mexico.
What is significant about the Benner cycle is that Dr. Taylor notes “drought years [for the Central U.S.] since 1970 are usually considered to be 1974, 1983, and 1988” – so if a cycle exists the Midwest is past due for a major drought event.
The 1988 Midwest Drought
This year’s growing season in the Midwest is shaping up to be much like the 1988 season according to many farmers and agricultural extension agents. In 1988 growers faced one of the most damaging droughts in U.S. history - corn production fell by more than 30% from year earlier levels. Disruptions to U.S. corn supplies is important as the U.S. accounts for more than 40% of the global corn exports.
Drought maps comparing conditions a month ago to current conditions make it clear the outlook for crops has deteriorated:
As a result of drought concerns corn prices soared 17% last month in the futures market. The USDA rated 48% of the U.S. corn crop as good/excellent last week, the lowest rating in this category since 1988. That year U.S. farmers produced 33% less corn than the USDA had forecast at the start of the growing season - and prices soared on the shortfall.
This year’s corn crops are at the critical stage of pollination. Over the next several weeks the crop will need moisture to reach forecast yields. Heat also impacts pollination. Corn crops tend to stop growing at temperatures much over 90 degrees. So far this year temperatures have been well above average, which like drought can adversely impact final yields.
Corn shortages generally also impact the demand for soybean, wheat, and other grain prices as they are used as a substitute by consumers. Global demand for corn has expanded for 16 straight years and was expected to reach a record level this year according to forecasts.
Unfortunately Russia is also experiencing a drought. Russian wheat production – and, more importantly, expected wheat exports – may decline substantially from year earlier levels.
While US farmers planted more corn acreage this spring since 1937 – and yields per acre today are multiples higher than what they were back then – pre-harvest corn stockpiles (the stocks-to-use ratio) are expected to fall to levels not seen in more than a decade. On a stocks-to-use ratio basis one report forecasts corn inventories this year will fall to levels not seen since 1974 – even with a good harvest. A poor harvest could push next year’s stocks-to-use ratio to levels rarely seen – and corn prices skyward.
La Niña Concerns
Because the ocean holds so much energy it influences onshore weather in the U.S. For the last two years we have experienced a pattern known as La Niña according to Iowa State’s Dr. Taylor. The intensity of the weather pattern was one of the stronger La Niña events seen in the last century. The probability of a drought in the Midwest is higher during La Niña conditions. We are now into the third year of La Niña, but Taylor notes the condition has faded to neutral conditions as of mid-June.
Looking at the ten strongest La Niñas over the last 110 years Taylor’s research indicates that “four went from neutral back to La Niña by August of the third year, destroying corn, hurting soybeans, and putting an end to forage crops.”
Six times the weather condition morphed into El Niño – a much more moisture and temperature friendly condition for Midwest agriculture and crop yields. Taylor puts the odds at six in ten that the corn crop will recover and we have a new El Niño – but he also puts the odds at a four in ten chance of a return of La Niña which could devastate corn yields.
Implications for Investors
After the massive and historic Arab Spring disruptions in the Middle East, should a drought hit the U.S. corn belt the impact on global grain prices would be significant - and felt globally. The export restrictions on grains, food riots, instability, and accompanying economic stagnation would have a direct impact discouraging business activity and crude oil production.
The capital expenditures need to maintain crude oil production from a naturally depleting resource would be reduced or postponed by food price driven unrest, and the stability of some of the new governments in this energy exporting region would be questioned. We should know within a month if a drought – and soaring grain prices and the associated global instability – will approach the devastation seen in 1988.