Oleksandr Artiushyn
Senior Originator Weather & Agro
Munich Re
Grain production faces unprecedented challenges due to the increasing frequency and severity of extreme weather events caused by climate change. These events may disrupt operations throughout the supply chain, leading to uncertainty and potential losses for stakeholders. To mitigate weather-related risks, stakeholders are exploring various risk management strategies, including the adoption of new farming technologies, geographical diversification and innovative weather hedging tools. Overall, informed decision-making and proactive risk management are crucial for ensuring the resilience of the grain production industry in the face of evolving weather patterns.
As the global climate continues to change, the agriculture industry, in particular grain production, is experiencing unprecedented challenges. The frequency and severity of extreme weather events, such as droughts, are increasing across global regions and, in particular, in Europe. The drought that happened in Europe in the summer of 2022 was considered by some researchers to be the worst drought in 500 years. According to the European Drought Observatory, 64% of the continent was under either warning conditions or the state of alert during this period. This extreme event highlights the possible scale of the weather impacts. Moreover, the shift in weather patterns is not only causing more frequent and extensive droughts. We also observe their prolonged durations, greater intensity and simultaneous occurrences across continents. As a result, climate change is making grain production more volatile, which requires adequate responses by the grain industry.
The impacts of this agricultural production volatility go far beyond farming. Every player in the agribusiness supply chain, from input suppliers to grain handlers, faces uncertainty and potential losses due to fluctuating grain volumes. For example, there was an extreme heatwave in Canada in 2021, when the record temperature of almost 50°C was recorded, breaking the previous national record of 1937 by 5°C. Consequently, many farmers lost their crop and were unable to fulfil their grain delivery contracts. Some grain handlers had to operate at reduced capacity or were even struggling to cover fixed costs due to lower revenues. The volatility in grain volumes can be caused by not only lower crop yields, but also smaller harvested areas. Many farmers in France, for example, could not harvest late grains or plant winter crops in the due times last autumn due to the continuous rainfall that lasted several weeks. Lower planted areas may lead to significant shifts in the availability of some crops on the market, especially if you rely on particular crop varieties or specifications, for example, committed to deliver locally grown organic food.
Moreover, it is not just the quantity of grain that can be affected by extreme weather. The shifts in weather patterns may affect crop quality. In some regions there could be more frequent drops in the protein content of milling wheat or the downgrading of malting barley to feed barley due to unusual precipitation patterns during the harvesting time. Even if the total amount of rainfall remains constant during the crop cycle, it could be that the rains come earlier or later than before, leading to lower availability of the grain meeting particular specifications or leading to excessive costs, for example, for drying abnormally wet corn harvest.
Even international grain trade can be interrupted by unfavourable weather. River transportation can be totally disrupted by low water levels, forcing the suppliers to transport grains in a less cost-efficient way or creating transport congestions. We have seen this happening on multiple rivers recently in Europe and see an increase in demand for covering such risks from various industries. Even the Panama channel was affected by low water last year, which was caused by unusually low precipitation in the surrounding area. It was the second driest year in the canal’s 110-year history. The number of ships passing through the channel was significantly reduced due to water-saving measures. Unfortunately, we see more and more extreme weather records these years in different parts of the globe, and the weather effects on the international grain trade could be substantial.
Many players involved in the grain industry are considering taking risk management decisions to reduce their exposure to increased extreme weather risk. Such measures vary from selecting drought-resistant planting seeds or applying new farming technologies by growers to the significant capital expenditures to further enhance geographical diversification by leading grain processors. At the same time, while the weather exposure could be to a certain level mitigated, the risk of catastrophic weather still exists. We see these years that more and more companies, including globally leading grain trading houses, have started transferring weather risks in the insurance or derivative form.
In the past many players have been hedging their weather exposure with exchange-traded futures or options on the respective commodity price. At the moment there is an increased interest in more structured solutions, as many players need a price hedge only when there is adverse weather. For example, a company is sourcing grains from local farmers and would need to import more grain and at a higher price only when these local farmers have a crop shortfall and could not deliver the usual volumes. In this case, this would be price-efficient to cover the high commodity price risk only subject to simultaneously low crop yields locally. With a higher volatility in weather and crop production, the grain industry players need to carefully reassess possible options and consciously decide which part of the risk they are prepared to take and which part of the risk would be too high to hold.
Parametric insurance has gained attention as a potential solution to weather-related risks in grain production. Unlike traditional insurance, it offers tailored coverage based on predefined weather or area yield parameters. Its simplicity and scalability make it accessible to various stakeholders, from individual farmers to large grain processors who are not involved in farming as such. The transparent and automated payout mechanism of parametric covers reduces administrative burdens and ensures prompt compensation in the event of losses. However, while parametric insurance has benefits, it’s important to recognize its limitations. It should be considered that there could be basis risk and the parameters need to be selected very precisely. Therefore, while parametric insurance can be part of a risk management strategy, it’s essential to assess its suitability alongside other options.
On the weather patterns of this year, the anticipated transition from El Niño to ENSO-neutral conditions by April-June and the continuation of ENSO-neutral conditions through May-July may have significant implications for various regions and crops within the global grain industry. For example, in the Midwest of the United States, which is an important crop-growing region, the shift towards ENSO-neutral conditions may lead to more typical weather patterns, potentially resulting in average precipitation levels suitable for crops like corn and soybeans. However, as we move towards June-August, the likelihood of La Niña should become more pronounced. In South America, during La Niña events, countries like Argentina and Brazil may experience varying levels of precipitation regionally. Above-average rainfall is commonly observed across the northern parts of the continent, while the southern region may experience below-average rainfall. La Niña sometimes leads to hotter and drier summers in southern Brazil and Argentina, causing concerns among Argentinean wheat growers about the future wheat crop. Meanwhile, some parts of Brazil may witness above-average rainfall, which is beneficial for crops such as soybeans, corn, and sugarcane. Regarding the impact of the ENSO change on Australia, the transition to La Niña conditions could bring wetter-than-average conditions across much of the eastern and northern parts of the country. At the same time, in regions like Western Australia, which is an important wheat-growing region, the onset of La Niña may bring drier conditions, posing challenges for wheat production. One needs to note that while forecasting provide valuable insights, there is always uncertainty around future weather patterns. Therefore, participants in the agribusiness supply chain should continuously monitor weather forecasts and adapt to evolving weather dynamics to mitigate potential risks and optimize their production or sourcing strategies.
In summary, grain production faces unprecedented challenges due to the increasing frequency and severity of extreme weather events caused by climate change. These events may disrupt operations throughout the supply chain, leading to uncertainty and potential losses for stakeholders. To mitigate weather-related risks, stakeholders are exploring various risk management strategies, including the adoption of new farming technologies, geographical diversification and innovative weather hedging tools. Overall, informed decision-making and proactive risk management are crucial for ensuring the resilience of the grain production industry in the face of evolving weather patterns.