Weather It Be True

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By Greg Peel

The flooding rains which began in Australia late last year culminated early this year in tragedy in South East Queensland and astonishing footage of Brisbane being washed away. Today we find it difficult to comprehend television coverage from Thailand which simply evokes thoughts of Coleridge and “water, water everywhere”. Immediate impacts of weather events include the loss of lives and livelihoods, but wider global ramifications can be felt through subsequent impacts on commodity prices.

In the first two quarters of 2011 many Australian mining companies suffered extensive loss of production through flooding and the September quarter is only now seeing a return to normalcy for some. Depending on location, different operations suffered by varying degrees. Arguably the hardest hit was the Ranger uranium mine in the Northern Territory, for which water may yet ensure the demise of Energy Resources of Australia ((ERA)).

Across Queensland in particular flooding not only inundated pits but tore up goods rail lines and damaged ports to provide a double-whammy effect in many cases. Some mining companies were sitting on stockpiles which could have been drawn upon to fulfill contracts but for the fact they could not be delivered. Force majeur became popular. Other parts of Australia were also impacted, from NSW to WA and Victoria.

Australia's farmers who had so long suffered from drought in many cases faced the opposite problem. The global importance in Australia's export of commodities such as coal, base metals and grains ensured that restriction in production and supply forced global prices higher but still resulted in opportunity and real losses for Australia's producers.

Right now the Australian gold miner Kingsgate Consolidated ((KCN)) is experiencing the same grief at its highly prospective Chatree project in Thailand. Having spent years dealing with a glacial government approval process (which is ongoing for extensions), Kingsgate is now losing what production it has to the rain.

More importantly for Thailand and the world is the loss of crops to the floods. Rubber plantations can cope with a bit of water and sugar cane actually quite likes a good monsoon to provide an ensuing bumper crop, but Thailand's rice industry is facing devastation. Flood damage to rice production, notes Deutsche Bank, is expected to be extensive.

Thailand is South East Asia's leading exporter of rice. Projections at this stage are of a loss of 24% of average rice exports to 8Mt. In 1995, floods cut Thai rice exports by 11% which pushed the global price of rice up 30%. The Thai Rice Exporters Association is predicting next year's rice exports from Thailand could drop by as much as 30%.

Fortunately weather has a habit of balancing itself out across the globe, often providing the opportunity for net global exports of commodities to do the same. India has recently experienced higher than expected rice inventory levels, notes Deutsche, and hence the government has lifted a ban to allow 2Mt to be sold internationally. Pakistan is also hoping to boost exports next year by 30%. Unfortunately the weather balance can often go too far.

Floods may bring devastation but rice crops still rely on a lot of water. A lack of water has recently reduced production in the US and in key exporting countries in Latin America. Most worryingly, China has recently been suffering from the impact of drought. For the first time in several years, notes Deutsche, China has become a net importer of rice.

Financial markets in 2011 have been thrown into turmoil by the European debt crisis, but a disturbing side-issue has been the forced slowing of economic growth in China. Beijing has the capacity to ease its monetary policy stance to balance out global economic growth, but to date has been unable to do so due to runaway inflation. The most significant inflation has been experienced in the price of food, and for still mostly poor Chinese, food represents a significant proportion of household spending.

Rice forms the staple diet of half the world's population, Deutsche points out, particularly in Asia and Latin America. Food accounts for around 30% of Asia's inflation basket but that figure rises to 33% for China and 46% for India. The greatest food price inflation for the Chinese in 2011 has been experienced in pork which is the country's most popular meat. Pork inflation has eased but remains stubbornly high, while other elements of the inflation basket have now begun to slow in growth. Analysts globally are expecting China's CPI to fall back to around 4.5% by year's end from a current 6% which is where Beijing will feel comfortable.

Now, however, food price inflation is reemerging as a potentially significant threat for the Chinese economy in 2012, suggesting the potential for further tightening from the Chinese government at a time when Europe remains a major problem for the world.

Meanwhile in Australia, meteorologists are warning of increasing chance of another La Nina episode as we approach the end of the year. “Consequently,” suggests UBS, “it is increasingly likely that we will see renewed disruption to the seaborne trade of thermal and coking coal, and even nickel laterite trade out of South East Asia”.

Australia's meteorologists closely monitor the Southern Oscillation Index in order to make their predictions. Overlaying the shorter term fluctuations of the SOI and El Nino-La Nina events is the Pacific Decadal Oscillator, which is still to be fully ratified and acknowledged by the scientific community. The PDO suggests that as well as the shorter term cycles of of typically three to seven years of the Little Boy and Girl, the world experiences longer wet-dry cycles of 20-30 years which overlay the shorter rotations.

Past devastating flooding in Australia (eg Brisbane 1974) has occurred during a combination of a wet PDO cycle and a severe La Nina event. Recent decades in Australia have seen a dry PDO cycle and a rash of El Nino events which have been accredited for the prolonged drought. Last year brought a sudden severe La Nina and subsequent destructive floods. A wet PDO cycle is currently due and that experience suggests to PDO protagonists that it has now begun.

I first wrote about the PDO in an FNArena feature story in February: Two More Decades Of Wet For Australia? With another La Nina possibly approaching, the theories outlined therein are further supported.

The good news is that the next La Nina is not expected to be as bad as the last one. The bad news is however, as UBS notes, that having suffered through the last one Australia is not in a very good position to cope with another one, even if it is less severe.

From a natural standpoint, the long years of drought meant so little soil moisture in relevant areas that at least the first of last year's rains washed straight in. The persistence of that rain into 2011 nevertheless meant the soil became saturated and flooding ensued. Nine or so months later and that soil moisture level remains generally higher than normal.

From a non-natural standpoint, strict environmental laws in Australia have ensured that many pits have not yet been able to be pumped dry due to the risk of various chemicals contaminating that water. Some older pits still have “substantial” amounts of water in them. Many mines thus have a lesser capacity to take on more water than they did last year, and as such a less severe La Nina can still mean significant loss of production once more.

And that again suggests commodity price inflation for the globe at a time when the global economy is once more threatening to contract, notwithstanding loss of earnings for Australia's miners.
 

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