Commodity Watch: Whither the Weather?

AHMAD AL-SATI
PORTFOLIO MANAGER

Ahmad is the President and portfolio manager for Gemcorp Capital Advisors LLC, based in New York. 

Ahmad has spent most of his career in the global credit markets. Prior to Gemcorp, Ahmad was President of Pandion Mine Finance and RiverMet Resource Capital, LP - a fund focused on investing in precious metals, where he was responsible for managing the investments and the day-to-day operations of the registered investment adviser. 

Markets are pricing weather volatility. Hedge funds are hiring atmospheric scientists to model the impact of weather on commodity prices at 10x their typical average salary as scientists, with total compensation upwards of $1m.

Weather has always been part of the calculus for commodities traders. Floods and droughts impact crop yields and prices and can derail mining production (water shortage is causing Codelco to consider a $1bn desalination plan at its mine). Lower reservoirs impact electricity production and data center viability (Google’s $10bn data center in Washington state is dependent on hydro). Hurricanes disrupt energy infrastructure and production. derailing oil supplies. Warmer winters and hotter summers adversely impact the supply/demand dynamics of natural gas.

Studies have shown how El Niño, which disrupts typical weather patterns, causes inflation in food, energy, and non-energy commodities. Now, disruptive weather events are occurring more frequently changing how commodities, essential to our everyday lives, are produced and priced.

Short-term weather volatility causes sudden shifts in prices by increasing demand as supply shrinks. Trading around these events is specialized and can be lucrative or ruinous—directional bets are not for the faint of heart.

Long term, uncertainty from shifting and uncertain weather patterns may increase prices as traders place a risk premium on specific commodities or production decreases due to weather. Coffee, for example, is becoming more bitter and expensive as producers shift to Robusta (instead of Arabica) or to other cash crops entirely.

Second derivative consequences are important. Three examples:

• In 2022, China suffered a drought. The result: lithium and aluminum spot prices rallied. Why? Because lower hydroelectricity caused a production halt for 10 days. 
• Hurricanes impact cotton prices in the U.S. because Texas produces 50% of U.S. cotton. Recently, a hurricane was projected to destroy field cotton. It did not. Instead, the hurricane destroyed cotton in storage facilities. 
• In 2008, sudden weather-related increases in corn prices caused a series of bankruptcies of meat packing and ethanol companies.

Yet, despite its increasing importance, weather risk is becoming ever harder to assess. In 2024, coffee prices rallied by 9% on an expected frost. When the frost did not materialize (historic patterns held), prices plummeted, benefiting short sellers. That said, the opportunity remains as models get better and demand for food, energy, and the building blocks of our world continues to rise as the population grows and GDPs increase. 

Commodities are finite and the increased demand should result in improved cash flows. Investing in those continuous flows while attempting to dampen the volatility is how investors can generate income and benefit from exposure to an asset class that historically was an inflation and geopolitical hedge.