Weather Or Not, Make Money

It is difficult to forecast the economy and markets accurately, but accurately forecasting the weather can be downright exasperating. But, from time to time, predicting the weather–or at least paying very close attention to how it is developing–is part of making economic and market forecasts. The effects of weather on three different continents could be a major factor affecting the commodities markets and, in turn, the global economy in the coming months.

A close watch of the impact on Europe of the volcanic eruption in Iceland, the North American hurricane season and the drought in South America will be important to gauging whether or not food and energy commodity prices will rise sharply and threaten the global economic recovery.

Cooler Continent

The volcanic eruption in Iceland has eased from its mid-April peak; however, there are no indications that the eruption is coming to an end and could go on for many more months. The last time it erupted, in 1821, the eruption lasted for two years.

When volcanoes erupt, they launch sulfur dioxide into the stratosphere, where it reflects sunlight back into space. As a result, large volcanic eruptions have resulted in global cooling. According to climatologists, the current eruption is not producing enough sulfur dioxide to block sunlight and lower Europe’s temperature. However, an Icelandic volcano near the current eruption, which has been triggered by nearby eruptions in the past, could produce such an effect. What could be considered a worst-case scenario of the potential effects of an Icelandic volcano eruption last took place in 1783. After an eight-month eruption of an Icelandic volcano, Europe’s agriculture was affected so dramatically in the following years that it contributed to the famine and unrest that drove the French Revolution in 1789.

Agricultural commodities may rise sharply if harvests appear to be affected. A spike in food prices would be unwelcome amid ongoing economic problems for Europe. The European economy saw little growth in the fourth quarter of 2009 and a tepid recovery in the first quarter of 2010. With Europe already divided due to the weak economic recovery, the bailout of Greece, and rising economic and political nationalism, the ash cloud could have political fallout further weakening the Eurozone and its currency.

Storm Season

The widely followed Colorado State University forecast team predicts an above-average 2010 hurricane season. Between June 1 and Nov. 30, they predict eight hurricanes and four major hurricanes.

They predict the probability of a major hurricane making landfall along the U.S. coastline is 69% compared with the last-century average of 52%. Perhaps more importantly regarding energy prices, they predict a 44% chance that a major hurricane will make landfall on the Gulf Coast from the Florida Panhandle west to Brownsville–above the long-term average of 30%.

The dissipating El Nino effect, along with the expected anomalously warm Atlantic Ocean sea surface temperatures, will lead to favorable conditions for hurricane formation and intensification. Conditions this year have a number of similarities to the above-average hurricane activity years of 1958, 1966, 1969, 1998 and 2005. In 2005 hurricanes Katrina, Rita and Wilma devastated the Gulf Coast and shut in 24% of annual oil production during the six months that followed the storms. This drove oil and gasoline prices sharply higher during the summer months. A repeat would be an unwelcome burden to U.S. consumers. After all, 2010 presents a much more fragile economic backdrop than in 2005 when the major hurricanes last struck.

Electricity Drought

Despite possessing tremendous reserves of fossil fuel and being a major oil exporter, Venezuela derives 82% of electricity generation from renewable energy. Hydroelectric power is the primary source. The Guri dam, along with nearby dams, supplies about 73% of Venezuela’s electricity. This reliance on rainfall has resulted in Venezuela’s electricity situation turning critical as a prolonged drought is nearing a critical point.

Data posted by Venezuela’s state power agency claims the water level of the dam is dangerously close to the crisis level of 240 meters above sea level. At 240 meters half or more of the dam’s 20 turbines would be severely damaged or shut down, dropping electricity output sharply. It remains to be seen whether the traditional start of the rainy season in May will be disrupted by the El Nino effect and exacerbating the crisis.

Extended daily blackouts are taking place in the Venezuelan interior, which runs the risk of further raising public discontent against the Chavez government. With the electricity crisis worsening, the government will increasingly rely on security forces, recently bolstered by the arrival of Iranian Revolutionary Guard Corp members, to maintain order on the streets. If a power outage or a political backlash disrupts oil output, energy prices for the U.S. could be expected to rise significantly given our heavy reliance on Venezuelan crude especially headed into the peak demand period during the summer driving season.

A close watch on how the weather is developing in these parts of the world is important to gauging how the skies are fairing in the global economy and markets.

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