The knock-on effects of drought: What’s next for food and energy?

  • Nishita Sharma
    October 27, 2022
  • Kumar Amit
    Senior Specialist 

As Europe experiences its worst drought in centuries, we asked our procurement experts to assess the likely impact on global food and energy markets. 

The current drought in Europe may be the worst in roughly 500 years. And, in the midst of an existing food crisis and soaring energy costs, it couldn’t have come at a worse time.

In the latest instalment of our ‘Commodities in Focus’ webinar series, we asked our experts, Nishita Sharma and Kumar Amit, how this drought is likely to impact food and energy prices going forward. You can watch the full webinar on demand, here. In the meantime, here are some of the key takeaways from that conversation.

The impact on agriculture

The current drought is affecting a staggering 64% of agricultural land in Europe, which will significantly impact yields and, in turn, the global food supply chain. 

The price of key grains and oils already reached a record high in the second quarter of this year, mainly due to supply challenges caused by Russia’s invasion of Ukraine. Now, further shortages caused by drought are expected. 

Summer crops, like corn and sunflower seeds, bear the brunt of this impact with some yields predicted to fall by up to 18%. Others (such as wheat) that were harvested before the drought took hold, will be less affected. We predict an upward price pressure on wheat, as stocks-to-use ratio in Europe is forecast to reach a record low in the marketing year 2022/23, and the global ratio (excluding China) is forecast to reach a 15-year low during the year.

On a positive note, the EU’s rapeseed output is on the rise, and the region is not a large producer or consumer of another important vegetable oil, soybean (a summer crop), so the impact of drought on vegetable oils is likely to remain minimal. Rapeseed production actually increased this year, by about 11%, due to the harvest taking place before the drought.

What’s in store for winter crops?

Going forward, soil moisture anomalies paint an alarming picture for the sowing of winter grains. And while the situation in Europe continues to look bleak, the United States is also seeing droughts of its own, which may further affect market prices.

In fact, by the end of September this year, drought had reached 75% of the United States’ agricultural land; the highest levels since 2012.

A decrease in dairy

Traditionally the cheapest source of protein, the production of milk tends to lag after a drought, and our experts expect growth to fall by 3-5% in this area during 2023-2024. 

We’ve already seen European cattle and sheep farmers dig into winter reserves of grain and feed over the summer. Now, drier than usual grass is limiting grazing opportunities, and feed and processing costs have also risen steeply. 

Inevitably, the price of dairy products will increase in 2023 to keep pace with these rising production costs. 

An increasingly turbulent energy market

Food isn’t the only commodity affected by droughts, however. Lower water levels will also restrict electricity generation across Europe. 

Again, the timing of this couldn’t be worse. As our energy specialist Nishita Sharma put it: “The world is in the middle of its first truly global energy crisis. And Europe is the centre of attention.” 

Several aggravating factors, like the War in Ukraine, have made this energy crisis more acute, and Europe’s dry spell is the cherry on a particularly unappetising cake.

In particular, low water levels have stunted hydro-generation, with output dropping by 20% in the second quarter of 2022. Nuclear power plants, that rely on water for cooling, have also seen lower energy production, and impacted supply routes are limiting the transport of coal. All of this has led to an increased reliance on natural gas, at a time when governments are trying to move away from this resource as a response to the war in Ukraine.  

Analysing different scenarios which include a combination of various supply and demand risks for gas prices (see table below), our forecast is that natural gas prices – which have increased more than 90% since the beginning of the year – will continue to be volatile into the first quarter of 2023.

A multitude of factors – including continued disruptions to Russian gas supply, a delay in the restart of the Freeport LNG export terminal in the US following an unplanned outage in June, low hydro/nuclear power generation along with risks of an unseasonably cold or long winter – will keep the prices at an elevated levels during the winters. However, there is a chance prices will retreat from the highest levels during the second part of the year due to an anticipated 14% drop in demand. This will be a consequence of high prices and further gas-saving measures implemented by European governments.

What does this mean for production?

The cyclical nature of our connected global economy means the rise and fall of energy prices will, in turn, impact costs across many other markets.

Categories that require a lot of energy to produce will be especially affected. For instance, roughly 17,000 kWh of electricity is required to produce a single tonne of aluminium. So, those prices are likely to be highly affected by inflation as energy prices continue to soar. As will those for glass, flavourings, starch, plastics, resins and fruit.

Want to learn more?      

For further insights into the European drought, ongoing energy crisis, and what this means for markets going into 2023, you can watch the webinar on demand here.

Co-authored by: Nishita Sharma and Kumar Amit
Co-authored by: Nishita Sharma and Kumar Amit