July 19, 2012

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TSG IntelBrief: The Geopolitics of Drought

As of mid-July 2012, deepening drought in the United States, Russia, Ukraine, and Australia is causing crop yields to fall dramatically below predicted levels, resulting in an unexpected near-term spike in the price of corn and the forecast of longer-term price hikes in corn, wheat, animal feed, and, in turn, beef, and pork. What is far more difficult to forecast is whether or not this slow-motion, long-lasting, and widely-dispersed disaster will introduce additional stressors in already challenged regions, to include the roiling Middle East as well as the economically struggling European Union (EU) and United States.

Of deep geopolitical relevance is the potential nexus between the soaring cost of these commodities and the rising tide of political dissent. Reporting from the Middle East, for example, documented a strong correlation between the significant spike in food prices in 2008-2010 and the subsequent Arab Spring uprisings. Thus, to better understand the current phenomenon — and its potential for creating additional tension and instability — it is necessary to capture a sense for both the similarities and differences between pre-Arab Spring spikes in food prices and the one currently spreading from parched fields worldwide.

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A Worsening Grain Picture

This exploration should rightfully begin with a careful review of the numbers. Fifty-five percent of the continental United States, the world's largest grain exporter, is in moderate-to-severe drought, the largest percentage since 1956. This, in turn, has caused corn prices to rise over 50% just in the last two months, with analysts cutting estimates of the 2012 corn crop by 20%. Rising corn prices will inescapably drive up prices for animal feed, causing a rapid and long-lasting rise in the price of beef as ranchers either buy expensive feed or cull their herds. Due to the uncommonly dry winter, the U.S. has already seen its position as the world's largest wheat exporter briefly overtaken by France. And weather forecasts strongly suggest a break in the extreme temperatures and drought conditions is unlikely to occur in time to make a difference for this year's crops.

Only recently, Ukraine saw its grain exports rise so dramatically that it became the world's leading barley exporter, the third largest corn exporter, and the fourth largest overall grain exporter. Due to drought conditions and rising land values, however, the country experienced an 87% drop in grain exports for the first two weeks in July (relative to last year's number). Similarly, Russia, the world's third largest exporter of wheat, has cut its total grain estimates by 20% (from 56.2 million metric tons [MMT] to 49 MMT) as a result of drought conditions. The recent devastating floods not only didn't provide the much-needed precipitation in the grain-producing regions, it actually damaged the grain transport infrastructure at Black Sea ports, thereby further exacerbating the increasingly untenable situation. Continuing the trend, Australia, the second largest wheat exporter, is predicting a decrease of 5.4 MMT from last year (though, it should be noted last year's crop of 29.5 MMT was a record harvest).

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Growing Stress on the World Food Supply

The above numbers illustrate the current and, more importantly, the forthcoming stressors on global grain markets. Given the ample grain stockpiles in all of the above countries, the world is not facing the possibility of mass famine, but rather a question of exceptional stress and instability in an already stressed and unstable situation. (Note: As noted below, there are countries — such as Yemen — that are, in fact, facing famine conditions.)

Perhaps one of the most pressing geopolitical questions revolves around the degree to which the expanding volatility in grain prices and supplies (which will result in higher prices for nearly all food products, from meat to cooking oil) might impact the already fragile situation in Egypt — the world's largest wheat importer. In importing 10 MMT of wheat, Egypt is faced with the sobering prospect of purchasing a higher-priced commodity with a devalued currency. This doesn't at all suggest another revolution is in the works, but it does connote a difficult task ahead for a still-forming government , one that immediately and directly impacts a weary population that literally depends on the government's bread subsidy programs.

Likewise, Iraq's inexhaustibly tense political state of affairs is also likely to be negatively impacted by low domestic grain production and higher prices for the expected 3.9 MMT of wheat that Baghdad must import to ensure each citizen receives their monthly nine kilogram wheat allotment that is guaranteed under its Public Distribution System. The same goes for Jordan, which has no water and imports over 95% of its grain. It just signed an agreement with Russia to invest in wheat production in Russia, and yet, as noted above, Russian wheat estimates are dropping. Again, although none of these problems are, by themselves, fatal, the last thing any of these Arab countries need is more stress on their wounded economies or their anxious population.

And it's not just unstable grain-purchasing countries such as Egypt, Iraq, Jordan, and Libya (which must import 1 MMT of wheat this year due to damage from last year's civil war) that might face additional hardships. Yemen  and Somalia — which, not coincidently, are also major sources of terrorism concerns — depend on food aid provided not only from international and non-governmental relief organizations, but also directly from individual nations. The United States, for example, is expected to provide Yemen with US $170 million to be used for immediate food purchases. However, if the overall stockpiles of grain drop because of persistent drought while overall food prices rise, financial aid such as this will becomes less effective. Perhaps more so than any other country in the region, Yemen doesn't need another major stressor and yet it is experiencing a famine in which fully half the country is food poor just as the world's bread baskets are growing empty.

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The Effects of Man-Made and Natural Disasters

While the spikes in food prices might be similar to those in 2008 through 2010, the causes are different and potentially more troubling. Research into the earlier price spikes showed that speculation rather than actual shortages drove up commodity prices. The sizable increase in the amount of corn diverted into ethanol production was another major factor. This time, however, the cause of price instability is not man-made financial machinations, but instead a widespread and persistent natural disaster. There are no regulatory mechanisms to correct rainfall levels and no policy corrections that will mitigate the effects of unprecedented heat. Thus, while the causes of this current crisis might be different than that experienced during the period leading up to the Arab Spring — and clearly much more difficult to contain — the effects might very well be similar if governments and businesses are again caught flatfooted.

Because the global economic and political spheres are presently stressed at historical levels, it would be prudent for policymakers to factor into their assessment just how significantly this prolonged and wide-ranging drought might, through higher prices and lower stockpiles, introduce additional and uncertain stressors into a volatile global system. Very few within the policymaking domain predicted the full scope of the Arab Spring, or that food riots in 2008 would lead to widespread revolt in 2010 followed by revolutions in 2011 and 2012. Thus, while additional near-term revolution and instability cannot be described as probable, it is certainly very possible...and therefore warrants careful, coordinated, and comprehensive scrutiny.

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