IEPlus: BofA Merrill Lynch considers risk and opportunities in US drought

An ongoing drought in the United States, where at the end of August 63% of the lower 48 states suffered from drought conditions, is posing a range of opportunities and risks for investors, according to a thematic report released by BofA Merrill Lynch Global Research.

“The US and global drought underscores increased long-term challenges to global food, water and energy security, as demand for food and energy each are expected to climb 50 percent by 2030 with the demand for water growing by 40% over the same period, potentially creating a perfect storm of interlinked challenges,” the bank said.

These changing conditions pose a range of opportunities and risks for investors.
For those interested in the themes of fighting drought and in promoting food, water and energy security, Bank of America Merrill Lynch introduced a screen that identifies liquid stocks exposed to global drought-related themes under the Bloomberg ticker MLEIARID.

The stocks included in the screen are those that it considers to be long-term solution providers in such areas as water, fertilizers, crop science, energy efficiency, second-generation biofuels and renewables.

“Food, water and energy security are increasingly bigger issues, and as governments, businesses and other players struggle to adapt to and mitigate drought conditions, there will be an evolving set of opportunities and risks for investors,” said Sarbjit Nahal, equity strategist within the Environment, Social and Governance team.

Commodities are experiencing immediate impacts from the drought, with all key agricultural commodity markets having tightened dramatically on the deteriorating outlook for supply with higher prices as a result.

“Corn and soybean prices are expected to stay elevated in the near term. Although further spikes cannot be ruled out, grain prices are expected to cool off by mid-2013. In the US, the government could issue a temporary waiver of its ethanol-blending mandate, which could alleviate the tightness in the corn market, since 40% of US corn is used to produce ethanol,” the report said.

In the agricultural and chemicals sectors, there are short-term opportunities and risks. Providers of agricultural inputs such as seeds, fertilizers and crop-protections chemicals stand to benefit from increased incentives for growers to maximize production. As a result, there are attractive investment opportunities in all major regions of world.

In the consumer sector, weather conditions should have minimal impact on packaged foods. There could be some low- to middle-single-digit cost impacts on certain European Union members in 2013, negative impacts for agribusiness companies and higher grain prices that could test the pricing power of food companies.

Finally, in the industrials and insurance sector, drought conditions are actually a positive for farmers as soft commodity price increases more than offset production decline and help extend the global agriculture cycle.

“According to disaster modeler AIR Worldwide, the drought could cause losses of $1-3bn after recoveries, a manageable event for crop insurers and their reinsurers,” the bank said.

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