Will Climate Change Lead to Higher Food Prices?

Climate change research “suggests that rising temperatures have a direct impact on rates of rainfall, runoff, and evaporation…as the Earth warms, the combination of shrinking glaciers, reduced snowpack, and increasingly erratic rainfall raises fears of [food] shortages, particularly in the world’s most vulnerable regions.”¹ In this context, we are forced to consider the question: how will we cost effectively be able to feed a growing population when climate change threatens to reduce global agricultural output? Some critics of climate change argue for the theory of carbon fertilization, which contends that increased carbon dioxide levels may actually increase crop yields. However, the IMF believes that, even when accounting for the potential benefits of carbon fertilization, crop yields are projected to decline from current levels by 2080.² As such, a declining supply of crops and a growing demand for food – mixed with erratic and damaging weather patterns – present a stark future in which crops will be subject to significant price volatility. Food consumers should care about the impact of this volatility, as price increases may very well be passed along to the consumer at the grocery store. As such, the ability for the food industry to de-risk price uncertainty is crucial to maintaining the economic viability of global food production. Fortunately, the ability to hedge or speculate on commodity prices is already a regularly occurring phenomenon; in fact, agricultural derivatives are a core component of the Chicago Mercantile Exchange (NYSE: CME) business model.

As an exchange, the CME connects buyers and sellers of financial risk, enabling participants to trade contracts based on the price of agricultural products like wheat, corn and soybeans. For example, if a farmer wanted to sell a future corn harvest at a guaranteed minimum price (thereby minimizing the potential for price volatility), the farmer could purchase a put option from a CME participant; in exchange for a premium paid to the seller of the option, the farmer would lock-in a minimum future sale price for corn. In its role as an exchange, the CME is compensated by charging fees on every trade conducted on its platform; as such, the CME may be poised to benefit from an uptick in trading volume due to climate change. For example, CME management explains the cause behind a 13% increase in agricultural trading volume in 2015: “Large amounts of rain due to changing weather patterns caused by El Niño during 2015 created concerns over planting delays for agricultural commodity products in the United States. We believe this resulted in increases in price volatility across the sector, which has led to increases in overall agricultural commodity contract volumes.”³ As management alludes, price volatility is a boon to the CME’s business in agriculture, given the need for market participants to hedge price risk. Importantly, we must consider that El Niño was only a single event – from that perspective, how should we understand the scope of the CME’s role in a world in which El Niño (and extreme weather events like it) may become the norm?

In a separate attempt to address climate change, the CME has built a “Green Exchange” offering that enables companies to trade emissions credits under a cap-and-trade regime. While the U.S. did not ratify the Kyoto Protocol, numerous other countries and U.S. states have already instituted cap-and-trade programs. Further, key thought leaders, like World Bank President Jim Kim, argue that pricing carbon is critical to tackling climate change: “We must design the best ways to price carbon in order to help cut pollution, improve people’s health, and provide governments with a pool of funds to drive investment in a cleaner future…”⁴ To capitalize on the push for carbon pricing, the CME acquired 100% of GreenX, a provider of environmental derivatives, in 2012.⁵ Through the CME platform, companies can trade voluntary carbon emissions credits both in the U.S. and Europe. As governments increasingly seek to combat the impacts of climate change, the CME has put itself in a position to facilitate the implementation of cap-and-trade regimes globally.

Through its current offerings in both agricultural derivatives and carbon emissions credits, the CME can have a significant impact on the future financing of climate change. As the efforts to combat climate change evolve, the CME will need to continue to innovate new products to address the future needs of market participants. For example, by 2030, overall demand for water may outstrip supply by 40%; in this scenario, how will water be supplied and traded?⁶ Thus, the CME will need to play a role in intermediating these kinds of transactions to help fight climate change going forward. (763 Words)

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1. Rebecca Henderson, Sophus Reinert, et al., “Climate Change in 2016: Implications for Business,” HBS No. N2-317-032 (Boston: Harvard Business School Publishing, 2016), p. 4.
2. William R. Cline, “Global Warming and Agriculture,” Finance & Development (March 2008): 25.
3. Form 10-K, December 31, 2015, on CME website, http://investor.cmegroup.com/investor-relations/secfiling.cfm?filingID=1156375-16-116&CIK=1156375, accessed October 2016.
4. “New Principles to Help Accelerate the Growing Global Momentum for Carbon Pricing,” The World Bank, September 20, 2015, http://www.worldbank.org/en/news/feature/2015/09/20/state-and-trends-of-carbon-pricing-2015, accessed October 2016.
5. “CME Group Acquires GreenX Holdings LLC,” CME press release (London and Chicago, April 3, 2012).
6. Rebecca Henderson, Sophus Reinert, et al., “Climate Change in 2016: Implications for Business,” HBS No. N2-317-032 (Boston: Harvard Business School Publishing, 2016), p. 4.