El Nino Is Coming: Are You Prepared?

There's a high chance that 2014 will welcome an El Niño with wide-ranging effects.

May 16, 2014 at 7:33PM

El Nino, the periodic phenomenon of unusually warm Pacific Ocean surface temperatures, carries a lot more mystique than the average shift in weather. This is because it can seriously disrupt global weather and thus impact many industries. Drought in Australia, Asia, and West Africa can hurt crop production, while excessive rain can hurt South American agriculture. The side effects of a warmer Pacific could also severely damage fish populations, reduce Atlantic hurricanes, and increase the price of nickel.

There are plenty of other businesses that face changing fortunes amid a 65%-plus chance that El Nino will occur this summer. Can you profit from the change in weather?

Elnino

Typical El Nino weather variations. Source: NOAA.

Food providers and producers
If commodity prices increase, then both consumers and consumer-focused companies will have to absorb higher prices. Coffee, most of which is produced in South America, could particularly be affected by El Nino. Would a bet against coffee companies pay off?

Probably not. It's a well-prepared industry, as Starbucks (NASDAQ:SBUX) and other coffee-dependent companies buy coffee far in advance. Starbucks has already almost completely met its coffee needs for 2014 and has covered 40% of its needs for 2015. And El Nino typically only lasts between nine and 12 months, though in the past it has persisted for up to four years. In addition, Starbucks' operating margin was a comfortable 16.6% last quarter, giving the company plenty of buffer from any shock to coffee costs -- especially since that product represents less than 10% of its total operating costs.

Insurers
During the El Nino of 1997, there were only three Atlantic hurricanes, while the devastating 1998 hurricane season saw 10 and occurred during a La Nina (an unusually cold Pacific Ocean). In fact, during an El Nino, the probability of two hurricanes making landfall in the U.S. is only 28%, versus a neutral year's 48% and a La Nina year's 66% odds. Similarly, the odds that a storm will cause over $1 billion in damages during an El Nino, neutral year, or La Nina is 32%, 48%, or 77%, respectively.

A weak hurricane season like last year's could give insurers a boost via fewer catastrophic losses. Travelers (NYSE:TRV), for example, incurred about $500 million in hurricane and tropical-storm losses in 2011, but over $1 billion in 2012 due to Hurricane Sandy. With fewer claims and expenses in 2013, net income increased to $3.6 billion -- well more than the $2.4 billion earned in 2012 and $1.4 billion in 2011.

It is not known if a weak hurricane season is priced into insurers' stock prices. However, any bet on weak hurricanes should be tempered with the possibility of flooding elsewhere -- and the fact that catastrophic storms can still hit no matter the temperature of the Pacific.

The chance to profit is slim
Due to the erratic nature of the weather, any financial bet would be speculative, rather than a true investment. Also, many industries are already intimately aware of the challenges weather can present and have hedged against trouble. Additionally, due to El Nino's typically short duration, any bet on the weather would lack the benefits of long-term investing.

If anything, a company that hedges well and manages risks like El Nino might indicate solid management and a company worthy of further research.

In fact, you can read about a few energy companies with great dividends that may actually do better when El Nino comes knocking. You can read about them by clicking here. 

Dan Newman owns shares of Starbucks. The Motley Fool recommends Starbucks. The Motley Fool owns shares of Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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