Heatflation: How Sizzling Temperatures Drive Up Food Prices

How to invest for a changing climate and increasing food prices

The impact of climate change on weather patterns and an overall increase in global temperatures has affected staple crops like corn, wheat, and rice, causing. prices for these items to go up around the world. This has created a phenomenon called "heatflation"—a spike in the cost of food caused by overheated crops.

What can countries that are seeking to secure food supplies do to protect their populations from price inflation? Where is the future of agriculture? And how can individual investors prepare their portfolios to withstand heatflation? Read on to learn more about a global trend that will impact the world forever.

What Is Heatflation?

Inflation has reached critical levels in 2022, and many are familiar with its effects. In short, when the prices of goods and services rise, each dollar buys less than before.

There's another ubiquitous discussion point, too. Whether it's a climate scientist discussing human impacts on the world's climate, or current U.S. President Joe Biden incentivizing electric vehicles, climate change is nearly everywhere in the news.

But what many might not be aware of is the phenomenon that links both. What happens when record-breaking temperatures start to impact the production of essential commodities like wheat? 

Heatflation. 

It's a term that describes the economic link between higher temperatures and inflationary pressures on agricultural goods. 

The economic effects of a warmer Earth

Researchers for the European Central Bank (ECB) investigated the links between increasing temperatures and inflation. By examining price indicators and seasonal temperatures across 48 countries, they found that extraordinarily hot summers created the most significant, longest-lasting effect on the price of food. 

The conclusion: over the medium-term, hot weather has a meaningful impact on inflation. The effect was measurable for nearly a year following the abnormally hot summers. 

Heatflation affects a variety of agricultural products

Some of the causes and effects are obvious. Farmers dealing with dangerous temperatures must spend more on irrigation and cooling for their crops. At the same time, heat stresses the plants, negatively impacting yields.

This combination of higher costs and lower production leads to an increase in produce prices. 

But it's not only wheat crops and other plant harvests affected by heatflation—animal products like milk and meat are also impacted by heat. Higher production costs and lower outputs lead to reduced yield potential and high prices. 

Further, changes in climate affect the amount of available farmland in some locations. The U.S. has likely already passed peak farmland, a phenomenon worsened by drought and other changes in weather patterns. 

And that's just a few examples—heatflation can affect any commodity impacted by adverse weather conditions.

What does heatflation mean for investors?

When heatflation hits, the prices of goods go up, and we start to feel the pinch in our wallets. 

As food prices go up, so does the cost of living. When, for example, the cost of a food staple like wheat drastically increases, hundreds of millions of people are affected.

The pressure heatflation puts on the economy can lead to slower growth, fewer jobs, and a geographical shift in agriculture. 

Although there’s no easy solution to heatflation, the geographic shift can be an opportunity for investors. Early movers might be able to get ahead of the shift to tropical and emerging markets prior to the cost of land and labor in these areas spiking.

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What Causes Heatflation?

It's no secret that the world is facing food production challenges. Uncommonly hot and dry weather is becoming increasingly normal, and, as a result, pushing up the price of food. 

For example, food prices go up when a record-breaking heat wave damages a crucial wheat harvest. And as global temperatures continue to rise, extreme weather becomes more common, which can also disrupt food production.

Although temperature and food prices may not be directly related, long-term climate changes can affect how certain areas farm. Even without a massive heat wave, excessively dry weather impacts wheat production and staple crop yields.

Water shortages can exacerbate food prices. Hotter temperatures mean less precipitation, in general, and whatever does fall comes as rain instead of snow. Snow has the advantage in that it replenishes the groundwater supply as it slowly melts.

Rain, on the other hand, can’t penetrate the dry, hardened soil. It often washes directly into rivers and streams, sometimes taking soil, nutrients, and land with it. 

Beyond crop damage, extreme weather incidents can also disrupt supply chains, further increasing inflationary pressures. For example, hurricanes and strong storms can disrupt ocean traffic, shut down ports, and even halt ground transportation by train or truck.

How Does Heatflation Impact the Price of Food Around the World?

In recent years, countries worldwide have been impacted by heatflation. India experienced devastating effects from a heat wave last spring, leading to an export ban. But farmers in Western Europe, China, and the U.S. are also hurting from hot spell after hot spell. 

For example, in mid-2022, a crop analyst at Strategie Grains cut expectations for the EU wheat crop by over a million tons based on dry weather. 

Record heat's impact on global wheat exports

One of the key ways that heatflation has impacted global prices is by damaging wheat exports. 

In early 2022, a heat wave in India, a major exporter, led to the banning of wheat exports. This reversed an earlier claim from Indian Prime Minister Narendra Modi that India could fill the gap caused by Russia's invasion of Ukraine. 

The sudden ban not only reduced the supply of wheat on the international market but also drove up wheat prices worldwide. In the days following, the Chicago benchmark wheat index rose by 6 percent.

Heat wave in India threatens the country's wheat harvest

Another way that heatflation has impacted food prices is by affecting domestic supply. In India, for instance, the hottest March on record created hope for record production levels through the monsoon season. However, ongoing heat in India's breadbasket northern wheat belt caused crop yields to decline sharply. 

As a result, in 2022, food prices in India have risen by as much as 10 percent. These effects have been compounded by continued strong demand from China, which has been buying up wheat to build its strategic reserves.

While wheat prices have begun to stabilize in recent months, they are still well above their pre-heatflation levels. With global wheat supplies remaining tight, the United Nations Food and Agriculture Organization (FAO) expects wheat prices to stay high, especially if the ongoing war in Ukraine affects the two countries' export capacities.

Droughts in California bring heatflation closer to home for Western investors

While India may seem far away to the average American investor, heatflation can also hit closer to home. California is America's top agricultural state, producing nearly half of the country's fresh fruits, vegetables, and nuts. 

When dry conditions persist, as they have for the past several years, it's not just the Californian farmer who feels the impact. Record highs, wildfires, and a lack of water also lead to lower crop yields and smaller fruits and vegetables, which ultimately drives up food prices across the country.

Water is a notoriously scarce resource in California, and farmers are already using 80 percent of the state’s groundwater supply for irrigation. Many farmers are now forced to pay for groundwater pumping or surface water deliveries. Others are investing in drought-resistant crops to minimize the risk of losses due to dry conditions come harvest time. Even with these precautions, the impact reaches far beyond California's borders.

Farmers in the West and Southwest of the United States are expecting an average drop in yields of up to 38 percent in 2022. Some states, like Texas, Oklahoma, and New Mexico, are expecting a much more significant decline.

Record-breaking heat wave impacts dairy production

Another example of how heatflation has impacted food prices is dairy. This summer, hot and dry conditions across much of Europe limited grass growth, resulting in higher feed costs for dairy farmers.

India also relies on 80 million dairy farmers, mostly small herds, to make it the world's largest milk producer. The animals are affected by hot weather, and a heat wave in India directly affects milk production.

Like the country's wheat crop, higher production costs and lower yields this year led to nearly 8 percent inflation in the price of milk and other dairy products.

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How Heatflation Can Hit Countries Seeking Food Stability

As countries worldwide seek to make their economies more resilient to climate change, the risk of heatflation is becoming more real.

Uncertainty surrounding food security in the wake of a conflict-riven Ukraine will produce lasting impacts on global food imports. 

Countries around the world are seeking to make themselves more heat-resistant amid fears of a growing number of deadly heat waves and the impact of a changing climate on agriculture. Crucial investments are needed to ensure that food and water supplies can withstand hotter conditions.

Investment in technological advancements 

Across the globe, countries are seeking to make themselves more prepared for the effects of climate change. One way to do this is by investing in heat-resistant technology and infrastructures, such as air-conditioned buildings and shade nets to protect crops, herds, and farmers from the sun and extreme heat. 

Another strong investment is designing crops that flourish in dryer, hotter conditions to reduce the risk posed by annual heat waves. 

Exploring new agricultural locations

Beyond technology, a major lever is to shift agricultural activity to temperate regions with enough rainfall to grow crops. Some of these shifts will happen voluntarily and gradually, while others will be forced.

For example, together with Russia, the now conflict-riven Ukraine once supplied nearly a third of the world's wheat exports. Unfortunately, the world can't currently rely on imports from either country.

That's why it's crucial to have a plan in place to anticipate the effects of heatflation and global warming. Many sectors will take advantage of nearshoring opportunities. Production or processing is moved to nearby countries in order to benefit from a shorter, more sustainable value chain (compared to offshoring) or longer growing seasons. 

From the U.S., Latin America would be a perfect destination for nearshoring. It’s not too far away, yet many of the countries there offer tremendous benefits for agriculture. 

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Can Shifting Food Production to Latin America Help Feed Hundreds of Millions of People?

Latin America is quietly becoming the go-to region for agriculture. The sector has shown stability in many countries in the region over the past years, even when the rest of the economy was contracting. 

The region's optimal agricultural climate, varied topography, bountiful natural resources, and long growing seasons help it sustain normal harvests even in the face of extreme weather events. 

This is good news for a world that is increasingly struggling to meet the demands of a growing population. Additionally, South America is home to multiple countries that are major players in the global agricultural exports market. For many countries in this region, agriculture accounts for at least 10 percent of their GDP.

As the demand for food continues to rise, Latin America is positioned to play a vital role in meeting the world's future agricultural needs.

The key ingredients for sustainable agriculture

Latin America has a lot of potential to become a future powerhouse of agricultural production. The region holds significant portions of the world's natural resources in the form of primary forest, precipitation, and renewable water. 

Around 30 percent of the world’s farmland and 30 percent of the global water supply are located in Latin America. Vast resources like this make the region a promising alternative for traditional agriculture regions like India and California. 

Moreover, the sheer size of Latin America and the variety of climates and temperature zones found in a country like Colombia could help it satiate a large percentage of the world's demand for many different crops. 

The country hosts a compelling variety of sub-climates, from coastal areas to plains and mountains and even tropical rainforest. Among other products, Colombia produces significant amounts of limes, avocados, and bananas and is investing heavily to boost sustainable agriculture.

Agriculture potential in South America

There's a lot of work to be done in South America to produce more food for the world. Meeting these demands in a way that is sustainable and environmentally friendly will require significant investment from governments, non-government organizations (NGOs), and private institutions. 

But if, for example, wheat production and other agriculture becomes impossible in traditional areas, like India or Ukraine, due to shifting climates or political instability, what choice will the world have?

Fortunately, Argentina is already responsible for a significant portion of global wheat exports. Brazil is one of the top producers of sugar, soybeans, and coffee and could expand wheat production. And Colombia is one of the fastest-growing exporters of citrus fruits.

These conditions create enticing opportunities for investors interested in Latin American farmland.

As an investor, how can you protect yourself from heatflation and benefit from these geographic shifts?

To start, be aware of what's happening in the marketplace. Understanding how heatflation impacts food prices and which regions are most affected will indicate potential next steps.

Investigating viable alternatives to traditional farming locations may lead you to Latin and South America, where there are many attractive opportunities for nearshoring, especially for U.S. consumers. Colombia is especially attractive with its equatorial climate and Atlantic and Pacific coasts giving easy access to both sides of the U.S.

Further, a diversified investment portfolio that includes inflation-resistant assets like farmland, especially in up-and-coming areas, can serve multiple purposes. 

Agricultural land is an effective way to diversify your portfolio due to its lack of correlation with traditional asset classes like stocks and residential real estate. It’s also an attractive asset that tends to act as an excellent inflation hedge. In addition, the income stream provided by crop production allows investors to benefit from increasing food prices simultaneously with land appreciation.

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