Despite this week seeing rain for the first time in months, the UK and a lot of Europe is still very much in a drought - and the impacts are being felt.
The sales of disposable BBQs have been extinguished and in nearby Somerset we’ve got our first hosepipe ban in over 50 years which will dampen spirits, not lawns.
But what does it mean for the economy and investments?
Food
Farmers say they’re at breaking point as the drought hits crops and livestock. High temperatures with low humidity winds have created a hairdryer effect, aggressively taking the moisture out of the air and soil. Animals, vegetables, grains, fruits and potatoes are all being affected.
Poor grain prices have a knock-on effect, first on the cost of animal feed, and then on the cost of meat. Heat stressed cows produce less milk too.
As yields reduce, prices increase to counter for that, and weigh heavily on inflation.
Energy
In Germany, the Rhine and Danube rivers are critical for freight, but they’ve dried up to the point in places where lighter barges are needed and ship traffic has nearly stopped. Coal, crude oil and gas are some of the major cargoes that are being disrupted by the lack of water, which are necessary in the early-stage production of many goods. Berenberg Bank think it could lead to a temporary 0.5% inflation increase.
In France, more than two thirds of electricity generation is nuclear, but nuclear power plants need to discharge their excess heat into nearby rivers, and if the temperature of those waterways gets too high, they have to shut down. Last Friday 15% of France’s nuclear power was expected to be offline.
As energy output decreases, costs will increase, which will also weigh on inflation.
Productivity
During heatwaves productivity naturally declines.
Insurer Allianz suggests that for every degree above 30°C, worker output per hour declines by 3%. The London School of Economics suggested that £1bn of output was lost during the UK’s June heatwave, with workers cutting back hours to survive the rocketing temperatures.
In India – a case study for rising temperatures affecting productivity – factories experience a 2% drop in revenue and output for every 1°C rise in temperature due to fatigue, rest breaks, and equipment overheating. Estimates suggest that heat could cost the Indian economy over £58bn – that’s over 2% of its GDP – due to overheating.
Consumer spending
Hot weather may have driven shoppers towards beer gardens and ice creams, but it appears to have kept them out of non-food stores. UK non-food sales fell 0.7% in July, versus 1.4% growth a year earlier, while online non-food sales rose 1.3% year-on-year – suggesting the heat hit physical footfall rather than demand.
Clothing proved more resilient, while big-ticket items such as TVs suffered as shoppers remained cautious about spending on higher-value purchases.
Insurance
You might think that travel insurance would have risen due to the wildfires in France and Spain, but that’s not the case. Travel insurance costs have remained relatively static. But drought and wildfires are impacting insurance elsewhere.
Heat increases the risk of subsidence as dry soil shrinks, which will also lead to increased insurance premiums in the UK. UK subsidence claims are reported to have reached £225m in the first half of the year.
However, it’s more complex than that: UK insurers are tied into European and global property insurance via reinsurance, and with wildfires spreading round France and Spain they’re seeing the impact on the increased costs. Wildfire is now accounting for 10% of insured catastrophe losses, up from 2% a decade ago.
Water companies
Drought is a paradox for water companies. Water scarcity makes it more valuable but also increases scrutiny on how it’s managed.
High leakage rates, weak investment in infrastructure, and executive pay are under the microscope.
Currently customers are expected to foot most of the bill to upgrade infrastructure, with £3.4bn to be raised by increasing bills over the coming years.
A mindset shift
Droughts and heatwaves are often thought of as environmental events, but they're increasingly economic events too. From food and energy to productivity and trade, a shortage of water can ripple through supply chains and prices, impacting growth.
As climate extremes become more common, investors may need to think of water not just as a natural resource, but as an increasingly scarce economic one.
While drought creates obvious challenges, it also accelerates investment in resilience. Companies helping farmers use less water, utilities improving supplies or businesses staying productive in extreme heat could see growing demand.
What’s Parmenion doing?
At Parmenion, we're mindful that environmental challenges such as drought can have real economic consequences. That's why all our portfolios include considerations of ESG (Environmental, Social and Governance) risks and opportunities.
This aims to ensure that environmental issues such as those posed by drought (and climate change) are considered in investment decisions, in order to minimise financial risks and the impact on investment returns. Our ESG Growth range goes further, looking to invest in companies which provide solutions to a variety of ESG challenges.
Through diversified portfolios and a consideration of these risks and opportunities, we aim to help ensure clients' investments remain resilient in a changing world.
This article is for financial professionals only. Any information contained within is of a general nature and should not be construed as a form of personal recommendation or financial advice. Nor is the information to be considered an offer or solicitation to deal in any financial instrument or to engage in any investment service or activity. Parmenion accepts no duty of care or liability for loss arising from any person acting, or refraining from acting, as a result of any information contained within this article. All investment carries risk. The value of investments, and the income from them, can go down as well as up and investors may get back less than they put in. Past performance is not a reliable indicator of future returns.
