September 12, 2024

By Ben Palen, Ag Management Partners LLC

Earlier this year, I wrote a couple of articles that addressed some issues that I believe to be essential topics for the evaluation of natural capital investments. They were the facts that (a) since the start of this century, the world has added some 398 million acres of cropland (mostly in tropical countries), and (b) those of us in the agricultural space have become very good at producing, but the reality is that we are producing well in excess of demand at this time, and as a consequence, margins are negative for many crops. These issues, and a trend of slowing rates of population growth in such countries as China, have clouded the outlook in the natural capital space, and especially so for agriculture.

In the earlier essays, I also noted the changing weather conditions in certain parts of the world, and suggested that, notwithstanding those conditions, it seemed to be a questionable business strategy to base, say, crop planting decisions on the likelihood that some weather event would help prices even when overproduction of a certain crop was anticipated.

Some recent reading has caused me to rethink that suggestion. The reason, according to NASA climate scientist and crop modeler Jonas Jagermeyr, is that about 75 percent of the world’s farmland is vulnerable to “significant climate disruptions.” Part of the reason for that vulnerability is the fact that the 10 hottest years on record have occurred since 2014. The risk of a food “shock”, in which a multi-year period of extreme weather causes crop failures and related social issues, is estimated at 50 percent by the leading insurer Lloyd’s.

Anecdotal evidence from our own farming operations in the Great Plains, and information obtained from other farmers in regions as diverse as California and the Canadian prairies, may give some hints of what has started to occur with climate change. Rainfall has at times become more sporadic, which is another way of saying that drought periods are getting longer, and somewhat more extreme. Longer periods with consecutive strong winds are also more apparent, and they have the effect of increasing soil moisture loss by way of greater evaporation. Rising temperatures in such fertile regions as California’s Central Valley have made it challenging for certain crops, even those with adequate water availability from irrigation. The changes in snowpack levels already have had adverse impacts in those regions that rely on that snowpack for irrigation water during the growing season.

What is a natural capital investor to make of these factors? And how can one mitigate the risks of investment decisions and operations when climate impacts are becoming more pronounced? It would be fair to say that those of us in the natural capital space are entering some uncharted territory. With acknowledgement that some observers question climate change because it may not be happening in their backyards, the reality around the world is that the evidence of such change is mounting.

There are some different schools of thought about how to address this issue – keeping in mind that the essence of such issue has significant potential social and economic impacts on large segments of the world’s population. Some of you will recall the Arab spring events of the last decade. At least part of the reason for those protests was food insecurity. Imagine what would happen were food insecurity to occur in more heavily populated areas of the world. 

As I noted above, about 398 million acres of new land have come into crop production in the world since the dawn of this century. There are suggestions – notwithstanding the slowing rate of population growth in such nations as China and considering the potentially adverse impacts of climate change on food production – that hundreds of millions of acres of land need to be converted to farmland in order to blunt the impact of climate change on production of crops. It is likely that this would involve a massive removal of forests, and the environmental consequences of such action are almost certain to be politically untenable. 

The solution very likely lies with science. We are already seeing the use of some crop varieties that are more drought-tolerant than their predecessors. We also see the shifting of the crop mixes in certain areas to take into account such things as warmer growing seasons and less (or more) rainfall. The increased adoption of such agronomic techniques as cover crops in some areas has helped to mitigate the impact of more difficult growing conditions.

There is an emerging sector in the worlds of science and economics that can pinpoint long-term trends, in a pretty localized way, for temperature and precipitation. That data can help to guide investment decisions and pricing of natural capital assets. Further, the growing prominence of parametric insurance products for risk mitigation will play a role in allowing investors and operators to manage the risks of climate change. We have made use of such data, and the parametric products, for our clients in certain instances and they have proved to be of value.     

It is a truism that from challenges come opportunities. The recognition of the impacts of climate change on the natural capital sector cannot be overstated. That said, the sector has demonstrated a clear ability to recognize change, and to adjust accordingly. In my opinion – considering my time horizon of 40 years in the world of agriculture and all of the changes that have occurred in those decades – we will find ways to get more from less. This may turn out to be the challenge – and the opportunity – of our time, in the natural capital sector. 

See Palen’s previous articles here and here.

ABOUT THE AUTHOR:

Ben Palen is a fifth-generation farmer with experience in many aspects of agriculture, including projects in the United States, Africa and the Middle East. The focus on all projects is sustainable practices based on a mix of boots-on-the-ground work and selected use of agtech tools.

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