Q32020, Part 2
The U.S.-China Trade War ꟷ More Than Just a Phase?
While the U.S. – China trade war may never be fully resolved, a new “normal” is being discovered. The reality is the U.S. and China need each other to maintain growth in their respective agricultural economies. Unfortunately, much of the Phase One trade deal benefits are being offset by the COVID-19 pandemic, which had a significant impact on the 2019 marketing year. The historic Phase One agreement called for China to buy more U.S. agricultural products and lower non-tariff barriers. Market players have expressed interest in exporting more U.S. agricultural products to China. Much is made of the fact these are record levels of purchases; but with China’s purchasing power increasing, the annual targets can be easily met, especially if Hong Kong is included. It should be noted, Chinese government officials are balancing domestic farmer needs, exceptionally large ending stocks, meeting tariff rate quotas (TRQ), domestic political concerns and foreign political concerns. Buying commodities is more than an economic decision.
Reading Between the Rows: Agriculture
The definition of what is included in the Phase One deal is vague. There is some question of whether agricultural imports include inputs, such as fertilizer, chemicals, seed, and equipment. Even if it does include inputs, China importing $40 billon of U.S. agricultural and related products in calendar year 2020 will be challenging with COVID-19 lowering consumption, especially considering that the $40 billion figure represents an increase of $16 billion over the record import level. The historically low commodity prices afford China an opportunity to quickly take a big step toward meeting the Phase One requirements while not being forced into purchases at higher prices. Two words China used repeatedly in all correspondence during the trade negotiations were “market driven.” The purchases are market driven, given the plunge to multi-year lows in commodity prices. It should also be noted that the “new normal” relationship between the U.S. and China is still evolving and continues to be impacted by world events, such as COVID-19.
Another interesting sidebar is the question surrounding the possibility of including Hong Kong’s imports of U.S. agricultural and related products in the Chinese totals. Including Hong Kong could reduce the import total by a third. Hong Kong has a population of 7.4 million compared to 1.4 billion for China in 2017. It defies logic to assume that Hong Kong itself is importing $1 billion of tree nuts for its own consumption. Most of the Hong Kong imports are transshipped to the mainland and could easily be reclassified as additional Chinese imports from the U.S. when the tax laws change.
China has a policy of food security. Typically, food security is defined as not being dependent on other countries for food supply. For countries like India, food security means India grows the food it consumes and only imports during times of crop shortages. For China, food security means not being too dependent on one country. As South America increased soybean production, China increase soybean imports. Some argue this was just a coincidence. As Brazil’s soybean acreage increases, more corn will be planted as a rotation crop. In 2019, Brazil’s corn crop exceeded 100 million metric tons (MMT). Most people rightly view Brazil as a competitor, but the increase in corn production could have a silver lining. As South America and Ukraine increase corn production, China can increase corn total imports without being too dependent on one country (U.S.). With the recent U.S./China trade war, the ability to switch from importing U.S. soybeans to importing South America soybeans verified the Chinese trade policy.
China has almost 200 MMT of corn stocks, which means China does not have to import any corn. It should be noted that China greatly expanding corn imports would solve several long-term and short-term issues. First, increasing corn imports would allow China’s meat industry to grow and reduce domestic meat cost. Second, increasing corn imports would allow China to meet Phase One trade import goals. Third, increasing corn imports would encourage more corn production in the world to meet future needs. Fourth, corn imports would support China’s continued investments in South America and Africa. Fifth, China will have a stronger negotiating position in nonagricultural world disputes. In addition to the five reasons stated, low crop prices, the prospects of a giant U.S. corn crop, and lower ethanol corn consumption makes increasing imports to build corn stocks extremely logical.
China’s government control, growing demand and large consumption base means the range of possible corn imports is incredibly large. China corn imports is the major wildcard on the world stage. Larger export players believe China’s corn imports are going to be double or triple the current forecast by the last USDA World Agricultural Supply and Demand Estimates (WASDE) report. Assuming the U.S. receives half the Chinese corn import increase of 14 MMT, 2020/21 U.S. corn exports would only increase from 2,150 million bushels to 2,425 million bushels and carryout would still be higher than 2019/20.
The combination of China aggressively rebuilding and transforming its animal operations supply chains from small backyard operations to large modern commercial operations that require higher quality feed mills while Brazilian farmers are ramping up production, will result in world soybean and corn consumption being much higher than current market 2020/21 marketing year expectations.
According to China’s Agriculture Ministry, the African Swine Fever (ASF) had reduced the market hog population by roughly half. China’s meat sector has imported more meat and invested heavily in chicken operations to offset some of the lost pork production. Currently, Chinese government officials have reported they are investing heavily in world class hog operations that will quickly bring production back online. The ability of hogs to reproduce quickly makes this easy to do from a biological standpoint. From a financial standpoint, investing in a hog barn with a fully operational sow breeding operation is very risky without a vaccine for ASF. Higby Barrett believes a widespread available vaccine is a year away. The United States Department of Agriculture (USDA) Foreign Agriculture Service (FAS) Global Agricultural Information Network (GAIN) stated in its China Feed Grain report, published April 6, that the idea of a vast hog and poultry expansion is underway. The following comes from the report.
“Pig farms nationwide are enthusiastic about restocking, encouraged by record high pork prices, the potential development of an ASF vaccine and waves of government incentive measures. Leading pig breeding farms are wasting no time in building new projects and scrambling for piglets and sows.
The period from March to May will see another round of piglet restocking, pushing up demand for good quality corn all year round. JCI predicts that there will be a piglet feed consumption boom beginning in March and continuing into the second quarter of 2020, based on the increase in sow stocks that began in October 2019 and the fact that it takes approximately five months for piglets to grow into commercial hogs. This will lead to increased demand for 1st Class feed corn, while China’s National Food and Strategic Reserves Administration (NFSRA) reported that 2019/20 domestic corn quality is worse than 2018/19. Among the nine provinces that are tested, six reported worse quality. Industry also reported a large portion of Heilongjiang corn was 3rd class. Even Jilin saw a large amount of 3rd class corn for their 2019/21 crop. COVID-19 epidemic control measures prevented farmers from selling corn, resulting in some corn mold due to rising temperatures and poor storage conditions. All these factors indicate mills may have to import good quality corn to support piglet and sow restocking.
“On the poultry side, based on a survey conducted by the National Broiler Industry Technology System, it is estimated that the COVID-19 outbreak has lowered broiler slaughter by 9 percent in January and 45 percent in February. Production is estimated to have dropped by 21 percent in the first quarter of 2020. With the waning of the COVID-19 epidemic, feed mill production capacity was at close to 80 percent of normal level at the end of February. The poultry industry is also benefiting from government incentives to support recovery and restocking. In March, four leading broiler enterprises announced new broiler construction projects, with a total investment of up to 7.4 billion RMB or $1.1 billion.”
The trade war increased spindle market share for synthetic fibers, as China lacked access to U.S. high-grade cotton. Phase One and China’s tariff rate quota (TRQ) suggest that China will import more cotton. The historically low commodity prices afford China an opportunity to check several boxes. China could quickly rebuild depleted stocks, meet its TRQ requirements that the World Trade Organization (WTO) ruled China was recently non-compliant and take a big step toward meeting the Phase One requirements while not being forced into purchases at higher prices. Two words China used repeatedly in all correspondence during the trade negotiations were “market driven.” The purchases are market driven given the plunge to multi-year lows in commodity prices. For this study, the short-term impact of TRQ is more related to where the stocks are ultimately stored. Longer-term, during a period of high prices, locally available supplies are more likely to be consumed than foreign supplies.