Weekly Insights: Long-Term World Issues Impacting Agriculture
Long-Term World Issues Impacting Agriculture
The major changes from the first quarter 2020 are an expectation for the COVID-19 pandemic to last longer than first believed, China showing signs of honoring the Phase One trade deal, Brazil’s currency continuing to decline in value, and managed money investing in commodities as a hedge against inflation. The U.S./China trade war has entered Phase One of a trade deal; the COVID-19 pandemic has caused supply and demand issues and problems with the global economy; China is aggressively rebuilding its animal operations; and energy prices collapsed and rebounded and may be collapsing again.
COVID-19
In the short-term, the badly battered U.S. economy shrank at a record 32.9% annual pace in the second quarter. On one hand it is the deepest recession in history, but unlike a war, the assets are in place to bounce back if people return to previous spending habits. China’s economy grew 4.9% in the July-to-September quarter compared to the roughly 6% pace of growth that it was reporting before the pandemic. This builds on the second quarter’s 3.2% growth, which followed a historic contraction of 6.8% in the first three months of the year, when authorities locked down the central Chinese city of Wuhan in a bid to curb the fast-spreading virus. The promising economic figures mean that China’s overall GDP growth over the first three quarters of this year is now up 0.7% from the previous year. By contrast, the U.S. economy is expected to shrink by 4.3%, while the eurozone is forecast to contract by 8.3% .
Many of the countries whose economies were hit hardest are wealthy countries and agricultural surplus countries. How Brazil’s currency devaluation is helping its farmers’ profitability and what that means is covered below. A declining dollar should help the U.S.’s competitiveness for agricultural exports, but Brazil, Argentina and Ukrainian currencies have declined faster. COVID-19 is lowering domestic demand by restaurant owners. U.S. and European consumers spending less on food does not necessarily mean lower food consumption, but it is extremely painful for the food sector.
Major energy surplus countries were expected to have significant declines in food consumption, but crude oil prices bounced back into the $40 to $50 per-barrel range. Currently showing signs of a possible price collapse.
Some spending habits will be permanently changed because the COVID-19 pandemic sped up existing trends in the marketplace, especially related to technology. People were forced to make investments necessary to work at home, cook at home, and shop online. Some people will never go to an office again, which will impact energy and eventually automobile sales. Supply chain vendors have made investments to truly go paperless to avoid human contact. No reason to believe companies will revert to the old system. Offices and travel are very expensive items on a profit and loss statement. Hard to see a path forward where company budget committees do not resist resuming travel. For example, in the last week of July, itineraries purchased by corporations were down 97% from a year earlier, according to Coupa Software, a California-based business-spending management firm. Industry insiders estimate approximately 15% of the business-travel market is lost forever because of technological substitutions. Also, the opportunity to take advantage of a recession to push standard office costs to the employees is very likely, especially if the employees view working from home as a benefit. The key is how to adjust to changing markets and turn a profit.
The other major impact from the trade war and COVID-19 is market players expanding and diversifying supply chains that will have long-term damage to the U.S and Chinese agricultural economies while benefiting South America, Africa, and Asia. Market players are also more aware of the importance of better environmental controls and health standards. Implementing environmental and health standards is often a very expensive fixed cost. To this end, the modernization of the animal industries achieves several policy goals for China and the world.
COVID-19 has had a major impact on gasoline consumption, which has directly impacted ethanol consumption. Brazil and the U.S. have very large ethanol industries, but Brazil’s primary feedstock is sugarcane while the U.S.’s primary feedstock is corn. It is believed once the economy is reopened after shelter-in-place restrictions are lifted across the U.S., ethanol corn consumption will return. One long-term question is how many people will keep working from home.
The agricultural industry is still learning the impacts of a global pandemic. In the U.S. and other wealthier nations, some of the lost income will be covered by government payments, but many farmers and ranchers will go bankrupt. Higby Barrett assumes the farmland will change hands but remain in production.
Nowhere has the impact of COVID-19 been felt more harshly than in the livestock industries. The cattle herd had already begun to contract as part of the typical five-year cycle. The closing of packing plants created a shortage of meat at the retail counter and a glut of meat waiting to be processed. The end results were record packer margins with lower volumes of retail meat, record high retail meat prices, dairy cow herd reduction, a feeder pig crop being aborted, chicks being euthanized, and cattle being left on grass to slow weight gain. That being stated, by and large the breeding stock numbers have not been reduced significantly, which means the animal numbers can rebound quickly.
Most of the grain and soybean meal is consumed by integrated hog and poultry industries that control production from eggs or feeder pigs to packing plant. Owning the packing plant offsets some of the loss on the animal side of the equation. By 2021 and beyond, it is assumed the larger integrated animal operations will offset the decline in smaller operations, and feed ingredient consumption will increase. With the breeding stock still intact, animal numbers are expected to quickly bounce back and expand. Some of the 2020/21 marketing year impact from COVID-19 is being offset by the Chinese government aggressively expanding its hog and poultry operations, which ensures strong corn and soybean meal consumption expansion.
China Agriculture Imports
With per capita consumption (PCC) still well below developed countries, the consumption rate could be much higher depending on to what level of imports China allows. Does being self-sufficient mean no imports or not being too dependent on any one country? India appears to define self-sufficient as producing what is consumed in the country. The amount of imports or exports in any given year is dependent on weather events. China seems to define self-sufficient as not being too dependent on any one country. The significance is while other exporting countries increasing production increases competition for the U.S., the increasing production provides confidence to importing countries governments that imports can be increased without sacrificing national security. It appears when the U.S. became less dominant, China was more willing to greatly increase soybean imports. Over the next decade, Higby Barrett believes as South America and Ukraine increases corn production by 87 MMT and FSU increases feed grain production by 18 MMT, the extra 105 MMT of production will provide Chinese leaders the confidence that corn and feed grain imports can be increased without sacrificing national security.
China Soybeans Imports Versus U.S. Share of World Trade
Source: USDA and Higby Barrett
Another issue that a growing economy experiences is surges of price inflation. China’s government policy of providing incentives to quickly rebuild and expand the hog industry while allowing the poultry industry to expand points to China allowing more grain and soybean imports in the future. Pork is a favorite meat in China. To prevent public unrest, it is important that China allows the world to lower the domestic prices for basic commodities. Because inflation played a major role in the Communist coming to power, keeping domestic price increases under control is an important policy consideration within the Chinese government.
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 experienced in the first two quarters of 2020, the prospects of a very large U.S. corn crop, and lower ethanol corn consumption makes increasing imports to build corn stocks extremely logical.
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 USDA market 2020/21 marketing year expectations.
In other trade news, the U.S. Mexico Canada (USMCA) and the U.S./Japan trade pacts are ratified. Also, after the upcoming U.S. presidential election in November 2020, President Trump has expressed interest in a U.S./Great Britain free trade deal. If Vice President Biden wins, a U.S./Great Britain free trade deal would likely receive more support in congress.
African Swine Fever (ASF), Hog Industry Expansion and Meat Imports
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 very easy to do from a biological standpoint.
China has imported as many as 10,000 breeding stock sows and boars from Norway. The number sounds low until it is factored in the breeding stock can have 12 pigs per litter and have two litter per year. Assuming half the offspring are females, and all are retained for breeding, in one year the breeding stock can expand to 420,000 gilts and 70,000 sows. By the end of year two, the breeding stock herd could expand to 23.5 million. For comparison, the U.S. breeding inventory is 6.3 million and China’s current inventory is estimated to be 36.3 million. Before ASF, China’s breeding inventory was between 40 and 45 million. In the 2021/22 crop year, China should be setting records in domestic pork production. How well the domestic market absorbs the volume will be interesting. Also, if the domestic market can absorb the extra volume, will China allow the pork industry to increase corn and soybean meal to levels required to support the expansion? Higby Barrett believes China will allow the imports.
In 2008, the Chinese government allowed the country to be flooded with meat to ensure available supplies during the Olympics. After 2008, exports remained at elevated levels before crashing during the Great Recession of 2009. Beyond 2020, Higby Barrett believes the expanding Chinese animal sector will limit meat imports but increase grain and oilseed imports.
To meet short -term needs China is allowing a surge of meat imports. Is this just a one-off event to ensure a fun Chinese New Year (CNY) or a new policy? Higby Barrett believes China will continue to allow expanded meat imports because its own industry is expanding. For all the focus on pork, the increase in poultry imports has been impressive. It should be noted that China retailers still have two months to import meat before CNY.
U.S. Meat Exports to China (January through July)
Source: U.S. Census Bureau Trade Data
During the trade war, China implemented a 30% trade tariff that shifted significant soybean, corn and cotton export volumes to Brazil and Argentina. The U.S./China trade war also resulted in a flight to safety, which in turn sent the U.S. dollar to record highs versus the reais. After Phase One, the currencies stabilized, but COVID-19 sent the world traders toward the dollar and away from the reais. This currency devalued between Brazilian farmers buying crop inputs and selling crops. Because commodities are quoted in U.S. dollars, the resulting price signal to Brazilian farmers in reais is record high prices and profits for two straight years. Eventually, the currency devaluation will stop or reverse, and Brazilian farmers will lose money; but as a rule, once pastureland and forests are converted to crop land, they remain in production even if commodity prices decline. With lower prices the farmer will likely reduce yield improving inputs, but the extra volume will weigh on the world agricultural market prices, which will lower the U.S. farmers’ income. The good news is lower world feed costs and available supply will encourage world animal operation expansions. Therefore, overtime the supply price impact will lessen as consumption increases.
U.S. Continuous May Soybean Future Converted to Brazilian Reais
(Reais per Bushel)
Source: ICE
Russia Currency Impacting World Acreage
Since 2009, the Russian Ruble has been declining in value compared to the U.S. dollar. The declining value has created a desire for Black Sea farmers to plant wheat and barley for export. In 1990, the Former Soviet Union (FSU) had over a 100 million hectares in production before declining below 70 million hectares in 1999. With land in production at 87 million hectares in 2020/21, FSU has room to expand provided the world wants more wheat and barley.
Argentina Government Tax Policies
The main factor limiting Argentina acreage expansion is the tax structure (Argentina Export Tax Changes), which encourages crushing over exports. In response to declining soybean exports that generate foreign reserves, Argentina has temporarily cut soybean export taxes by three % age points to 30% to increase exports. Soybean meal and soybean oil tariffs will temporarily be cut to 28% and increase incrementally until January.
The latest announcement serves as a reminder that export policy changes can result in considerable costs, potential gaps in supply chains, and impact farmer planting decisions. History suggests that when Argentina alters its export taxes there can be considerable impacts on global soybean movement.
China Coarse Grain Update
China’s government will likely issue new import quotas to buy millions of additional tons of corn in 2020-21, three industry sources cited by Reuters have indicated. One source also indicated COFCO has already received and used a special low tariff rate quota (TRQ) of at least five MMT to book primarily U.S. corn supplies for delivery through April 2021. Chinese commitments already exceed its USDA WASDE reported annual 7.2 MMT TRQ. Reuters sources indicate China has already booked around 12 MMT of corn from the U.S. and around 5 MMT from other countries. Pro Farmer reported “Chinese corn prices are surging as its domestic crop was damaged by typhoons and flooding, its once massive reserves of corn have been whittled down and China is working to rebuild its hog herd. Plus, the Phase One trade deal gives China incentive to bring in more of the grain from the U.S.”
China’s imports of corn, wheat and sorghum are significantly higher than calendar year 2019. Customs data released by China shows the country has already imported 6.7 MMT of its 7.2 MMT corn TRQ for 2020, with three months remaining in the calendar year, which is 72.5% higher than 2019. China has never fulfilled its quota. Also included is 1.1 MMT in corn imports during September, which was a 675% increase from 2019. China’s imports of wheat, barley and sorghum were also up sharply from year-ago in September at 1.1 MMT, 1.3 MMT and 570 TMT, respectively. China’s year-to-date wheat imports of 6.16 MMT is 168% versus 2019 and near the wheat TRQ of 9.6 MMT. China’s sorghum imports through September have increased 463% versus 2019 to 3.5 MMT and barley imports of 4.6 MMT are slightly higher.
