Increasing demand for grains is reducing the impact of stock levels

The annual conference organised by R&H Hall/Barnett Hall/Precision Liquids provided opinions on the global financial situation, the potential impact of Brexit on the animal feed sector and the impact of evolving technologies.

The keynote address was once again presented by Dan Basse of AgResource Company based in Chicago. Dan’s company is involved in market research and policy guidance and it acts as an information/opinion source for companies around the world.

Dan opened his presentation on global product markets by stating that the world political/economic order is now in disorder. “Central Banks are normalizing low interest rates. Politically, we have Brexit, President Trump, regional protectionism on trade and uncertain politicians (Putin/Erdogan/Macri).” As a result markets must endure heightened financial risk/volatility and investors will have to be more careful in 2019, Dan commented.

The biggest issue for agriculture has to be US trade sanctions. China had been its biggest market for agricultural goods in 2017 ($19.6 bn) but further expansion of this trade level was halted when sanctions were introduced. Dan said that the US actions could be described as an effort to keep an economic hold on China.

Grain supply tightening

The fact that grain stock/use ratios in the main exporting countries are likely to reach record lows means that global production in 2019 is very important. If the main exporting countries do not produce trend yields/production at least, Dan indicated that grain prices could rise further.

While global grain production in 2018 is currently estimated slightly below demand, Dan indicated that world meat production is expected to continue rising into 2020 and there is no indication that the ongoing expansion in global pork and poultry production is set to slow down. As expanding demand requires expanding supply, any hit on the production side could have big price consequences.

The bulk of this increasing demand for meat is coming through Asia and Dan commented that the ongoing spread of African Swine Fever (ASF) in China will impact the expansion of its pig herd. If this disease continues to expand it is inevitable that Chinese pork production will fall far short of demand.

If this happens then increased imports of pig meat into China seem inevitable and, as the US trade sanctions continue, the EU is likely to be the main beneficiary of this increased trade. Dan said that China currently imports around 1.5m tonnes of pig meat annually but this could increase six-fold if they cannot contain swine fever.

This combination of increasing demand for meat, and consequently grains, increases, is the impact of a year when production is curtailed by natural constraints. For this reason, Dan believes that for the first time in a number of years there is an upside for sentiment on grain prices going forward.

New demand drivers continue to emerge, he said. The trade in world wheat has grown by nearly 100m tonnes in the past decade. If one excludes the unknown entity that is China’s corn/wheat stocks and the impact of current US trade disputes, Dan feels that the outlook for feed/grain prices is brightening. At some point the US / China trade dispute will be resolved and when this happens it is likely to boost trade further between the blocks.

While most conversation on grains revolves around maize and wheat, due to their importance, Dan foresees much more tightness in minor feed-grain markets.

He mentioned barley in particular and warned that those who need this crop may have difficulty sourcing it in the coming years. Prices are likely to continue to respond to this scarcity but high prices will also force users to minimise their dependence on more costly ingredients.

Changing trends

On the broader economic scene Dan recognised the uncertainty generated by evolving changes in consumer habits. He commented that there are now shops and retail outlets which have no tills or item scanning devices. Cameras and scanners see what a customer is picking up in the shop and the cost of these items is debited from the customer’s account once they leave the shop.

Other changes see the potential of Amazon to deliver product and food orders directly to a customer’s door. Such systems now even show the customer a photo and other information about the animal from which the meat originated. And then there is the question of artificial meat and how consumers will react to this new entity.

More than a decade ago it looked like oil prices would continue to move on an upward trajectory. Then the recession hit, demand fell, and it looked like oil prices would continue to drop. Now demand for oil is huge again, stocks have been used up and price is trending upwards once again. This trend seems likely to continue and it opens up opportunities for vegetable oils.

Return of inflation

Dan said that inflation rates have been rising in the US on the back of the strong economy. He suggested that this could push up interest rates in the years ahead, with possible US Fed Funds Rate peaks at 3-3.25% in early 2020.

Dan commented that the US dollar is up 8% on other currencies so far in 2018. This is negative for US agricultural exports and he suggested that a 20% drop in the value of the US$, or a settlement of current trade disputes, is necessary to spark a lasting recovery in agricultural markets. He also noted that agricultural production is expanding outside of the US despite the Trump trade tariffs and the stronger dollar.

Countries like Argentina, Brazil, Russia and Ukraine have seen significant devaluation of their currencies and this is providing farmers in those countries with much higher prices in local currency terms. This is acting to continue to drive the production effort in those countries.

Dan noted that there has been a huge growth in global debt and that much of this is held by governments. He stated that China has a serious debt level but that this could be controlled in a centrally managed economy, especially where government has a good vision for its future.

The return of inflation, in combination with the Trump policies, appears to be leading to increased employment in the US. Dan reported that many employers now find it very difficult to secure labour in the US and companies are being forced to pay big wages plus a sign-up fee to get new employees.

Optimistic on grain prices

All issues considered, Dan is somewhat optimistic on prices in the short to medium term. While maize is currently cheap, his view is that this will trend upwards because overall demand is rising. The magnitude of any further rises will be impacted by future production patterns and how and where weather will impact.

Looking further down the road, Dan suggested that the land area in production is likely to max out around 2050 to 2060. Much of the increased production of the past decade is driven by increased planted area but this can only continue for so long. Increases in cropped areas in south America and central Europe must level off at some point as all of the economic land around the globe is pulled back into crop production.

“Financial markets are badly broken due to the consequences of quantitative easing.” Paul Sommerville of Sommerville Advisory Markets told us that quantitative easing, more commonly referred to as QE, pumped trillions of currency units into economies around the world in an effort to stimulate growth and inflation, to help kick-start economies. This injection of cash changed the way economies and financial instruments behaved and Paul argues that the printed money did little more than increase global debt and bail out banks.

However, the main consequence of the actions taken has been asset price inflation. Because the assets, including stocks, housing and corporate bonds, are priced reference to sovereign bonds - and those bonds are woefully mispriced - this has created a “bubble” known as the “everything bubble”. Paul explained that if interest rates rise all these asset values will have to readjust, perhaps violently. The main problem is that the transmission mechanisms are broken, Paul said. He believes that much (all) of the QE money was used by banks to purchase government bonds. But this money did not drive growth in the economies and the bond return fell well below 1%. He went on to say that there are $10 trillion worth of government bonds now yielding less than 0% return. While there may still be bond appreciation, the fact is that the QE money is not getting into the real economy to make a difference.

Japan is a particularly bad example of how QE is to unfold. Through various different mechanisms the government already owns 45% of all Japan debt, with 74% of the ETF market (an exchange-traded fund). Japan’s debt is currently 250% of GDP on its government account and almost 600% of GDP when all domestic debts are included.

The problem is made more challenging due to its population demographics. Total population is expected to decrease by nearly a 1/3 within 50 years. Estimates suggest that the 127m population in 2015 will drop to 88m by 2065 and head towards 51m by 2115.

Age structure is obviously an issue with 27.7% (>35 million) of the population over 65 in 2017 and there are two million over 90. So who will repay the debt? Paul also questioned the level of debt in the Chinese economy and the current indicators of economic performance in the US. Both have the potential to deliver negative surprises but management can help.

A presentation from professor Michael Wallace of UCD, looked at research on what a hard Brexit would mean for the agriculture and feed sectors on this island.

Up to 2017, the compound feed market in the republic had grown to almost five million tonnes (Mt), while the market in Northern Ireland was just under 2.5Mt (see Figure 1). This also shows that the market in the republic (ROI) is growing at a faster rate (3.4%) than that in the North (2.5%) as stock numbers increase. In ROI this growth has mainly originated through increased dairy and cattle numbers while pig and poultry have been the main drivers for the increased feed use in Northern Ireland (NI).

Given the relative size of the two markets it is interesting to note that the movement of animal feed was broadly similar in 2017 with 147,100t going into NI from ROI and 170,500t coming from the North. The bulk of what comes south is pig and cattle feed, with pig feed almost 50% of the total.

In ROI 4.2 Mt of feed ingredients were imported in 2017, some of which will have been sold as straights rather than compound feed. Depending on the product, a significant amount of our feed imports comes from outside the EU. This acts to dilute the exposure in the south to a hard Brexit but the UK does supply around 20% of the total, especially cereals.

In the event of a no-deal Brexit additional transaction costs would apply, with tariffs being imposed. But a number of non-tariff trade barriers would also impact to possibly decrease trade volumes. WTO rules would mean that cereals from the UK could have up to 56% tariff which would hit both cereal and compound feed trade and would add about €55/t to a typical cattle feed compound.

Some additional costs are estimated, even for an agreement scenario, and Michael estimates these at between 2% and 5% for crops, depending on the small print. Michael’s work found that a hard Brexit would massively impact on beef and sheep prices for UK producers but all sectors would take a price hit.

This would impact on farm incomes and a no-deal Brexit and, coupled with the loss of supports, would be hugely negative for enterprise incomes, with beef and sheep worst hit. Further analysis showed that about 80% of beef and sheep farms used in the study would lose money in a hard Brexit with no supports. The impact on dairy and pig farms would be much lower.

A more detailed report of this research can be found in last week’s Northern Ireland editions of the Farmers Journal and this can be found on the following link https://www.farmersjournal.ie/beef-and-sheep-take-the-hit-in-hard-brexit-413712.

Given that a hard Brexit would have impact in the south also, Michael estimated that the overall feed demand on the island would be reduced by about 5% (360,000t) under a hard Brexit scenario. Again, decreased beef feed would account for the bulk of this reduction.