- Why are agriculture prices higher in 2022?
From pandemic induced lows established during 2020, agriculture prices began to rise in response to demand from the end of Covid-induced lockdowns and weather-related crop problems in areas such as South America and Southeast Asia. This demand surge was reinforced by a surge in demand for feedstuffs (primarily corn and soybean meal) in China that began in mid-2020 as China began to rebuild hog herds that were devastated by African Swine Fever (ASF). As we progressed into 2021 and 2022, ESG actions around decarbonization began to have a significant impact, initially in the renewable diesel area that boosted real and perceived demand for vegetable oils. Into this context came the Russia-Ukraine conflict that interrupted traditional supply chains and removed, at least temporarily, access to commodities such as corn, wheat, sunflowers and sunflower oil which further increased prices. As of July 2022, prices have retraced much of the increases that occurred during the initial phases of the Russia-Ukraine conflict but remain elevated above levels that prevailed from 2016 to 2020.
- Will the conflict in Ukraine accelerate or decelerate decarbonization efforts?
A recent poll of clients in the agriculture space indicated that because of high prices of energy products such as natural gas and crude oil, decarbonization efforts (including the movement away from fossil fuels), will be paused as the markets adapt and replace lost resources. However, it needs to be pointed out that high energy prices are expected to encourage segments such and biofuels and bioenergy that are connected with decarbonization as high energy prices improve the economics around some of these projects. High oil and gas prices also significantly incentivize investment in carbon-free energy sources. In their response to at risk supplies of oil, coal and natural gas from Russia the EU has ramped up sources of these commodities from other origins but in the long-term has recommitted to moving away from fossil fuels and more general decarbonization efforts.
- Are we seeing substitution effects in the agriculture environment?
Yes. And in fact, the “substitution effect” of various inputs is a regular feature of the dynamics of the agriculture market whereby an increase in the price of one input relative to another related input causes demand to decrease for the input that has increased in price and to increase for the related input. For example, disruptions from Ukraine led to higher wheat prices, incentivizing wheat to be removed from feed rations as approximately 15% of wheat in the world is used for feed. Substitution also occurs as renewable diesel facilities capture vegetable oils such as soybean oil. As the price of soybean oil increases relative to other edible oils, users will look to alternatives such as palm oil to meet their needs.
- Do we have enough oilseed crushing capacity to meet renewable and regular uses of soyabean oil?
No, there is not enough oilseed crushing capacity in markets such as the US to meet the current demand for soybean oil demand for food and renewable diesel needs. But more crushing facilities are being built and more planned. To the extent that these new facilities are soybean crushing facilities and are being built mainly in response to increased demand for soybean oil, the question is what is going to happen soybean meal produced? Clearly it will need to be fed to local livestock populations or exported. In the long-term, we could see a movement toward more high oil content oilseeds (e.g., canola) or crops that are wholly devoted to oil content.
It is important to say that in aggregate there is enough soybean crushing capacity globally to satisfy demand for capacity. However, the whole global crushing industry was built to solve a different problem than today. It developed over many years to produce high protein meals for animal feed, particularly in China. This has put excess capacity in China and the US with the capacity to crush only about half of their soybean production. The rest of the soybeans get exported, largely to China.
- Has there been enough investment in fertilizer in the past 10 years to meet demand in the next 5 years?
At a global level the simple answer is ‘yes’. There is, however, a “but…”. Two significant occurrences over the last two years have changed established supply dynamics. Covid has heightened governments’ awareness of food security and has highlighted the emergence of some resource nationalism. In October 2021 China decided to restrict exports of fertilizer to ensure it had enough produce for domestic demand: China has been a major global exporter of urea and phosphate fertilizers. Russia also went down the same route in Q1 2022, albeit setting export quotas rather than completely exiting the export business. Secondly the war in Ukraine has also disrupted established supply routes; globalization in fertilizer supply has been thrown into question, either because of active sanctions or because of the more deep-seated concerns of being reliant on supply from a country with which the receiver shares few cultural values. So there has been enough investment at a global level, but with new capacity in both China and Russia potentially not sustainably accessible, that may now be thrown into question.
- Have the extreme weather events associated with climate change impacted crop production variability?
Climate change plays out over a very long time period and the impacts from climate change are hard to separate from what are normal fluctuations in weather impacting agriculture production. It can be said that trend yields of basic agriculture crops such as corn, soybeans and wheat have continued to increase with these increases driven by technology advancements, and we expect this technology driven yield increases to continue. However, we are closely watching the evolving weather pattern changes and these changes are being incorporated into our long and short-term outlooks. For example, thirty years ago in North America there was very little corn or soybean production in places like the State of North Dakota and the Province of Manitoba but these crops are commonly grown there now both as a result of improved genetics and a generally more favorable environment (as in a longer growing season). The same could be said for the Black Sea region. At the same time, certain parts of Africa and regions such as the Western US have suffered repeated droughts that have negatively impacted crop production and put into question their long-term viability as major agriculture producing areas. Our research teams are well-positioned to monitor these changes and assess their impacts.
- Will the upward trend in grains and oilseed yields eventually plateau, like has taken place with palm oil?
No. Palm oil is a tree crop, which is vastly different than an annual crop like grains and oilseeds. With a tree crop investments are made to plant new trees on a plantation, those trees produce little or nothing for the first three years but will then remain productive for 25 years or so. This means a new generation comes only once every 25-28 years or so. It would take a huge leap in productivity for a plantation owner to cut down trees prematurely, foregoing three years of production until the new tree is mature. Annual crops are bred, and improvements are made in the seeds every year. For this reason, productivity gains in annual crops (grains and oilseeds) tend to be more predictable and reliable than in tree crops (palm oil, coffee, and cocoa). And, the technology and resource base exists for yields to continue to increase. However, there are factors that could negatively impact crop yields moving forward. But, there are some risks to think about in row crop production. For example, the full adoption of organic farming practices, given current varieties and breeds of agriculture crops, would likely lead to slow or no growth in yields for traditional row crops. In addition to this risk, as we look at the long-term consequences of the Ukraine-Russia conflict as there is a risk the Russian invasion of Ukraine could set back these two countries’ crop production for several years. The impact from the obvious disruption in Ukraine will last years and sanctions, while not directly impacting Russia’s exports of commodities such as wheat, will make activities such as crop financing and access to needed technology more difficult thus impacting yields.
- What role does agriculture commodity inflation play in expanding production?
Agricultural production is highly responsive to price and in general, high prices will encourage production. That said, some barriers to higher production need to be noted. First, while prices farmers get might go up, so do prices for inputs such as fertilizer, seed, crop protection and fuel. If the increase in these inputs more than offset revenues, production will be impeded. In addition, regulatory constraints can also impede what would otherwise be an environment conducive to higher production. And the impacts can be very regional. In geographies such as the EU and US where cropped areas are at a maximum, there is limited ability to increase production outside of yield gains. South America and in particular Brazil has available acres that can be brought into production however the regulatory environment needs to be closely monitored to see if this is possible.