Author: jonkingsman

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Screening out the noise

Traders among you will know how difficult it is to identify fundamental price trends, and to separate them out from market noise. The same applies to consumer trends: how can you differentiate a genuine trend from background noise?

This past week has been a particularly noisy one in terms of consumer food trends.

Back in October 2015 the International Agency for Research on Cancer (IARC)—the cancer agency of the World Health Organization—classified processed meat as a carcinogen and red meat as a probable carcinogen. Their conclusion was based on a review of more than 800 studies. After an initial flurry of headlines, the media largely discounted the warnings, arguing that eating processed meat only raises the average lifetime risk of developing colon cancer from 5% to 6%.

However, the story is back. The Guardian this week published a long read entitled “Yes, bacon really is killing us”, arguing that the nitrates in processed meats are giving us colon cancer. A French MEP has taken up the cause and launched a campaign demanding a ban of nitrites in all meat products across Europe.

The Guardian also published an opinion piece this week entitled, “Why what we eat is crucial to the climate change question”, arguing that “our food – from what we eat to how it is grown – accounts for more carbon emissions than transport…and roughly the same as the production of electricity and heat”.

Greenpeace meanwhile has gone on a campaign against meat consumption with a report titled Less is More: Reducing Meat and Dairy for a Healthier Life and Planet. The organisation wants to reduce global meat and dairy consumption by 50 percent by the year 2050. They argue that reducing meat and dairy consumption:

  • Fights climate change: a 50 percent reduction in consumption of animal products “will lead to a 64 percent reduction in greenhouse gases relative to a 2050 world that follows current trajectories”.
  • Means less deforestation: by eating less meat — particularly beef, which requires 28 times more land to produce than dairy, pork, poultry, and eggs combined — there is less incentive to clear cut forests for grazing and growing animal feed.
  • Protects endangered species: animals and the mono-crops required to feed them destroy the habitat for local wild species, particularly for large herbivores. Since 1970, the Earth has lost half of its wildlife but tripled its livestock population.
  • Protects water sources: studies suggest “if industrialised countries moved towards a vegetarian diet, the food-related water footprint of humanity could be reduced by around 36 percent.”
  • Makes us healthier humans: Greenpeace cites studies linking consumption of animal products to cancer, obesity, diabetes, cardiovascular disease, and more.

And as if meat wasn’t in enough trouble last week, South Africa has been hit by what has been called the world’s worst listeria outbreak; so far it has killed 180 people and affected hundreds of others. The country’s health ministry says the outbreak originates from a Tiger Brands processed meat factory in the northern city of Polokwane, something that the CEO of Tiger Brands denies.

The anti-meat movement is gaining such momentum that even Donald Trump is reported to be swapping his beloved beef burgers for salads.

However, if you are thinking of doing the same and ditching meat for a vegiburger, French media (France 5) broadcast a documentary last week on soybeans and how bad they are bad both for your health and for the environment (in terms of deforestation and agricultural expansion).

Soy products apparently contain oestrogen-like compounds that your body processes much like its own oestrogen. Women who ingest high levels of soy are reported to find changes in their hormone cycles, as soy can suppress hormones associated with ovulation.

But it is not just women that can be affected; soybeans have also been accused of reducing fertility in men. Soy-consuming men were found in one study to have only 65 million sperm in their semen, compared to non-soy-eating participants who averaged 120 million sperm per sample. However, the UK’s Nation Health Service warns that the study behind this has limitations: it was small, and mainly looked at overweight or obese men who had presented to a fertility clinic.

Rather confusingly, the French documentary went on to argue that soy not only has negative effects on human health, it is also bad for animals. This time the problem had nothing to do with hormones, but with the herbicide glyhosate that is sprayed on soybeans. Some argue that the herbicide works its way along the food chain via meat and dairy products, and causes cancer in humans. The documentary tested various dairy products sold in France and found trace elements of glyhosate in all of them, even the organic ones.

If you are getting the stage where you no longer know who to believe or what to eat, New Food Economy last week followed up on an earlier opinion piece arguing that pretty much all nutrition studies are flawed. They argue that food studies tend to be small and speculative; the effects of any given food or food component tend to be small; research designs are often faulty; and researcher bias is somewhere between rife and universal.

There is also a problem with the data. Most studies are conducted by asking people what they eat—and most people lie. All this presents a problem for health professionals looking to reduce obesity and its associated costs.

This is particularly relevant as Public health officials in the UK called last week on food sellers and manufacturers to cut calories in their products by 20% by 2024. Public Health England suggests that food producers have a number of options for meeting the target, including reformulating products, promoting healthy options and reducing portion sizes.

The report notes that children are overeating: obese boys consume up to 500 excess calories a day while girls who are overweight or obese consume up to 290 excess calories a day. On average, adults were found to consume about 200 calories beyond what is necessary in a day.

All that is a lot of noise for just one week. But can we discern any trends through the noise?

  • The way food is produced and consumed has moved to centre stage in terms of public concern and media focus. This is likely to continue: anyone involved in agriculture and the agriculture supply chain will remain in the spotlight (so get used to it!)
  • The anti-meat lobby is strengthening; plant-based protein looks as if it has much further to run. But having said that we are already seeing some push back with vegetarian (particularly soy-based) diets coming under attack.
  • One trend that may be fading is the willingness to blame particular foodstuffs for obesity or other health issues. Consumers are beginning to distrust the studies; there are simply too many of them pushing in too many directions.

But what would a trader do in such a situation? He would endeavour to screen out the daily volatility and look instead at the fundamentals.

The fundamental reality is that people are eating too much and moving too little. The market is slowly making its way in that direction.

 

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Investing in Brazil’s sugarcane sector

As the agricultural world waits for confirmation of ADM’s proposed takeover of Bunge, attention is turning to Bunge’s sugarcane business. ADM doesn’t seem to want it; nor, apparently, do other potential buyers. Brazil’s sugarcane industry was once considered the El Dorado for investment in agriculture. Here are ten reasons why it all went pear-shaped.

1/ The exchange rate moved against investors. At the start of the inward investment boom into Brazilian sugarcane in 2005, one US dollar would buy 2.36 Brazilian Reais. Investment inflows, accompanied by widespread optimism over Brazil’s economic future, pushed the Brazilian Real higher – so high in fact that by the peak of the boom in 2008 one US dollar would only buy 1.56 Brazilian Reais. Today, one US dollar will buy you 3.25 Brazilian Reais. So if you are an international, dollar based company, that converted US dollars into Brazilian Reais in 2008 at an exchange rate of, say, 1.6 Reais to the US dollar to buy a sugar mill in Brazil you would today be looking at an exchange rate loss of close to 50 per cent.

2/ The Brazilian economy stalled. We all committed an error in believing that President Lula’s good governance would continue in terms of the macro-economy and the exchange rate. As long as China continues to grow, we argued, Brazil would grow with it. China continues to grow, albeit at a slightly lower rate, but Brazil’s economy has stalled.

3/ Costs rose significantly. Whenever there is a gold rush, costs will rise: the price of a shovel can multiply many times over. Brazil experienced its own “gold rush” between 2005 and 2010 with the rapid expansion in its ethanol and sugar sector. This led to a shortage of just about everything, including qualified labour and machinery, and led to a considerable increase in production costs. A shortage of qualified labour also led to an increase in costs elsewhere. Field inputs such as fertilizers, herbicides and pesticides were not applied in an optimal way, resulting in a drop in agricultural yields.

4/ Bad weather hit production at a critical time. Although the new, or expanded mills, urgently needed cane to crush it takes time to prepare the land, to plant the cane and then to let the cane grow to maturity. A series of bad weather events slowed this expansion in the cane area and mills were forced to run at substantially reduced capacity, sharply increasing unit costs further.

5/ New cane varieties had to be developed for new areas. Agricultural (land and climatic) conditions in the new areas that were coming under cane were not the same as in the existing areas. The cane varieties that thrived in Sao Paulo State did not necessarily thrive in the new areas.

6/ Government intervention handicapped the sector. Back in 2005 a friend of mine was warning of the danger of investing in an industry where the price of half of your production (in this case the ethanol part) was effectively fixed by the government. As long as the Brazilian government set the gasoline price, the government also caps the ethanol price. At the time, however, it was inconceivable that the government could set the domestic gasoline price below both the international price of oil and the production cost of ethanol. But that is what the Brazilian government did for a prolonged period of time, severely damaging both the national oil company Petrobras and the domestic ethanol industry.

7/ Ethanol lost credibility. The vision we all had back in 2005 was that ethanol was a green renewable fuel that had a significant role to play in the battle against global warming. We imagined Brazil exporting this renewable green energy throughout the world. We did not foresee that ethanol would fall out of favour and that the media and consumers would push back against using food for fuel. Nor did we anticipate the push back against expanding sugarcane plantations into Brazil’s underused cattle-ranching areas.

8/ Oil prices crumbled as the shale oil sector grew in the US, mineral, undermining the economic rationale for alternative liquid fuel. We all want to protect the environment, but how much are we willing to pay to do so?

9/ Finance for the sector dried up as things stated to go sour—a situation aggravated by the global financial crisis of 2008. Planting and crushing cane is hugely capital intensive. With the exception of Raizen’s parent Shell, the new owners and operators of the sugar mills found it difficult to provide the finance necessary to keep going.

10/ Traders don’t make good farmers  (or do they)? Processing cane is not the same as crushing soybeans. With cane you have to get actively involved in growing the cane; with beans they just turn up at your factory gate. Traders tend to concentrate on the short term; farmers on the long term. Traders like to quickly get out of a losing position; farmers don’t sell their farm just because of one bad crop. 

However, this is a controversial issue (and will be one of the points of discussion at our June conference.)  Trading companies have learned some hard lessons in Brazil over the past ten years, and they are putting what they have learnt into practice. This is helping a turnaround in the sector; Bunge’s sugarcane business, for example, is now profitable. 

But there other reasons why now may be the time to invest in Brazil’s sugarcane sector.  Here are five (of them.

1/ Brazilian ethanol once again has government support.The Brazilian government has recently taken its foot off the neck of the domestic ethanol industry. It has allowed domestic gasoline prices to fluctuate in line with world prices and helps the competitiveness of Brazilian hydrous ethanol as an alternative domestic fuel. At the same time, the government’s ambitious RenovaBio programme sets out guidelines for future support.

2/ Food prices have fallen over the past couple of years and ethanol has largely dropped off the radar screen of public opinion. Poor weather and poor harvests were the main drivers for the increase in food prices that we saw a few years ago. The fact that corn prices are low even with 40% of the US corn crop going to ethanol takes the sting out of the food versus fuel debate.

3/ Global warming isn’t going away. Ethanol is a green renewable fuel with a much lower carbon footprint than mineral oil and as such could see a revival of interest, or a reduction of opposition, from the environmentalists. As for the farming lobby in the US, ethanol is an important alternative outlet for corn when food prices are low. Political support may once again grow within the US for ethanol.

4/ Electricity co-generation from bagasse is profitable. The country is short of electricity and returns are likely to remain high. Brazil should also have an advantage in terms of green plastics. With world oil prices low it will be hard for green plastics to compete but (for the moment at least) consumers seem willing to pay a premium for a “green” bottle. Brazil already has a couple of green plastic plants.

5/ Ethanol in Brazil currently gives millers a better return than sugar. This should result in a shift within Brazil towards making more ethanol and less sugar and may result in sugar prices bottoming. This flexibility gives Brazilian sugarcane sector gives operators valuable optionality, something that traders love! Brazil is not only the price regulator in the world sugar market. It is the lowest cost producer for the next marginal tonne of sugar that the world will need as consumption expands. If the Brazilian Real remains weak it will be difficult for other sugar producing countries to compete.

So there are some strong reasons to be optimistic. Are they strong enough for someone to make a stand and purchase Bunge’s Brazilian sugarcane business? We will soon find out.

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Investing in agriculture

I was invited this week to participate in a Natural Resources Forum on Investing in Agriculture at the London Stock Exchange. Topics ranged along the value chain, from investing in farmland through logistics to consumer trends.

One speaker, an expert on farmland investment, gave three warnings to potential investors:

  • All farms are local and local expertise is essential. The quality of the land can vary from one field to another, as too can microclimates in terms of flooding and frost
  • Prolonged periods of bad weather can throw off even the most conservative revenue predictions.
  • The market for farmland is illiquid; it is easier to buy than to sell.

There was an interesting discussion as to whether  farmers would be able to meet the world’s ever increasing demand for calories. Although, as one participant put it, “they aren’t making farmland anymore”, others warned against  “Malthusian” arguments that food production is limited. Agricultural yields continue to increase and the world has plenty of under-used land. Besides, with 40% of the US corn crop and 50% of the Brazilian cane crop going to ethanol production, extra calories could relatively easily be drawn back from fuel to food.

It was my task to speak about agricultural commodity merchandising and I highlighted the sector’s three structural challenges:

  • Trading margins have disappeared as markets have become transparent and information has become instant
  • The growth of algorithmic trading systems have made it more costly to hedge and harder for fundamental traders to predict future price moves
  • Agricultural merchandising companies are in danger of losing their social license to operate

I argued that at this point in the commodity cycle there is an oversupply of food, an over supply of freight and infrastructure, and an oversupply of agricultural merchandising companies. I explained that we are currently seeing consolidation all along the supply chain as some players merge and others exit.

We then discussed the way that market power has shifted along the supply chain from producers to food manufacturers (brands) to retailers to consumers. This shift presents a number of challenges in terms of brand vulnerability, but also some opportunities if you can identify a trend earlier enough.

One trend that we discussed was the way Californians are now adding butter to coffee. Who would have predicted a few years back that butter would make such a come back?

In their Investment Outlook for 2018, Credit Suisse identified ten priorities for the millennial generation. Number three on the list (after education and affordable housing) was what Credit Suisse called “sustainable consumables”. The bank defined them as, “consumables produced in a socially and environmentally responsible way, taking into consideration the entire supply chain of goods”.

Credit Suisse highlighted “Beyond animal agriculture” as a major component of this trend. It wrote,

According to the United Nations and the Food & Agriculture Organization (FAO), raising animals for food is the primary cause of species extinction, oceanic dead zones, Amazon deforestation, and antibiotic resistance. Moreover, it has a greater impact on climate change than the entire transport sector. Our modern system of animal agriculture is one of immense inefficiencies, externalities and vulnerabilities unable to sustain the predicted doubling of meat demand by 2050, according to FAO.

With such measurable risks, two parallel and disruptive technologies have emerged: plant-based food and cellular agriculture. Today, plant-based varieties of virtually all animal products such as meat, cheese, milk, eggs and fish are sold worldwide. Investment opportunities in the private sector are abundant, as business creation in the space is growing, brands are gaining importance and acquisitions by large consumer corporates are increasing.  

Credit Suisse continues,

To end all forms of malnutrition by 2030 was one of the challenges world leaders laid down when they adopted Sustainable Development Goals at the end of 2015. Nearly 800 million people worldwide remain chronically undernourished, and over 2 billion suffer from micronutrient deficiencies, also known as hidden hunger. Another 2 billion are overweight, with 600 million of these being obese. Meanwhile some 150 million children under 5 years of age are stunted, approximately 50 million children from this same age bracket are undernourished, while some 40 million children are obese. The UN initiated the Scaling Up Nutrition (SUN) movement, now counting 60 countries, bringing together governments, civil society, UN bodies, donors, business and scientists. 

Business can contribute and play a significant role in nutrition by addressing food and nutrition across the value chain, providing more affordable, accessible yet sustainable food solutions for many, and we are starting to see initiatives in this direction. Big food companies are already offering products containing important micro nutrients to help combat under-nutrition and deliver on the UN Sustainable Development Goals.

Credit Suisse listed blockchain at number six on its list of key millennial trends, and we are already glimpsing the impact that this technology could have on reducing both risks and costs in the supply chain.

Vertical farming (proximity agriculture) was at number seven on Credit Suisse’s list. The bank defines this as “redeveloping urban space to bring agriculture to cities, using techniques such as growing plants in vertically stacked layers, indoor farming or integrating agriculture into existing structure.”

Bringing this all together, it appears now that there is a clear and increasing convergence of interest between investors, consumers, social welfare and the environment. That’s what you get when you empower consumers!

These issues and others will be discussed at our Commodities Conversations event in London’s Natural History Museum on 6th June 2018. Places are limited so register here.

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Called out: civil society and agribusiness

 

Towards the end of last year I was having lunch with an old friend in the sugar business when the subject turned to NGOs – Non-Government Organisations – and NFPs – Not-For-Profits. He told me that his daughter worked for a leading international development agency as a specialist in island economies. She had under-spent her budget allocation for the year and her boss was afraid that they would lose it the following year. So he told her to spend it.

Taken aback by the short notice, all she could do was to organize a “fact-finding” mission where she and her colleagues flew out to an island in the Pacific for what was basically a vacation.

I thought of that this week when Oxfam, a leading UK charity, came under fire for alleged malpractice in at least three countries. The British right-wing press jumped on the story, arguing that the UK taxpayer money that helped fund the charity would have been better spent at home.

This media attention is unusual. NGOs (more widely known as “civil society”) are usually considered to be “untouchable”. As my friend had put it at lunch, civil society can criticize businesses and governments, but it is “politically-incorrect” to criticize civil society.

Back in 2013 Oxfam published a damning report—Sugar Rush—on land grabs and human rights abuses in the sugar sector. The report made the headlines at the time and added to prevailing anti-sugar-industry sentiment.

My sugar business friend had been particularly upset by the report. At the time I remembered that he had called it “unfair, ill informed and biased”.

I called him up, expecting him to be pleased that the tables had been turned, and that it was now Oxfam that was under the spotlight. I found him more upset than pleased. He told me that he had been a long-time donator to Oxfam, and he was angry that a small group of employees had so severely damaged the charity’s reputation. “They do great work”, he said. “They need public support to continue that work”.

I reminded him of the Sugar Rush report and his reaction to it. He brushed my comments aside, arguing that everyone needs to be “called out” when they do something wrong, and that “it is charities like Oxfam that keep businesses honest and governments on their toes. They do us a service, not a disservice.”

“So you shouldn’t be upset when Oxfam gets called out for doing something wrong,” I argued. “Someone needs to keep the charities honest,” I added. He reluctantly agreed, and then changed the subject.

After I had hung up, I thought over what he had said. Civil society does have an important—maybe essential—role in “naming and shaming” businesses and sectors that behave badly. Civil society draws bad behaviour to the attention of consumers, leading to consumer boycotts and lost revenues. Civil society acts as the local police force in the business environment, and NGOs are particularly active in the world of agriculture. No one enjoys being criticized, but criticism can and does lead to positive change.

I decided that Oxfam, as well as other charities, should respond positively and constructively to criticism, and to learn from it. And now that criticism of civil society is apparently no longer “politically incorrect”, NGOs will have to get used to it. They must follow the example of business, particularly agricultural business, and improve the way they run themselves.

But I wasn’t happy with that conclusion, so I called my friend back and reminded him again that he had called the Sugar Rush report “unfair, ill informed and biased”.

“Yes I did,” he admitted, “and looking back we should have engaged with Oxfam on it at the time. But I have moved on. I realise now that if the Sugar Rush report was ill informed it was mainly our fault. We should have done a better job at engaging with civil society and our stakeholders to explain what we do, how we do it, and the constraints under which we operate.”

“And are you doing that now?” I asked.

“Not nearly enough. We need to explain that markets are not perfect. No one is perfect, and our sector has to continue to improve what it does in terms of health, human rights and the environment.

“We know that, and we are now working in partnership with the bigger NGOs to make this change happen. Civil society is our ally in this, not our enemy. That’s why I am saddened by this week’s news stories about Oxfam. We need strong allies, not weak ones. And we need civil society to maintain their moral authority in order to promote change.”

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The wisdom of mergers

In his book, “The Wisdom of Finance: Discovering Humanity in the World of Risk and Return”, the Harvard Business School professor Mihir Desai compares company mergers with marriages. He writes that both are fraught with difficulties, and warns:

  • Due diligence is vital
  • Filling a hole in your organization is not a merger strategy
  • Racing against the clock leads to bad decision-making
  • Synergies are always overstated
  • The costs of integration are always understated
  • Asymmetric mergers are easy but of limited value, and mergers of equals are horribly difficult but potentially very rewarding
  • Serial acquirers are problematic
  • Ultimately, it’s all about culture, “doing the work”, and execution. As Thomas Edison once said, “Vision without execution is hallucination”.

This past week brought news reports that ADM’s projected acquisition of Bunge is progressing faster than expected, and that an announcement could be soon.

ADM has revenues of $62.3 billion and a market value of $23 billion; Bunge has revenues of $42.7 billion and market value of $11 billion. ADM is the most U.S.-focused of the major grain companies and a takeover of Bunge would help it grow in South America, where Bunge is the largest exporter in the agriculture market, posting revenues of 40 billion reais or almost $13 billion.

Bunge is not only a big agricultural exporter from South America; it is also a big producer in the region, most notably of sugar and ethanol. The company owns and operates eight sugarcane-crushing mills in Brazil with a combined capacity of over 20 million tonnes, making Bunge the third biggest producer after Raízen Energia, which is backed by  Cosan and Royal Dutch Shell, and Biosev, a subsidiary of Louis Dreyfus.

The FT once described the sugarcane mills as “a financial millstone for Bunge”, although the mills are now expected to report an annual operating profit of $75m .

In November 2017 Bunge announced that it was in the process of separating the finances of its sugarcane unit from the rest of the company as part of an effort to reduce its exposure to the operations, and was considering selling the unit in an IPO. An analyst at the time valued the unit at between $1 billion and $2 billion.

Also last week, soda-seller Dr Pepper Snapple Group and coffee maker Keurig Green Mountain (owned by serial acquirer Luxembourg-based JAB Holding Co) announced that they were joining forces to create a beverage company with $11 billion in annual revenue. The combined company will be called Keurig Dr Pepper, or KDP, and is targeting $600 million in synergies on an annualised basis by 2021. Keurig’s CEO said,

“Our view of the industry through the lens of consumer needs, versus traditional manufacturer-defined segments, unlocks the opportunity to combine hot and cold beverages and create a platform to increase exposure to high-growth formats. The combination of Dr Pepper Snapple and Keurig will create a new scale beverage company which addresses today’s consumer needs, with a powerful platform of consumer brands and an unparalleled distribution capability to reach virtually every consumer, everywhere.”

I have quoted that statement in full because it highlights the most important market shifts in recent decades: the transfer of power from the producer to the consumer. It also highlights the importance of distribution networks, getting products in front of consumers.

Both Keurig’s acquisition of Dr Pepper and ADM’s possible acquisition of Bunge have one thing in common: a heavy sugar component. Some analysts questioned whether Keurig’s move into soda was the right one given the trend away from sugar and sugar-containing sodas. Sales of soda drinks decreased about 1.2 percent in the United States in 2016, falling for the 12th year in a row.

One analyst wrote that from Dr Pepper’s perspective,  the merger “makes a lot of sense…they needed to diversify their business line from sugary drinks, so I think that this is a really good deal.” Bulking up is a way to boost efficiency in the business at a time when soft drink sales are falling as consumers cut down on sugar. “If your truck is becoming less full because volumes are declining, you should have other beverages to fill that spot,” he added.

Just last week a survey was published that found that most Americans now believe that sugar is more harmful to health than marijuana. The Wall Street Journal/NBC News survey found people rank cigarettes, alcohol, marijuana and sugar in that order in terms of harmfulness. A surprising 21% of respondents said that sugar was the most harmful of the four.

So what are Keurig and ADM doing buying into the sugar business? Is, as one analyst suggests, Keurig just buying empty space on Dr Pepper’s fleet of delivery trucks? And does ADM really want to buy Bunge’s sugar mills, or do they have no choice in that they are being thrown in as part of a take-it-or-leave-it package deal?

Or are both companies betting that the anti-sugar trend has over-extended itself and is about to correct? Although there is little evidence in the media to that effect, a recent study found that sugar taxes do little to reduce sugar consumption, and that even if they did the resulting reduced sugar consumption would have little meaningful impact on health.

At some stage or another, people will eventually realise that sugar is not the cause of the obesity epidemic, and that cutting sugar consumption is not the silver bullet that many people expect it to be.

As such, ADM and Keurig should probably worry less about the sugar components of their deals, and more about the other potential difficulties that Professor Desai warns about in his book.

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Ten challenges for agricultural commodity merchants

We all depend on the big agricultural commodity merchants for much of the food that we eat and the clothes that we wear. Merchants move vast quantities of food and fibre from producers to consumers, from surplus areas to deficit areas. Without merchants, crops would rot in the fields, farmers would go out of business, and people would go hungry.

However we cannot take it for granted that commodity merchants will be able to meet the challenges that lie ahead. The sector is under pressure from all sides and its future is far from assured. With world population expected to reach 9.7 billion in 2050, that is a major issue that needs addressing.

Some of you may argue that these pressures are temporary; that commodity merchandising is a cyclical business; and that we are just in one of the down cycles. And you will be partly right. World food stocks are at an all time record, resulting in higher storage costs, compressed margins and reduced price volatility—all bad news for merchants.

However most of the sector’s current problems are not cyclical but structural. The ten most challenging issues for agricultural commodity merchants are (probably) as follows:

  1. Both the spread and the speed of information have increased dramatically, leading to better and more quickly informed clients, reduced price differentials and lower or negative trading margins.
  2. There has been a shift of market power along the supply chain, initially from farmer to trader, then to distributor and retailer, and now to the end consumer. Social media in particular has empowered consumers at the expense of producers and traders.
  3. This shift in power has focused attention on where food comes from, and what damage it may have caused both environmentally and socially on its way.
  4. This focus on social and environmental sustainability has increased costs (e.g. certification) for producers and traders.
  5. It has also led to a shift from tradability to traceability. Being less able to trade origins reduces merchants’ flexibility and profits. It can also increase costs if products have to be kept separate. Traceability is turning many commodities into ingredients.
  6. A greater focus by consumers on their own health can result in difficult to predict—and fast moving—trends. Sugar and fruit juice are examples, as is the pushback against GMO products in the US.
  7. Empowered consumers result in increased government intervention, whether in areas of health and safety, or in trade relations. Consumer trends can quickly change direction, and governments are rarely far behind. This increases merchants’ risks and pushes up their compliance burden.
  8. Increased consumer empowerment has been accompanied by the media’s increased hostility to agricultural merchants. This media hostility has reduced merchants’ political leverage, and made it harder for them to hire talent.
  9. At the same time, advances in Artificial Intelligence mean that computers are now better than humans at trading futures markets. As a result, agricultural commodity merchants are less able to leverage the insight that they glean from merchandising physical commodities into trading futures markets.
  10. Global climate change may increasingly make both crops and trade flows less predictable, increasing the risk when investing in infrastructure such as warehouses and port terminals.

Many of the trends listed above are “good things”. Empowered consumers, supported by fast-moving and attentive governments, are leading to changes for the better in terms of environmental and social sustainability, and health.

Agricultural commodity merchants should not try to resist or reverse these trends, but embrace them. The sector knows that if it is to survive it has to adapt and evolve. But how?

One thing that the sector can—and must—do is to improve its public image. Physical commodity merchants, rather than being seen for the good that they do, are perceived as evil speculators, accused of pushing food prices higher, creating shortages and hunger.

As a sector, we have to explain to the world what we do, to show the public that we are under the same pressures and constraints—and have the same challenges—as everyone else. And we must also explain that we are not perfect, that there is still progress to be made—and that we are trying to make that progress.

The first objective of our seminar in London in June therefore will be to discuss how we can adapt and evolve to survive: hence the choice of London’s Natural History Museum as the location for the meeting.

The second objective of our seminar in London will be to show the world that agricultural commodity merchants are human beings like everyone else. We have families; we live in communities; and we care deeply about our planet and the wellbeing of its inhabitants.

Charles Darwin once wrote, “In the long history of humankind, those who learned to collaborate and improvise most effectively have prevailed”.

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Commodity Consolidation

Last week it was reported that ADM has approached its rival Bunge about a potential takeover, eight months after Glencore proposed doing the same thing. Last summer Bunge’s CEO suggested that his company might be worth more as part of a larger organisation. Bunge, according to the FT, « has no poison pill or bylaws that would allow it to fend off an unsolicited approach, making it vulnerable to a hostile takeover ».

It is unclear how Bunge, with a market capitalisation of about $11bn compared to ADM’s $23bn, reacted to the ADM’s approach. It is also unclear how the deal might fare under US antitrust laws; the combined entity may to have to divest significant assets, especially in the US and Canada.

Meanwhile some analysts predicted that Glencore would enter into a bidding war for Bunge; others suggested that Glencore would sit back and pick up the assets that ADM might have to divest, particularly its North American grain silos and processing plants.

The offer for Bunge goes against ADM’s (apparent) strategy of diversifying away from low-margin and volatile commodities into higher-margin and more stable ingredients. In 2014, ADM bought natural the ingredient company Wild Flavors for about $3 billion, and has since also expanded into other « healthy » ingredients such as fruits and nuts.

Last week also saw Ferrero announcing a $2.8bn cash deal to buy Nestlé’s US confectionary brands, and so become the world’s third-largest seller of confectionery, behind Mars and Hershey. The FT suggested that the privately owned Ferrero was well placed to pay a premium to expand its confectionary footprint in the US at a time when publicly owned companies are under pressure over concerns about obesity.

However, some analysts warned that Ferrero would face a challenge in managing the move from a company with a small and carefully chosen premium portfolio of products to a multi-brand conglomerate more like Unilever or Nestlé.

Amazon’s $13.7 billion acquisition of Whole Foods last June was also in the news last week. The conventional wisdom at the time of the acquisition was that Amazon would slash prices, expand delivery services and pressure margins across the industry. So far at least, that hasn’t happened, for three reasons.

First, even with Whole Foods, Amazon’s annual grocery sales are tiny compared to industry giants like Walmart and Costco—with roughly 2% share of the U.S. grocery market. It is tough to transform a market with so small a market share.

Second, the deal was forged out of weakness rather than strength; both Whole Foods and Amazon Fresh were struggling before the acquisition.

Third, as an online retailer, Amazon lacks expertise in brick-and-mortar operations; it doesn’t have a model that it can stamp on to Whole Foods. As such, there seem few synergies between the two companies.

However, Amazon is known for playing a long game, and they may have technological disruption on their side. This week the company opened their first “Checkout-free” Amazon Go grocery store in Seattle. The store uses cameras and electronic sensors to identify customers and track the items they select. Purchases are billed to customers’ credit cards when they leave the store. As yet the company has no plans to introduce the technology to its Whole Foods stores.

But technological disruption is not just occurring at the retail end of the food supply chain. This week Dreyfus reported that they had teamed up with their banks to do their first agricultural commodity trade using blockchain technology–a cargo of US soybeans to China. Dreyfus said that document processing on the transaction was reduced to a fifth of the time it would normally take, and that the process reduced the risk of fraud and human error.

As such, the two (maybe three) mergers mentioned above are occurring at a time of rapid technological change–a time when the whole supply chain is being disrupted.

But what else do they have in common, and what lessons can be learned from them?

Mergers are tough to implement and quite often end up destroying value, as well as diverting management time from internal growth. Mergers are even tougher in struggling sectors: two struggling companies do not make a strong one. In addition, it is not necessarily a good idea to go into a merger from a position of weakness. Lastly, just because a company is successful at running one business, it doesn’t mean that it can be just as successful in another, even adjacent, business.

On the positive side it has become clear that companies are better at managing some businesses than others. Confectionary companies are, for example, better at managing brands than they are at managing commodity sourcing and processing. At the same time, too diverse a portfolio of businesses can put strains on management processes.

This could be particularly the case if ADM, an increasingly ingredients-focused company, expands its footprint further into traditional commodity merchandising.

One obvious solution would be for ADM to take Bunge’s more value-added downstream businesses, while Glencore would buy the commodity merchandising businesses.

It will be interesting to see how this one develops.

 

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The Hidden Life of Trees

Over the holiday period I read The Hidden Life of Trees: What They Feel, How They Communicate―Discoveries from a Secret World. The author, Peter Wohlleben, a forester from Germany, has become an unlikely media star and his book has become a bestseller, and not just among tree-huggers.

Mr Wohllben draws on recent research to argue that trees not only communicate with each other, they also feel pain and help each other out. He writes,

“Beeches, spruce, and oaks all register pain as soon as some creature starts nibbling on them. When a caterpiller takes a hearty bite out of a leaf, the tissue around the site of the damage changes. In addition, the leaf signal sends out electric signals, just as human tissue does when it is hurt.”

When a giraffe starts eating an African acacia tree, the tree releases a chemical into the air that prompts neighbouring trees to pump a toxic chemical into their leaves to make them unpalatable for the giraffes. When attacked by pests, some trees release a chemical that attracts predators that feed on the pest that is attacking the tree.

In a forest the trees communicate with each other through a “wood-wide-web” of soil fungi through which they can also send sugars that can help sustain sick relatives. One such fungus, in Switzerland, covers almost 120 acres of forest and is an estimated at about one thousand years old.

“Another in Oregon is estimated to be 2,400 years old, extends for 2,000 acres, and weighs 660 tons. That makes fungi the largest known living organisms in the world.”

 In a note at the end of the book, forest scientist Dr Suzanne Simard describes how douglas firs can live in synergy with neighbouring birch trees,

“We discovered that the exchange between the two species was dynamic: each took different turns as “mother”, depending on the season…mother trees recognize and talk with their kin, shaping future generations…These discoveries have transformed our understanding of trees from competitive crusaders of the self to members of a connected, related, communicating system.”

But what about agricultural crops, plants grown for food or fibres? Peter Wohlleben writes,

“Thanks to selective breeding, our cultivated plants have, for the most part, lost their ability to communicate above or below ground. Isolated by their silence, they are easy prey for insect pests. That is one reason why modern agriculture uses so many pesticides. Perhaps farmers can learn from the forests and breed a little more wilderness back into their grain and potatoes so that they’ll be more talkative in the future.”

 And in the preface to the English edition, Tim Flannery writes,

“Perhaps the saddest plants of all are those we have enslaved in our agricultural systems…They have lost their ability to communicate and are isolated by their silence.”

All this creates something of a problem. Anyone who watched the wonderful BBC series Blue Planet II last year will know that fish and (particularly) octopus are way more intelligent than we had thought—and way more social. We all knew that that sea mammals were social, but it was a shock to think that other sea animals, including shellfish, can have emotions and feel pain.

Consumers and legislators are already reacting. For example, the Swiss government recently banned boiling live lobsters, arguing that they really do feel pain. Lobsters now have to be “humanely” killed before being cooked.

I know some previously fishing-eating vegetarians who have now given up eating fish—or at least feel guilty when they eat it—after watching Blue Planet II. I am afraid to recommend that they now read The Hidden Life of Trees.

Join the commodity conversation at our seminar in London in June. 

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Discovering humanity in the world of trading

I am currently reading The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, by Harvard Business School Professor Mihir A. Desai. As a rule I tend to steer clear of books written by teachers at business schools. I find that they are often too academic, and rarely hold up in the real world of business. This book, however, is an exception. It tries, and succeeds, in explaining finance to a wider public, and it does this by bringing in examples from the world of literature and art.

The book also tries to de-demonize the world of finance and its inhabitants. Traders generally have a bad reputation, no more so than financial traders, particularly in banks and hedge funds. Dr Desai tries to explain that financial traders do actually play a valuable role in efficiently allocating resources, and do contribute to general global welfare.

De-demonizing agricultural commodity trading was part of the reason why I wrote my latest book, “Commodity Conversations”. My goal was to explain to a wider audience what agricultural commodity traders actually do, and how markets work. I wanted to show that agricultural commodity traders are not the evil geniuses that the media often make them out to be, and that they do contribute to global welfare by moving food from where it is not needed to where it is needed. Without agricultural traders, your food would not arrive on your plate.

Although Dr Desai demonstrates that financial traders do add value to global welfare, he just as clearly demonstrates how the financial system can be corrupted. He explains this in terms of the relations between agents and clients. Does a CEO always work in the best interests of his stakeholders (shareholders, clients, employees, suppliers, and the environment), or does he sometimes work in his own interest, boosting short-term profits in order, say, to meet bonus-earning targets?

This problem of misaligned incentives is not something that I covered in my book, but in retrospect I probably should have. If you want to convince a wider public of the merits of a system, you need also to explain that system’s weaknesses and flaws. Finance as it is currently practiced does have flaws, as too does agricultural commodity trading. Incentives do not always lead to the best outcomes.

But this does not mean that we—to use an old English expression—should throw the baby out with the bathwater. If a system sometimes fails, we shouldn’t necessarily discard the whole system. Instead we should all work to structure incentives to create the best outcomes, in terms of market efficiency, as well as of social and environmental welfare. Market regulators are doing a good job at the former, while a mix of consumer awareness and civil society is making progress with the latter.

No hard how anyone tries, however, the world of agricultural commodity trading will never be perfect. There will always be inefficiencies, badly targeted incentives and a preference for personal wellbeing over general wellbeing.

Many sectors try to compensate for the bad that they do in the course of their business by doing good somewhere else. A coal-burning power plant may be the only source of electricity in a remote region of China, but it can offset the pollution it emits by investing in renewable energy somewhere else. That is what carbon credits do.

Some notable businessmen, such as Bill Gates, give back to the community once they retire. But as companies never retire, what can a company, or a sector, do to give back to the community?

A friend recently drew my attention to a public education initiative by the UK’s private equity sector. Although private equity companies do add value in ensuring that assets are allocated efficiently, the general public views them as evil asset strippers who fire workers and close factories.

But what could agricultural traders do to compensate for the occasional harm that they may do, while at the same time improve their public image? One way would be for them to help the poorer sections of their supply chains to reduce crop waste. This could be done, for example, by giving subsidised financing or grants for warehouses, packaging or refrigeration plants close to farms.

Although any individual project might not in itself be economically feasible—or it might be too risky for an individual company alone, it could result in net gains for the sector as a whole.

So maybe what agricultural trading needs is a foundation similar to one set up by the UK’s private equity sector, but with the goal of improving efficiency and reducing waste along the whole supply chain.

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The value of sustainability standards

In 2015, ISEAL Alliance conducted a survey of over 100 business leaders as to how they perceived the benefits of environmental and social sustainability certification to their businesses.

In terms of the business value of certification, the interviewees referred most frequently to the final benefits of improved reputation (60%), improved profitability (53%), cost reduction (30%), growth in production (30%), and improved supply security (23%)

The survey found that certified businesses found value in:

  • Improved working conditions with positive impacts on worker’s health and livelihood, as well as attention to sustainability in the supply chain
  • Reduced conflicts with local communities
  • Improved performance of (small-scale) producers and improved short and long-term supply security
  • Enhanced sustainable forest and fishery management which contributes to the preservation of the resource and thus long-term supply security.

However, last month Andre de Freitas, the executive director of the Sustainable Agriculture Network (SAN) wrote that it is time to recognize that certification has its limits in agriculture.

Earlier this year his organisation came to the conclusion that although they have seen many positive impacts from certification for workers, producers and the environment, it was not the best way to improve the sustainability of most farmers in the world. SAN took the decision to stop working with certification in agriculture.

Mr de Freitas argues that certification has four main interrelated limitations:

  1. Certification standards are complex. This means that the gap between producers’ reality and what is required by certification is often too wide. Most farmers in the world lack the technical and financial resources to be able to bridge this gap.
  2. Certification can be costly. This pushes certification to higher-end products and developed country markets, which usually can better absorb the increase in the price of raw materials. The author cites coffee as an example: certification can be feasible for the more niche premium products, but not be attractive for the higher volume used in price-sensitive categories. Another example is rice, a staple food in much of the developing world, where certification is virtually nonexistent.
  3. The high complexity and cost hinder the ability to scale up and go beyond low double digits in terms of penetration in a given sector. This is a typical low-hanging fruit situation, where, after an initial period of fast growth, every subsequent increase in uptake becomes more difficult than the previous one.
  4. SAN found that in their experience certification had been shown to have limited effectiveness to deal with some of the more intractable problems in agriculture, such as child labour, poverty, sexual harassment, sanitation, and others.

The author argues that these limitations mean that certification will work for farms that are already reasonably well-managed, have access to resources, have markets that are able to better value their products, and encounter fairly well-functioning local governance structures. He adds that these conditions are very specific and are not the reality most farmers in the world live in.

How we can reconcile these two opposing views was one of the main topics of debate at last week’s Sustainable Sugarcane Forum in London.

One of the biggest challenges highlighted at the event was in getting consumers to pay a premium for certified products.  If consumers refuse to pay a premium, producers have no choice but to recover the cost of certification through the productivity and reputational gains that ISEAL listed in their report. If producers can’t recover their certification costs, then they actually end up worse off financially.

One of the presenters at the event presented a possible solution to this conundrum: an actively traded credits market where industrial food manufacturers, in their efforts to reach their 2020 sustainability goals, buy credits rather than sugar. Credits already provide some limited extra income to producers and this is likely to expand significantly over the next few years.

Having said all that, Bonsucro’s increasing number of certified mills and our expanding membership suggest that stakeholders do find value in certification. There appears to be a real momentum building.

Not only that, but  in discussions with stakeholders at the event, and at other times over the past year,  both producers and consumers have highlighted to me many of the benefits that the 2015 ISEAL survey also highlighted. Of course producers would consumers like to pay a premium for certified product, but even without one, certification is worth it.

But what about SAN’s other criticisms? Many are valid, but you need to remember that voluntary sustainability standards are just one of the tools in the development toolbox. They cannot do everything. They are not the silver bullet that will kill the vampire twins of human rights abuse and environmental degradation. But they do help to keep the monsters at bay.