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As I wrote in a recent post, Stalin believed that the political and economic future of the Soviet Union lay in industrialisation. He set high prices for industrially produced goods and low prices for agriculturally produced goods in order to encourage a shift from agriculture to industry. He reasoned that surplus workers in the countryside would be better employed in industry, and that a policy of cheap food would drive economic growth.

This view has not disappeared. Within the developed world, most governments keep food prices low (to placate urbanites) while quietly transferring money back to rural areas through tax-funded subsidies. And in the developing world, many classical economists still believe that industry, and not agriculture, drives economic growth.

The data, at first sight, appears to support that view. The chart below shows how workers moved from farms to factories as the industrial revolution gathered speed in 19^th century Europe.

While this chart, again from ourworldindata.org, shows that the richer the country becomes the smaller the percentage of the workforce employed in agriculture.

This third chart shows how agricultural productivity increases as countries get richer. This could be because a shortage of labour in rural areas leaves farmers no choice but to improve productivity. It could also be because farmers get better access to information, finance and technology as their country develops.

The conclusion is therefore clear. Stalin was right: a country develops when farmers migrate from field to factory. This migration leads not only to GDP growth in the cities but also to greater productivity on the farms. Everyone gains.

As a result, development economists and politicians give this process a nudge through low food prices, forcing productivity gains in the countryside while subsidising workers’ wages in the cities. (This is known as ‘urban bias’.)

However, there may be some confusion here between causation and correlation. Forcing displaced rural workers into the cities does not guarantee that industrial activity will pick up. The industrial revolution in the UK ‘pulled’ workers into the cities; displaced rural workers did not ‘push’ industrialisation. People are ‘pulled’ from farms to factories once factories offer them better wages and a better future for their families. Pushing workers from their fields may lead to an increase in poor urban dwellers – and hence a fall in urban wages – but it does not directly ensure economic growth.

In a closing address to last years FT Global Foods System Conference, Pavan Sukhdev, President of WWF International, argued that the number of people employed in agriculture in developing countries is simply too large to be absorbed by industrialisation within any reasonable timeframe. He argues for a different approach, one driven by economic growth in the countryside fuelled by sustainable agriculture. He cites the Indian state of Andhra Pradesh in India as an example, where six million farmers practise what is called ‘zero-budget’ farming.

So why then do governments continue a policy of keeping food prices low? It seems redundant in developed countries where the shift in population from farms to factories has already occurred. Meanwhile in developing countries it can drive people from their farms without helping the country’s economic growth.

The answer can possibly be found in the way that governments quietly transfer money back to farmers through subsidies. City dwellers pay partly for their food through taxes.  Governments do this because urban voters are better organised than rural ones, and there are more of them. Cheap food buys votes in democracies.

Cheap food also helps keep leaders in power in less democratic countries. Consumers protest – and riot – when food prices are increased. The Arab Spring may have started in Tunisia, but it was food price protests in Algeria that gave it momentum.

So everyone wins with cheap food. The farmers are happy; they get paid partly through the sale of their produce and partly through tax transfers. Consumers are happy: they get cheap food in the shops, blissfully unaware that they are actually paying for it through their taxes.  Governments are happy, because they stay in power.

The problem is that not everyone wins. But more on that in future posts.

© Commodity Conversations ®

“We stand now where two roads diverge… The road we have long been travelling is deceptively easy, a smooth super-highway on which we progress with great speed, but at its end lies disaster. The other fork of the road – the one ‘less travelled by’ – offers our last, our only chance to reach a destination that assures the preservation of our earth.”

Thus wrote Rachel Carson in her best selling book ‘Silent Spring’, published back in 1962. ‘Silent Spring’ is largely credited as the catalyst that began the environmental movement and (eventually) the formation of the US Environmental Protection Agency.

In the book, Ms Carson writes about the widespread use of chemical pesticides and the negative effects they can have on biodiversity. In particular she highlights how aerial spraying of DDT led to a collapse of local bird populations – hence the book title.

Although dated, the book has some useful lessons for us all. The first, and most obvious, is that if you are a hammer everything looks like a nail. Chemical pesticides largely came out of research during World War Two into chemical warfare. Once the war ended, scientists used the knowledge that they had acquired to use chemicals to kill insect pests rather than humans.

In this sense, chemical pesticides have a similar history to nitrogen fertilizers. As Michael Pollan writes in The Omnivore’s Dilemma, the US government found itself at the end of World War II with a surplus of ammonium nitrate, the principal ingredient in making explosives. Ammonium nitrate is an excellent source of nitrogen for plants, and the chemical fertilizer industry was the product of the government’s effort to convert its war machine to peacetime purposes.

In her book, Ms Carson writes of a USDA programme in 1958 to exterminate the fire ant, an insect that has a sting similar to that of a bee or a wasp. A million acres were sprayed in Florida and Louisiana with dieldrin and heptachlor, two relatively new chemicals many times more toxic than DDT. The results on wildlife, particularly birds, as well as on livestock, mainly pigs and chickens, were catastrophic. The poisons also accumulated in cow’s milk.

Spraying continued for the following two years but without any meaningful impact on the fire ant population. It appears that the pesticide only killed off the weaker fire ants but left the stronger ones alive to adapt and develop an immunity to the poisons. Ms Carlson likens it to human-induced Darwinism.

So that is the second lesson from the book: because nature constantly adapts, pesticides become increasingly ineffective. You either have to apply them in greater concentration or constantly develop new ones.

The third lesson is that everything in nature is related: try to solve one problem and you may create a worse one. As the author writes, ‘nothing in nature exists alone’. She gives the example of the US Forest Service’s use of DDT for combating the spruce budworm in 1956. The pesticide was successful in eliminating the spruce budworm but also killed off the natural predators of the spider mite, whose population then exploded to become an even worse problem.

Finally, Ms Carlson makes the point that, once they have been applied, these pesticides do not disappear, but build up in dangerous quantities in the soil, in earthworms, in the fish in the adjoining rivers and lakes, and in livestock. They then work their way along the food chain in surprising and dangerous concentrations. The spring was silent in 1962 because the birds had died after eating earthworms poisoned with DDT.

The world is a different place now than it was when Ms Carlson wrote her book 58 years ago. However, as the current ruckus surrounding glyphosate shows, the issues remain. The general public, including jurors, do not trust scientists. They believe that they are either in the pay of big chemical companies, or that they do not have sufficient data over a long enough period of time to evaluate a product’s safety. This distrust began with Silent Spring.

© Commodity Conversations ®

Our local grocery store owner has begun to put a label on each of the fresh products that she sells to show its ‘food miles’: the distance that each product has travelled between the farm and the shop.

Although popular, it is debatable whether buying locally produced food actually helps the environment.  As can be seen from this chart published last week by Our World in Data, transport (in red on each bar) only accounts for a small part of the total GHG emissions in the food supply chain. If you want to help the environment, what you eat is far more important than the distance it has travelled.

For example, a Defra study in the UK estimated the CO2 emissions of tomatoes produced in Spain and shipped to the UK at 630 kg per tonne compared with 2,394 kg per tonne for tomatoes produced in the UK. Tomatoes in Spain are grown unheated under plastic while tomatoes in the UK are usually grown in heated greenhouses.

A later study found that New Zealand lamb imported into the UK had a smaller environmental footprint than home produced lamb.

DEFRA has also looked at the road transport part of the food supply chain in the UK. They found that half of the vehicle kilometres, when measured in terms of the amount transported per kilometres, were driving the commodity from the store to the home. In other words, the best way to reduce your food miles is to walk, cycle or take the bus to the supermarket to do your shopping—and leave the car at home.

But what about bulk commodities? We as traders are often criticised for moving huge tonnages of grain (or sugar in my case) over vast distances. Surely it would be more environmentally friendly to grow the crops locally?

As most bulk commodities are transported by ship, the GHG emissions are really quite insignificant. Global shipping accounts for around 2 percent of total GHG emissions, but that includes minerals as well as finished industrial products such as cars and machinery. The total world trade in iron ore is about 1.4 billion tonnes compared to wheat, for example, at around 100 million tonnes.

A study for Canada, a major sugar importer, found that sugar accounted for about 13 percent of the country’s total food imports by weight and about 21 percent of the tonnes per kilometre (because it mainly comes from Central and South America). However, because it is shipped to Canada in big cargo vessels and transported internally by rail, sugar only accounted for 2 percent of the country’s farm to store CO2 emissions.

The concept of shopping locally and counting food miles to help the environment has therefore been largely discredited. So why then has our local shop made the move to label each of their products with the kilometres it has travelled?

I asked the owner that question and she told me that consumers want to do something positive for the environment, and they believe that shopping local does help. More importantly, she added, her customers like to feel that they are supporting local farming communities.

“Shouldn’t we also be supporting farming communities in the developing world?” I asked her. She shrugged and moved on to the next customer.

In frustration I walked down the street to the local MIGROS supermarket where I found that the vegetables and fruit pre-packaged in plastic were cheaper by the kilo than the vegetables and fruit that were displayed in bulk. Packing vegetables in plastic reduces food waste because they are handled less. This waste has an economic and environmental cost that is greater than the plastic packaging.

Perhaps we shouldn’t ditch the cling film after all!

© Commodity Conversations ®

This week, in an interview with Bloomberg, Sunny Verghese, the CEO and co-founder of Olam International, announced that his company would be splitting into two parts. The first, Olam Food Ingredients, will be made up of cocoa, coffee, edible nuts, spices and dairy. The second, Olam Global Agri, will contain the traditional commodity businesses of grains, animal feeds, protein, edible oils, rice, cotton, and commodity financial services.

Each new entity will seek to take advantage of two distinct trends. The first is the growing desire among wealthy consumers for healthy, sustainable and traceable products. (Milk farmers will be pleased to read that dairy products are included in this category.) The second trend is the dietary shift in developing countries, particularly in Asia and Africa, away from carbohydrates towards meat and fats.

In other words, the company is to be split between bulk food, feed and fibre for developing countries, and traceable, sustainable food ingredients for developed countries.

As I wrote in my recent book, traditional commodity trading companies have been struggling in recent years to reconcile these two trends: the need for traceability versus the desire for tradability.

With the exception of Glencore, the ABCD+ group of trading companies has chosen to build an active presence all along the supply chain. This has a number of advantages. It means that the companies trade more with themselves, increasing traceability while lowering counterparty risk. Moving downstream can increase profitability with less emphasis on low-value commodity businesses and more on higher value consumer businesses. Being present in the whole supply chain can also help to even out earnings. Steady profits from downstream businesses can dampen the earnings volatility of traditional commodity businesses.

A presence along the entire supply chain can also provide trading opportunities. As Brian Zachman told me, Bunge has an ‘end-to-end presence in the supply chain; that’s an inherently strong position, which is not easy to replicate. From the standpoint of risk management, our network also provides us with a lot of proprietary information that helps us optimize our value chains. In a way, our asset base is a call option on volatility in the supply chain.’

Finally, maintaining a strong commodity-trading base does not stop you growing your higher value ingredient businesses. ADM has invested massively in food ingredients, particularly flavours, over the past few years. As Greg Morris told me in his interview for the book, ADM views these investments ‘as expanding the value chain of our processing streams to create additional value for our customers. It allows us to create a stronger connection with our customer base, participate in faster growing markets and create a more stable business.’

In other words, being closer to the customer, and listening to what the customer wants, helps ADM in all their businesses.

However, Olam is not drawing a dividing line in the supply chain between upstream and downstream businesses. They are separating off the unglamorous, low-growth and cyclical commodity trading businesses from the sexy high growth food ingredients businesses. To achieve that, they are splitting the company between different commodities, not splitting it between two different parts of the supply chain.

Unfortunately, the distinction is not always a clear one. People in rich countries also need food, feed and fibre. People in developing countries also care (enormously) about food safety, and hence traceability. Coffee and cocoa can be just as cyclical as soybeans or wheat.

In addition, there is something to be said for being in a range of different commodities. Corn, say, can have a bad year while cocoa has a good one. This, in theory at least, helps even out earnings.

Olam is splitting with the aim of increasing their market capitalisation. The company argues that it will ‘unlock(s) significant long-term value’. Some investors, they believe, like the growth potential of the foodstuffs business but don’t like the cyclicality of the bulk commodity business. Other investors like the (sometimes outsized) profits that commodity trading can bring during the up cycles, and they are long-term enough to sit out the down cycles.

Even so, investors in public companies usually look for steady growth. Because of the cyclical and low growth nature of our business (Wilmar excepted), commodity-trading companies tend to have lower PE ratios than, say, food ingredient or food processing companies. In addition, investors tend to view commodity trading as not only cyclical, but also high risk.

Being in traditional commodity trading tends to act as a weight, a drag, on a company’s share price. That’s why some argue that traditional commodity-trading companies are better off as privately held, rather than publicly held, companies. But as Glencore Agriculture shows, being private doesn’t mean not having outside investors.

Both Olam and Noble went public during the commodity super-cycle. As the market cooled Noble got into financial trouble and Olam effectively took the company private, finding a white knight in Tamesek (the Singapore Sovereign, Wealth Fund) and later Mitsubishi. Splitting Olam into two may provide both an opportunity to exit.

Of the two new entities, Olam Global Agri may be the harder sell. Rather than being IPO’d, one source suggested that it could end up privately held with a couple of strategic investors; Tamesek and Mitsubishi may remain on board.

Having said that, it will take a couple of years before the reorganisation is completed. It is not impossible that by then commodities will once again be booming (sugar appears to have already turned). Perhaps Olam will once again get their timing right.

© Commodity Conversations ® 2020