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Part One of a Conversation with Howard Jay O’Neil

I spoke with Jay by phone from his home in Southern Oregon. He has recently taken semi-retirement from the faculty at Kansas State University, where he managed the commercial operations of the International Grains Program; he now operates his own private consulting business. When I spoke with him, Jay had recently returned from speaking at a buyers’ conference in Thailand organized by the USSEC, the US soybean export council. Prior to that he was doing similar workshops in Central America for the US Grains Council.

Jay told me that he started in the business in January 1973 straight out of college. “I joined Continental Grain in Orinda California,” he continued. “It was right at the beginning of what was later described as “The Great Russian Grain Robbery,” and I was right in the middle of it.

“I stayed with Conti until May 1977, when I was hired by Pillsbury to work as a grain merchandiser in the export grain organization they had at that time.

I worked in Omaha, Nebraska for one year, moved briefly to St Louis Missouri, their regional office for export trading, and then to their Minneapolis headquarters. I stayed with Pillsbury until 1984, when they sold their grain origination business to Cargill. Pillsbury had quite a sizeable operation at the time with over 90 domestic facilities.

“When the Soviets came in for grain in the 1970s, the US just didn’t have the transportation logistics to handle the volumes that they wanted to buy. The US agricultural industry was not ready or equipped for that much demand. There simply weren’t enough rail cars, barges, or export facility capacity to handle the volumes.

“By the early to mid-eighties the U.S. had built the export capacity needed to meet what we expected to be long-lasting Soviet grain demand. But then the Russian demand slowed down. They didn’t have enough money to continue buying the volumes that they had been buying.

“The industry found itself in a horrendous position with an over capacity of transport equipment and export capacity.  People were driving around the US looking for empty rail sidetracks where they could store their surplus railcars. We were using old military sites, unused industrial sites, anywhere we could find to store them.  We parked our empty railcars in the expectation that we would need them one day. But it would be many years, and hundreds of millions of dollars in industry losses, before the excess rail and barge capacity would diminish and balance out with cargo demand.

“I remember one particular meeting at Pillsbury in Minneapolis where the management group turned to the Vice President of our barge division, and told him to send out teams to look for trees along the Mississippi and its tributaries that were big enough to tie off barges to let them sit.

“Everyone was shouldering excess transportation assets, as well as export assets, and everyone was hemorrhaging red ink. In the mid-eighties the grain division in Pillsbury lost more than $200 million in a single year; that was a huge sum at the time. I imagine that many of our competitors were in the same position. We were only a medium sized grain company: the bigger companies must have lost even more. Every single company in the grain business at that time was losing money.

“The management group at Pillsbury did a study to answer the question, “When will the surplus railcars and barges rust away to the point where they go to scrap, or when will demand pick up enough to use those cars?” The answer the group came up with was sometime around 1999/2000! It was a surprisingly  good projection. The excess capacity situation continued through the 1990s as well, although of course to a lesser extent than in the 1980s. But boy, were the 1980s bad! We all suffered! We had all over-expanded!

“When Pillsbury sold their grain merchandising operations in 1984 I joined Ferruzzi down in New Orleans, managing their feed grain export business in Myrtle Grove Louisiana.

“We are all dependent on the market in this business. You can’t dictate what sort of profit margin you can obtain. You can only extract whatever profit margins the market will allow, and back then it wasn’t allowing any. During my time at Ferruzzi, many of the vessels we were loading had negative fobbing margins. The entire industry was in a down cycle and incurred negative profitability—negative fobbing margins. We were paying more for the barges and the railcars than we were getting back from many of the ships we were exporting.

“We closed our facility for two months in an attempt to stop the losses, but the fixed costs of maintaining the facility were higher than we expected. We found that it was better to continue throughput loading, and have at least some revenue coming through to cover some of our variable costs.

“That rule still applies today; it is better to keep facilities running, even at low throughput margins, than to close them. It is better to try to extract some revenue to, at least, cover something against variable expenses, than to have no revenue and still have to pay your full overhead costs. So we opened the elevator again, but things didn’t really get better.

I left Ferruzzi in 1986 and took  a job with Bartlett Grain Co in Kansas City Missouri, where I managed their cross-country grain trading group and export grain operations for 17 years.”

I asked Jay if the Carter grain embargo in January 1980 had made the situation worse.

“The US has had two grain embargoes,” he explained. “ One was under the Nixon administration, the other under Jimmy Carter. They were effectively soybean export embargoes. Both were very detrimental to the US grain industry. The Nixon and Carter embargoes motivated the Japanese to go to South America and invest capital in the development of the South American soybean industry.”

“Wouldn’t that have happened anyway?” I asked.

“It would have,” Jay replied, “but not as quickly, or on such scale. We created our own competition by imposing those two embargoes.

“Is history repeating itself now?” I asked.

“I have no doubts that history is repeating itself with the current trade war with China. We are once again helping to create our own competition. China has been put in a very difficult situation in terms of grain, both politically and economically. The Chinese are almost certainly saying to themselves that they can no longer depend on the US as a reliable supplier, and they will certainly try and diversify their buying options. China is already investing in South America, Sub-Saharan Africa, in Russia and the Black Sea looking to encourage soybean production outside of the US.

“We are once again creating our own competition and that won’t be reversible. We will see grain production increase around the world, and that will make it more difficult for US grain farmers for next ten or twenty years, and beyond.”

“But to what extent can China find alternative sources of supply of beans?” I asked. “I know that the Black Sea region, particularly Ukraine, has expanded corn production,” I continued, “but is corn a substitute for soy?”

“No they are not interchangeable. Animal feed has a percentage of starch, usually from corn, but you also need protein, and that comes from the soya meal.

“China has a substantial soybean crushing industry that has to be fed by imports. The country only produces 2-3 million tonnes of beans each year, pretty much all of which goes to direct human consumption. They must import the vast majority of their oil seed needs every year.

 “You can grow corn in a lot of places, but it is a  bit more difficult to grow soybeans. Then again, you have the seed technology companies that are coming up with better, shorter-season soybean varieties that can do well in colder climates such as Canada and Eastern Russia, areas that have previously not previously been able to grow soybeans.

“No one is predicting that these new areas will ever be major oilseed exporters. They will sell a few million tonnes here and there, but nowhere near the 85 plus million tonnes that China needs each year. China will have to depend on South America and the US, but with a growing percentage of that coming from South America.”

“After you left Ferruzzi they tried to squeeze the soybean futures market in Chicago. They failed, and the company went out of business. Is there is a danger that history repeats itself in that sense as well?”

“Unfortunately, squeezed margins may have prompted some trading companies to try and replace that lost income by taking bigger risks in the futures markets or on the flat price. This has rarely  worked.

“I have been in the business for 45 years and I have seen some great companies, Continental Grain, Cook Industries, and André either go bankrupt or exit the grain business. The ones that went out of business did so because someone speculated, took overly big risks, didn’t hedge. André got out of the business after big losses in their soybean department. Cook Industries went bankrupt because of bad positions on crush spreads in soybeans. Even Conti’s sale to Cargill followed losses in the Russian bond market.  It was always something foolish.”

© Commodity Conversations ®

Isis Almeida is a senior reporter covering agricultural commodities for Bloomberg in Chicago, writing about everything from cocoa to sugar, wheat to soybeans, and animal protein markets. In her current role, she covers markets globally and also follows some of the top companies in the industry. Isis joined Bloomberg in 2011 as a soft-commodities reporter in London.

She has also covered European power and gas markets and global LNG. Prior to Bloomberg, she covered biofuels for S&P Global Platts and was also a copy editor for Dow Jones Newswires. A native of Brazil, Isis has lived in The Netherlands, Denmark, Sweden, France and the U.K. before moving to the U.S.

Hello Isis, thank you for participating in our “Women in Commodities” series. Tell me, does being a woman make your job harder?

I think being a woman has advantages and disadvantages, and that’s no different for men. Women are in many cases better listeners and better at gauging personalities. That can make building trust quicker and easier.

I understand that Bloomberg has a programme, New Voices, to expand female sources. Can you tell me a little about that?

Yes, the New Voices programme is aimed at increasing our representation of female sources and other diverse experts across our platforms. Journalists track stories that cite or quote a woman expert. We also have a global database of women experts that includes more than 2,300 names now.

What is Bloomberg doing specifically to promote gender equality in the workplace and among sources?

In order to help increase the number of women interviewed across platforms, Bloomberg began funding a media training program for women executives in business and finance.

The company is also committed to promoting gender and diversity efforts on several fronts, in the newsroom and beyond.

You have recently moved to Chicago. That sounds like a great promotion, but a challenging one. Can you tell us more about that move? How is it going?

I had been covering agricultural commodities from London for the best part of the past 8 years and moving to the U.S. was a great chance for me to experience the American market first hand. Chicago is the centre of agriculture trading, especially for grains and oilseeds. And it’s also not far from New York, where a lot of the soft-commodity traders are located.

Being here enables me to expand my knowledge and source base, making me a better and more well rounded reporter. It also gives me the opportunity to work with a different set of people, which brings a whole new challenge.

The commodity world is said to be predominantly male: has that presented any particular difficulties?

I would say the leadership in commodities is predominantly male. I think remaining professional and objective is key to gaining respect in any industry you cover, whether you are a man or woman.

 What do you think the commodity trading companies should do to promote more women?

One thing that catches my eye is that as agricultural commodity traders refocus to be more integrated food companies, more women are starting to work at them.

Louis Dreyfus’ boss recently said that they have a gender-equal policy. Do you think that trading companies should have positive discrimination towards women?

I think we are seeing more companies (and that includes commodity and non-commodity firms) train their staff to be more aware of unconscious bias, which is already a step toward achieving gender balance and diversity.

Thank you Isis for your time!

© Commodity Conversations ®

Do you think that ASF—African Swine Disease, is a bigger problem globally than the trade wars?” And what is your Chinese import number for beans?

We are at 84 million tonnes, and we are holding that steady for the year ahead. There is a range of estimates for the number of hogs in China, somewhere between 470 and 600 million. Most of us believe in a number of around 550 million. There is no census, but more than half the world’s hog herd in China. That’s what makes ASF so important in terms of the grain industry.

The biggest farms in China could be 50,000 head, and I understand that there are plans to have farms as large as 100,000 head. You also have the backyard farmer that may have two or three hogs. It is all over the range in terms of sizes and shapes. I suspect that in the longer term ASF will lead to the backyard farmer getting out of hogs, and the industry will become increasingly commercialised. It will be the norm to have herds of 50,000 to 200,000 head on vertically integrated operations.

The point is that China was our only consistent annual demand increase, somewhere between 5 and 7 million tonnes of soybeans each and every year. Now with ASF that demand growth has now gone. Poultry and aquaculture production is increasing, so that will stabilise bean imports going forward. But again the key is that Chinese demand is not increasing. Parts of West Africa are helping us in wheat, but the volumes are not significant. Corn may be better placed with the increase in Chinese demand for ethanol, but again that won’t be significant.”

But couldn’t the Chinese replace bean imports with pork imports? Could we feed our surplus beans to domestic pigs and then export the meat to China?

That is the hope for the future. We estimate that the US could eventually export 40,000 hogs per day to China, but for the moment we are nowhere close to that. The Chinese producers are liquidating their domestic hogs and this is depressing domestic prices. So the import margins don’t work. But at some stage that will end, and imports should again become profitable, first from the EU and then from the US. That could happen as early as late summer here. You could also see China importing more poultry, beef and even fish.

Staying on the subject of meat, do you concur with the view that Russian grain exports will peak as the country builds up their domestic meat production?

I don’t think that Russian grain exports have peaked. The Russians have been trying to build up their livestock and poultry herds for some time now and they have also struggled with ASF. The disease moved across Africa, on through Europe, then Russia, and now into China. So the Russians have some of the same issues. I believe it will be a while before the Russians export a significant amount of meat. They will do some trade into Kazakhstan or North-western China, but their herd expansion needs to be more robust, particularly in hogs.

The Europeans have learned to live with ASF; the Russians are trying to learn to live with it. The Chinese will try to do the same. Pharmaceutical companies have spent millions of dollars on trying to find a cure or a vaccine for the disease, but so far have come up with nothing. It is an old disease, first discovered in the early 1900s in South Africa. It is very virulent. I call it the Ebola of the swine industry because the organs bleed from the inside. We are at least five years away from a vaccine or antidote.”

What about lab based meat, or the growing popularity of vegan and vegetarian diets? Is that a concern for grain and oilseed farmers?

Lab-based meat is rather like cellulosic ethanol; we can do it relatively well in the test tube, but it is difficult to scale up to commercial production. I believe that we are still 10-20 years away from the moment when we can really scale this to a point where it has an impact on global agriculture. As for plant-based meat, veggie burgers and the like use pea protein.

What about the anti-gluten movement—is it affecting wheat demand?

It hasn’t had a sizeable impact. In the rich western nations there is some drop in bread and carbohydrate demand, but we are seeing more demand coming in from Africa. On a global basis, wheat demand is still increasing at an annual rate of about 1.7 percent.

And what about the trend towards organic production?

US farmers are looking for alternative markets, including organic grains. But we don’t see demand for organic production having any significant impact on global grain flows.

We are more worried by current developments regarding glycophosphate. There are now 1,300 cases pending against Monsanto and their parent company Bayer. You have to wonder if the EPA won’t one date ban the product, or whether Bayer will remove it from the market because of liabilities. Remember, food companies are now testing for it in their products.

If they did remove or ban it, it would be a significant change in global agricultural production. We don’t have a cheap substitute. So if you were to ask me what could change our world, then the answer has to be glycophosphate.

If it were banned or withdrawn from the market today, what effect would it have on global grain production?”

There isn’t a good substitute except for manual or mechanical cultivation to remove weeds. Cultivators were widely used to remove weeds around crops until the introduction of glycohosphate in the late 1980s and early 1990s. If it were banned or removed from the market today, we would probably go back to more crop rotations to keep weeds and insects at bay.

It is a big deal. We could lose 15 to 20 percent in yields. And of course, if we go back to tilling we would have more carbon in the atmosphere, and we would have to have more passes over the fields. And we would have to bring in more land to produce the same amount of food.

What are the other challenges facing the sector?

We believe that climate change is having more and more of an impact every year. As both Poles warm, the Jet Stream has more angulations, leading to weather patterns getting “stuck”. If you look at 2018, much of Eastern Europe and Western Russia had hot dry weather, while Reykjavik in Iceland only saw three days of sunshine during the whole summer.

Weather patterns tend to get stuck. The temperature gradients between the Poles are lacking, and this leads to lots of rain or lots of dryness. We are seeing this currently in the central US where cold and wet weather is impacting plantings.

Climate change is real; you can see it in the data. It is already affecting grain production and will continue to do so. However, the sun is dramatically cooling, and this could have an impact later if the planet cools.

What about the grain merchants: are there any signs that they might see better margins in the near future?

I am afraid that the grain merchants may have to put up with low margins for a few more years. We don’t see any change in that. It is the globalisation of supply with producers in both hemispheres. The buyers have become more short term in nature. The consolidation among the merchants will continue.

Farmers also have more information than they used to, and farm storage has grown. Grain merchants can no longer pick them off at harvest time. Sophistication has increased all along the supply chain. There are no fools any more; everyone is well versed in where their margins should be.

Large farmers are increasingly selling directly to the end user and this is something that Blockchain may facilitate. However it is unlikely that a farmer will sell to China, so there is still a role for the international trader.

Is there anything you want to add?

Only that we are in a period of continuing technological revolution in both trading and farming. But we still see a need for good information, research and analysis.

Thank you Dan for your time!

© Commodity Conversations ®

Dan Basse is founder and CEO of AgResources

Growing up in Wisconsin, Dan Basse raised hogs on his father’s farm to put himself through Wisconsin State University. He had originally planned to be a veterinarian, but after a few years running the hog operation, he began to realise that some years he made money and he could enjoy the university life, while other years he didn’t make much money, even though his costs hadn’t changed. He told me that he was doing the same things in terms of costs, but it was all about marketing the hogs.

He began to get interested in markets to try and understand what drives prices. He took some economic courses, fell in love with the subject and switched his major from veterinarian studies to economics.

Dan how many hogs did you have when you were a student?

I had between 120 and 150 each year,” he told me. “Running the operation gave me some ideas about the business of farming. It was a good way to get a young lad into the world of agriculture. I knew that I didn’t want to be a hog farmer long term, so maybe it also encouraged me to work harder in college!

And does the farm still exist?

We still have the family farm but we now employ a farm manager to run it for us. My mother is still alive at 83, but my father passed away in 2013. The farm is located near the city of Milwaukie and we are involved in an urban restoration project there, building a few apartment buildings on some of the land. But we are still farming; we don’t have livestock anymore, but we grow vegetables and apples.

About ten years ago my wife told me to get a hobby, so I bought a dairy farm in Ohio where I raise high-end Guernsey cattle. It is an unusual cattle breed for the US, but the breed has been in my family going back three generations. We show them in fairs and have had some national champions, so it has been quite successful. I enjoy it. It is a good way for me to get away from my consulting business and enjoy the rural life.

Are the cattle grass-fed?

Yes. They are largely grass-fed, but we still have to use about 10-15 percent of a grain mixture so that the cows get enough vitamins, along with the balanced diet, that they need for milk production. We have about 270 head of cattle, so it is a relatively small business.

I have some clients with farms as large as 40,000 head. The average in the US is probably around 900 head, so my operation is small. The trend in the dairy sector has been from small to large operations, a mix of corporate and family-owned. The big problem we have in the US at the moment is finding help; the labour market is so tight. That is a constraining factor on the dairy sector, even for us with our three employees.

You founded AgResource in 1987 at the age of 30. Was it a success from the start?

Yes! Within the first couple of weeks I had 600 clients through a new entity called DTN, Dataline Transmission Network. At that time farmers didn’t have access to price quotes, and I was one of the first on the DTN service to provide research. The owners of DTN told me that no one would ever pay me the $50 per month that I was charging for my research, but they were wrong. Businesses need good research. Today we have over 1,200 clients in 87 countries.

In your opinion, what makes a good analyst?

First, you need the ability to take large amounts of data and to put it into a format that is sensible and consistent. Second, you need the ability to get on with people. You have to have contacts within the industry to bounce ideas back and forth. Having the data is one thing, but you also have to have ground level input from real people: market participants, farmers, traders, governments etc. So a good analyst has not only to understand data, but also to understand people and what drives them. Third, you need the ability to write and to communicate your research in a readable, interesting manner. It’s a rare combination of skills.

Economics is our preferred subject of study when we look for an analyst —normally a Masters Degree or a PhD. A farm background helps.

Dan, you are among the leading analysts in the grain sector. What do you think first made your reputation as an analyst?

There are two occasions that come to mind. The first was the Carter grain embargo when we quickly understood that the US government would be buying up a lot of the surplus grain stocks.

The second was the biofuel build outs and the way that the mandates in the US, EU and elsewhere would lead to a sharp increase in demand. You could smell, taste and put your fingers in it in terms of projecting future grain demand. It was therefore relatively easy to see the bull markets that enveloped the grain markets from 2007 to 2014.

It then became equally as easy to see that agricultural markets would begin to struggle as the biofuel industry matured. We lost that demand driver while at the same time productivity and yields continued to improve.

The current situation is less clear. Trade wars are not as clear as biofuel mandates. The future in terms of politics is far more difficult to predict.”

Do you think the Chinese ethanol program could be the next driver for global grain demand?

We think it will drive some demand, but it is not clear how quickly the program can be implemented. It should lead to 37 to 45 million tonnes of addition annual corn demand. That will ultimately deplete Chinese stocks by 2021, and led to increased imports after that date. But unfortunately when you look at corn yields and technologically, the industry is advancing faster than we thought it would. Yields are increasing faster than demand. But that Chinese ethanol demand will of course be helpful to the world corn market.

In the 1960s and 1970s we were all worried about having enough food to feed the world. And that repeated itself in the early 2000s with the growth of biofuels and the food versus fuel debate.

If you do some long term modelling of population growth and farm yields, we could start to run out of agricultural farmlands around 2050. Until then, I don’t see really what, apart from a weather problem, could alter the situation. I can’t see where the next demand driver will come from. Until we find one, any rallies in price are supply-based, weather etc. I can’t see demand catching up with supply until we get to 2025 or beyond.

Could biodiesel come to the rescue of the US soybean producers?

We have seen record demand recently for biodiesel. It is mandated, so that demand trend will persist. At some point it may become mature in the same way that ethanol demand matured. We believe that world energy demand will peak somewhere between 2029 and 2031. As we start to use more electric vehicles biofuel demand will slow, but for the moment it keeps gliding upwards.

The US has anti-dumping cases against a number of biodiesel producers, so we have been trying to keep supply out of the domestic market.”

Have GM crops aggravated these surpluses? Looking back, could you argue that the world didn’t, or doesn’t, need GM crops to feed itself?

I think we need GM crops to feed the world, particularly as population continues to grow. The problem that has occurred is that farmers always overreach when they see profitability; they have bought in more land than we needed. It is not just GM that has enhanced yields—it is also farm technology, GPS, drones etc, as well as better fertiliser, pesticides and herbicides.

Looking back to the 1800s, it has always been demand shifts, whether war, biofuels or the growth of Asia that have jump started our grain demand. Our current trade wars are disruptive in terms of flows of grain rather than overall grain demand. So it is a question of shifting the chairs around the table, rather than putting more food on the table.

© Commodity Conversations ®