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New York conversations

The family at the next table were stocking up enough food from the hotel breakfast buffet to last them for weeks. Admittedly it was a big family, three generations of them, but there wasn’t a square inch of space on their table that wasn’t covered in food. Every time a plate was emptied, the grandmother went back to the buffet to get a refill. None of the family members was overweight, and there was no way that they were going to eat all of the food they had piled onto their table. I guessed that at least half would be thrown away, if not more.

As I finished my coffee a businessman sat down at the table on the other side of me and started to tuck into a plate piled high with fruit: melons, pineapples, huge red strawberries and grapes. I estimated that he had more than a kilo of fruit on his plate. He saw me looking at him and smiled. “I am on a diet,” he explained. “I only have fruit for breakfast now.” I thought about telling him that fruit were carbohydrates and heavy in calories but he had already got up to fetch a pint glass of apple juice.

The grandmother walked past my table again with what could only be described as a bucket of scrambled eggs. She piled some of them onto her grandchildren’s plates, but they were more interested in the chocolate brownies that she had amassed earlier. The grandmother wasn’t eating anything; she was just making sure that her grandchildren were well looked after. I realised that she was expressing her love through food—and I thought once again how complex our relationship with food really is. Food is life and love, but it is also guilt and self-depravation.

The previous day I had dropped in to meet the editorial team at New Food Economy. The online magazine had recently run a series of articles about farmer suicides in the US. Farmers borrowed heavily the last time crop prices were high, and they had invested that money in new equipment and more land. With crop prices down again, farmers are now unable to meet their interest payments; as a result, farming now has the highest suicide rate of any profession in the US.

We discussed how low food prices mean that producers can’t cover their costs while at the same time they encourage consumers to overeat and throw away a large percentage of what they buy. While high food prices attract most attention from the media, the social and environmental costs of low food prices are always underestimated.

The next day I was talking with a Bloomberg journalist about how low food prices were impacting farmers, but she wasn’t impressed. “Maybe food prices are low in the US”, she told me, “but what about the currency effect? Russian wheat producers are doing just fine, as too are Brazilian soybean farmers. ”

She made another good point about low prices. “Perhaps,” she suggested, “the improvements in seed technology and farming practices—drones and the like—have reduced production costs while at the same time made crops more resistant to poor weather, pests and disease.

“Is it possible,” she asked, “that bad weather and disease has less impact on production now than in the past? It is possible that technology has taken some of the volatility out of the agricultural markets? If it has, then crop prices could stay lower for longer than in the past—especially if the US dollar stays high.”

Technology and innovation were the main subjects of conversation when I met a friend for lunch, but this time we focused on AI—artificial intelligence—and the way that the algorithmic funds (according to him) now dominate the futures markets.

“They are so secretive,” he told me, “none of my contacts know how they work. We all try to guess how they are programmed, and how they might react to, or to create, market moves, but it is impossible. Perhaps they change their trading strategies too quickly, or perhaps they have many variants of a particular trading strategy.”

“What about market fundamentals,” I asked him, “don’t they impact the markets?”

“Yes they do,” he replied. “Supply and demand will always drive medium and long term trends. But there currently aren’t any trends in these range-bound and over-supplied markets. For the moment I am just trying to survive. I call it “death by a thousand cuts”—all these tiny short-term moves just pick away at my equity. Algorithmic funds love these markets. And to be honest, they will probably also love trending markets. Perhaps computers are just better at trading than humans.”

My final business conversation of the trip was with another old friend in the business. I told him about the pessimism that I had encountered and he laughed. “It’s just that phase in the cycle,” he reassured me. “Cycles turn and when this one does farmers and traders will be able to make money again. It will then be the consumers’ turn to complain. The last time food prices increased, everyone blamed traders and speculators; no one blamed the poor weather or the preceding period of low prices that had driven farmers off their fields.

“Give it two years,” he laughed. “Traders and producers will once again be making money—and everyone will hate us. It’s been like that since the beginning of time, so you might as well get used to it!”

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Ten Questions for the Agtrade

Agricultural commodity traders are asking themselves key questions about the future of their businesses. Here are ten that we heard recently (with tentative, perhaps controversial, answers).

1/ How can we improve profitability in the supply chain?

At present the only way is to cut costs. This can be done by reducing headcount and by introducing new technologies and processes. Increasing traded volumes and the general scale of operations can also help. However, when everyone fights for increased market share competition gets tougher and margins suffer.

2/ Why is consolidation in the sector happening so slowly?

The main players are looking to increase scale to reduce their costs and diversify their risks. However once you get to a certain size you run into issues with the competition authorities. Consolidation is happening in the middle tiers. COFCO bought both Nidera and Noble Agri, but those two acquisitions show how tough it can be to integrate a business once you have bought it. Most M&A deals destroy rather than create value—and not just in the agtrade.

3/ Where is the value in the agricultural supply chain?

In recent years the value has seeped out of the agricultural supply chain as market power has shifted from producer to trader to consumer. This has resulted in lower food prices at the expense of farm incomes and traders’ margins. If people want to eat, that pendulum will have to swing back, at least partially.

4/ Is a sustainable supply chain a less profitable one?

No. To be sustainable a supply chain has to be profitable. If it isn’t profitable then it isn’t sustainable. Traders will have to be paid for what they do or they will stop doing it.

5/ Does increased traceability mean less tradability?

Maybe. Traders need optionality to be able to respond to price signals (for example changing freight rates) in order to supply their customers at the cheapest price. If one origin can’t be swapped for another then the supply chain becomes less flexible and more costly. However technological progress should soon mean that all commodities are traceable back to where they were produced. Traceability and tradability will then become co-dependent.

 6/ Is efficiency the key to a sustainable supply chain?

Yes, along with improved traceability. Increased efficiency should result in reduced crop loss and and fewer GHG emissions. A more efficient supply chain should also raise farm incomes and help local communities reduce environmental degradation caused by agricultural expansion.

7/ Is there still a role for speculation in agricultural supply?

Speculators absorb price risk. Risk has a cost. By transferring price risk to speculators the other actors in the supply chain (producers, consumers and traders) can lower their costs. This raises farm incomes and lowers food prices. Speculators also ensure that price signals are transmitted quickly, leading to faster supply responses.

8/ How will technology impact the agtrade?

In many ways, but most significantly, blockchain and a wider use of electronic shipping documents should make the whole supply chain more efficient and lower costs.

9/ Does the agricultural commodity trade have a future?

Absolutely. The world’s demand for calories continues to increase and the only way to meet that demand in an efficient and environmentally sustainable way is through trade. Someone will have to move these huge crops around the world—and to be paid to do so. The future for the sector as a whole is bright.

10/ Which companies will win and which will lose?

The winners will be those that embrace change, responding quickly to process innovation and technology. As Charles Darwin wrote, “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change”.

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Innovation and the Agtrade

The agricultural commodity trade is as old as the hills and one of the earliest professions. It has experienced constant change over the centuries and that change has accelerated over recent decades. Technological change and process innovation will continue to accelerate; we as a sector must continue to evolve and embrace these changes.

What have been the major innovations so far, and how will innovation and new technology further disrupt the sector?

Here are five ways in which the sector has already been disrupted:

  1. Social media has transferred market power from producers to traders and now to consumers, giving consumers a mass voice to start or reinforce trends, blacklist and shame some brands or products and promote others.
  2. Communication has become instant and virtually free. In the past trade houses invested huge sums of money in, and prided themselves on, their private in-house communication networks. These have now become redundant.
  3. Information has become widespread and democratic. This has eroded the price differentials that previously existed between surplus and deficit areas. It has also eroded the “information edge” that traders once had regarding future price movements.
  4. Satellites have improved crop forecasting, giving us better information regarding harvests and weather problems. Bigger and cheaper computers have made weather modelling and forecasting less of a luxury and more accessible. (Unfortunately for the trade houses, this information is now also widely available at a low or even zero cost.)
  5. Algorithmic trading systems have become so good they can be better at trading than humans. This is making it harder for traders to make a profit speculating in the futures markets, and more expensive for producers and consumers to hedge their price risks.

However, not all innovation has made things harder for traders. Here are five ways in which it has been positive—and will continue to be positive.

  1. Containerisation has undoubtedly been the biggest disruptor ever in the way that commodities are moved around the world. It has reduced shipping costs (and cargo loss) and improved traceability. There is no reason why this should not continue. Technology should continue to reduce transport and distribution costs in general.
  2. The “sharing economy” should further reduce shipping costs. Instead of trade houses owning fleets of ships or trucks, they will increasingly outsource distribution and transport to others who can better maximise capacity utilisation.
  3. Artificial intelligence will continue to reduce costs. Machine learning and artificial intelligence is already aiding or replacing some more complex roles. This is the flip side of the algorithmic trading point we saw in the earlier list. We have already seen the first successful blockchain transaction (a cargo of Canadian soybeans to China) and we expect momentum in this area to build.
  4. Technology in the form of RFID chips will soon allow traders to track commodities from the moment they leave the farm or producer until they arrive at destination. Pretty soon each bag of, say, coffee, tea and sugar will have one!
  5. Food composition itself will change. It could be simple stuff like Nestle’s new sugar, which is hollow and contains less calories. It could also be major innovations that will completely change the landscape of agriculture – like a switch to lab meat.

By definition, the biggest disruptor to the agricultural commodity trade will be the one that we don’t foresee. Take road transport. Who really predicted how improvements in battery technology would lead to the growth in electric vehicles, the sharing economy to the growth of Uber, and improvements in AI to driverless cars?

The technology companies are already targeting agriculture, whether in the form of vertical farming or retail distribution systems (think of Amazon’s purchase of Whole Foods and their cashier-free stores.)

Who knows, maybe the next Elon Musk will start out as a grain trader!

 

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The FT Commodity Summit

The mood at this year’s FT Commodities Global Summit was more upbeat than in recent years. The summit was again mostly focused on the extractive industries, oil, gas and metals—all markets that appear to have bottomed. Indeed this year’s theme was “The Start of a New Cycle”. Excess production capacity has now been absorbed and prices are on the up.

The “electrification” of the economy was the main subject of discussion for the energy and metal guys, particularly the anticipated growth in electric vehicles (EVs). Electrification is expected to be marginally bearish for oil prices, but then only sometime in the distant future, and wildly bullish for cobalt and copper prices. Speaker after speaker took the stage to warn that there simply won’t be enough of either to meet the planned expansion in EV production.

The mood turned remarkably flat, however, when it was time for the panel on agriculture. The panellists worried about razor-thin, or even negative, margins on their physical trade flows and sadly listed all the reasons : the democratisation of data; the speed of information; greater transparency in supply chains; the advent of algorithmic funds; heavier regulation; increased traceability and reduced tradability; over-production; and an over-hang of infrastructure.

Panellists explained that agricultural trade houses have been responding to the collapse in their margins by cutting costs, particularly by reducing headcount and implementing new technology to improve efficiency. They have also been trying to increase traded volumes so as to spread their overhead cost burden more thinly. Unfortunately, this fight for market share has resulted in increased competition and even thinner margins, a vicious circle that can only be solved by consolidation.

With margins so thin it doesn’t take much of a problem somewhere along the supply chain to push a transaction, or a company, into a loss. As long as it doesn’t over stretch management, increased volume can diminish the impact any particular problem can have on the company’s finances. So increased scale can reduce risks as well as costs. The panel predicted that we would see more partnerships, such as the recently announced one between Cargill and ADM in Egypt.

However, if the sector is to thrive—or even survive—it has to do more than reduce costs or spread risks. As the President of Cargill’s Agricultural Supply Chain Enterprise so aptly put it, “We all have to reinvent ourselves one way or another to ensure that we create value within the supply chain.”

Sitting in the conference hall listening to the speakers from the energy and metals sectors it became apparent that they at least are still making money from the physical movement of their particular commodities. Yes, they all complained about declining margins; but at least they still have margins to complain about. Agricultural trade houses don’t have that luxury.

Most agricultural commodity traders gave up trying to make money from FOBS to C&F a long time back. Instead they moved up and down stream into elevators, silos, barges, port terminals, and distribution and packing plants. They also went into trade finance and risk management. (At one stage they even tried their hands at running hedge funds.) However, competition is now just as tough at both origin (from farmers) and destination (from local traders).

But wait a minute. World population is growing, as too is our demand for meat. Someone will have to move all that food (and animal feed) from where it is grown to where it is eaten. They will have to store those crops from when they are harvested to when they are consumed. And they will have to process that food into a form that can be eaten: wheat into flour, soybeans into meal etc. Governments won’t do it. So it will be left to the agricultural trade houses.

That at least is the theory. Agricultural trade houses add value to the supply chain by transforming crops in space, time and form. But they won’t do that unless they are compensated for doing it. One way or another, if the world wants to eat, traders will have to be compensated for the value they add, the work that they do and the risks that they take.

If the world wants to eat, agricultural traders will not only have to survive, they will have to thrive. And if all other avenues for revenue are closed, margins on physical flows will have to become positive.

The US baseball player Yogi Berra once famously said, “In theory there is no difference between theory and practice. In practice there is.”

Just because the sector as a whole will thrive, it does not mean that all participants in that sector will survive. The companies that do will be the most efficient ones in terms of cutting costs and spreading risks. This means either scale or agility. We could see the bigger players getting bigger; the smaller ones getting more agile (in searching out opportunistic margins where they can find them), and the medium slower moving firms, well, getting out.

But all this could take time.  Remember, the UK economist J M Keynes once famously warned, “The market can remain irrational longer than you can remain solvent”.

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A conversation with Alex Stewart, co-founder of Abercore

Hello Alex, thank you for taking the time to talk with me today. First, can you tell me how you got into commodities?

After graduating from Durham University I delivered a thirty-foot sailing boat from the UK to New Zealand. There were three of us on board, it took about six months. When I got back to London I felt I had to do something that involved an element of travel. I was less interested in the financial markets, but I liked to understand how things get from A to B—physical things. That is what attracted me to the business.

Please tell me a little bit about Abercore. What were your motivations for starting up a new company?

My co-founders and I were all previously traders at Czarnikow. Over time we could see that the big sugar producers were changing the way they were doing business. They were increasingly concerned about transparency and traceability, not only in the sense of CSR (Corporate Social Responsibility), but also in knowing where their sugar was going, how the transaction was being executed and how they may be able to extract more value from it. We began to see similar trends coming from the consumer too.

However, although both sides increasingly wanted to interact directly, they didn’t always have the expertise or the tools to do it. Yes, a consumer can buy direct, but what exactly does that entail in terms of documents, accountancy, risk management, pricing, hedging etc., and also in terms of where you source the sugar from?

We set up Abercore in 2013 to help producers and consumers achieve their goals of executing direct business.

Where did the capital come from to start the business, and where does the finance come from to keep it going?

Our vision with Abercore was to establish a company that was predominantly focused on advisory services to producers but with a trading arm that could complement this advisory business. For example, we might be working in an advisory capacity marketing sugar for a European client, and a buyer in Africa would come to us with a specific requirement that our client couldn’t meet. In this instance the advisory work could translate into trading opportunities.

We each put our own cash into the company at the outset and as the business grows we have developed a relationship with NatWest, and they now finance our proprietary business. We have the financial ability to manage our own physical and futures transactions, although perhaps not on the scale of some of the trade houses. But then we don’t want to be a traditional trade house.

Why do you concentrate on Africa?

Africa is hugely exciting. By 2050 Africa’s population is predicted to grow by 1.3 billion people. That is the size of India. India consumes 25 million mt of sugar each year—so you are talking of consumption potentially increasing by that much. It is a huge growth area. There is so much opportunity.

People tend to group the fifty-four countries in Africa as one market, but each one has different trade agreements, different customs requirements, different everything. Our local knowledge gives us a huge edge over our competitors. 

What are the specific challenges in Africa?

Risk is the biggest challenge—risk in three forms: country, counterparty and competitor. You have to know your client, your competitor and your local market.

As far as competition is concerned, the biggest change we have seen in the last five years is the growth of the local traders. Local, rather than multinational, traders now capture a lot of the trading opportunities. But this isn’t just limited to Africa; it is being replicated throughout the world. This is a big issue for the multinational trade houses.

But then everything is becoming more local. Look at the consumer side and what Heineken is doing for example: they want to source as much as possible of their raw materials for Africa from within Africa. It makes commercial and social sense, and the social aspect is becoming increasingly important.

To what extent are your clients concerned about social and environmental sustainability?

Different people have different views as to what is sustainable. Sustainability is often about employing the local population, and caring for the local social and physical environment, making sure that your workers are well treated and that revenue is flowing back to the local farmer or cane cutter. That can be more important than buying sugar with a sustainability certificate.

The multinational food manufacturers in Africa will ask for certified product while local, second tier food manufacturers may be less concerned about the social and economic impacts of their buying decisions. These local companies are increasing their market share because they produce at a price that consumers can afford. So price is very important for them, perhaps more so than sustainability.

Agricultural traders have been suffering recently. Do you think this is cyclical or structural?

If you are a big trade house and see a big deficit coming you can take big positions on the market, on both the futures and the physicals in anticipation. In my mind this is harder to do in a surplus market. And with many of the agricultural commodity markets having been in surplus for the past few years this has negatively impacted the trade houses’ bottom lines.

On a structural level, other people are now fulfilling the trade houses’ traditional role in providing finance and liquidity, and managing logistics. Producers are now willing to manage finance, freight, insurance, even hedging—all the things that once only trade houses did.

So it comes down to what the trade houses have left. They have cash to speculate. They have relationships. They have a global vision. They have analysis. And they have the ability to move huge volumes around the world. That will remain the case. But the competition [both from local traders and producers themselves] is growing.

What is the hardest thing about being a physical trader – and the best thing?

The answer is the same for both – clients! The best thing about the business is that it is real. We are involved in the movement of commodities around the world, and we are adding real value in term of getting food to consumers.

So you like what you do?

I love it!

Thank you Alex.

Disclaimer: Jonathan Kingsman’s son Timothy works for Abercore

 

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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.