Farm shortfalls ripple across the sectors

The Food and Agriculture Organization of the United Nations (FAO) recently revealed that its FAO Food Price Index had hit its highest level since its inception, reflecting new all-time highs for vegetable oils, cereals and meat sub-indices. 

That won’t come as any surprise for supermarket shoppers, but it’s likely that the global supply shortfall for food and livestock feed is likely to worsen as farm economics are wholly unfavourable due to a concurrent surge in the price of nitrate fertilisers and other necessities. Prices began to crank up in the final quarter of 2021, as the price of gas required to produce ammonium nitrate began to rise steeply. 

The invasion of Ukraine has exacerbated the situation. The Black Sea region – occasionally referred to as “Europe’s bread basket” – is in turmoil and the longer hostilities linger, the greater the likelihood of major disruption to winter planting schedules.

Russia is the leading exporter of nitrogen fertilisers, while neighbouring Belarus, also subject to western sanctions, is another major fertiliser producer. Recent quotes for ammonium nitrate in the UK have been 3-4 times as high as they were 12 months ago, so some farmers are simply cutting back on the application of fertiliser, thereby reducing yields. In the US, farmers are going as far as switching crops. 

“The recent strong surge in US natural gas prices has further lifted the cost of fertiliser, thereby potentially seeing US farmers switch more acreage to less nutrient intensive soybeans from wheat and corn,” said Saxo Bank analysts in a note. They added that three-month corn and wheat futures had climbed again to “challenge the March record high”, driven by the war and drought and hot weather in the US. 

With the cost of transportation driving up input prices, along with labour shortages, high prices are likely to persist well into next year for UK households, though the implications for people living in poorer countries are graver still.

 

Empty stomachs, coffers

Food insecurity is running rampant in developing countries, worsened by depreciation against the US dollar, which is the standard for international soft commodity prices. It’s worth noting that nothing has a greater destabilising effect on emerging and frontier economies than food shortages. 

It’s no accident that empty bellies are historically associated with popular uprisings. Recent unrest in Sri Lanka, Pakistan and Peru highlights the risks. More worryingly, the prospect of an acute food crisis unfolding in the Middle East and North Africa (MENA) could serve to destabilise an already fractious region. 

Beyond these regions, there are risks around the commodity trading systems themselves. Goldman Sachs analyst Jeff Currie pointed this out in a note this week: “Should key commodities — from diesel to wheat to European natural gas — end up not being delivered, it would have a systemic effect on all parts of the economy, just like the financial risk of the [global financial crisis],” he said. 

Being delivered in this sense is related to futures contracts and the financial risks around them, as lenders to trading houses and other market participants are normally insulated from risk because of the underlying value of the commodities, so if these cannot be delivered then trading can dry up. 

As for investors, events over the coming months could challenge existing assumptions on how the agricultural sector reacts when the cost of food rises as a proportion of consumer spending, specifically the level of investment in response to the price dynamic. Supermarket buying in the UK is already down 6 per cent overall on last year. 

The unprecedented surge in input costs mean there is no guarantee that farmers will increase sown acreage, as might normally be the case. 

So, purchases of seed, pesticides and fertilisers may be held in check to a degree going forward, short of further government intervention. It is also possible that more land will be given over to crops such as legumes which can fix nitrogen from the air, and flourish in nitrogen-deficient soils. Supplementary planting of plants such as red clover and thistles can also help soil quality, and in the case of the latter a viable alternative to other forms of cattle feed.

Recent analysis from Peel Hunt reveals the likely extent to which other sectors will be impacted by the high price environment. 

With concerns over food security to the fore, it’s sobering to learn that Russia accounts for 23 per cent of ammonia exports, 14 per cent of urea and 21 per cent of potash. The broker added that Belarus is responsible for a further 18 per cent of global exports of potash. 

It is not difficult to appreciate how global shortfall in these key areas will have an effect on grain and animal feed production, but it will also have much wider impacts. For instance, the broker points out that the rag trade is being adversely affected by a 130 per cent rise in the cotton price, while the production of cosmetics and household products is set to become a more expensive affair due to substantial increases in prices for soybean, palm and coconut oils. The usual dynamic of supermarkets being boosted by inflation is not happening, Peel Hunt said, given the extent of the price rises.  

But there are firms doing well out of the conditions.

The palm oil price surge was not just down to the war. As MP Evans (MPE) executive chair Peter Hadsley-Chaplin explained in last month’s analyst call, labour shortages in Southeast Asia linked to Covid-19 had already hit supply. 

“So, with the restrictions, lockdown restrictions and quarantine measures, it made it very difficult for the Malaysian palm oil industry, which was already struggling with its labour, to operate efficiently and effectively,” he said. This meant harvesting and other essential work could not be done. “That’s an ongoing issue,” he added. 

“The rise in the price of palm oil dwarfs the additional cost of inputs and labour [for producers],” said Peel Hunt analysts Charles Hall and Clyde Lewis. 

 

Down the line

At the end of the supply chain, the impacts are clear. 

In a recent address to shareholders, Unilever’s (ULVR) chief executive, Alan Jope, cautioned that the fast-moving consumer goods giant is looking at €3.6bn (£3bn) in additional costs due to rising inputs, including the cost of freight. That equates to 54 per cent of net earnings through 2021. 

The question is how efficiently the group will be able to pass costs through to the consumer, particularly if we witness a marked step up in the popularity of generic brands. Establishing the correct price points is always critical if you don’t want to choke off or reroute demand, although doubly so when inflation is at a multi-decade high.

Other sectors are also feeling the pinch. Naturally, the challenges facing the brewing industry have generated plenty of column inches in the UK. Beer producers and, by extension, the licensed trade, were already struggling due to the energy-intensive nature of the business, together with the lingering after-effects of the Covid-19 lockdowns, but they are now faced by rising barley prices. 

The FAO estimates that the price of barley – a main ingredient in beer – has increased by 27.1 per cent since Russia’s invasion, although it’s worth pointing out that the grain represents a surprisingly small proportion of the cost of a pint.

At any rate, European brewers are not especially reliant on the Black Sea region for their barley requirements, as most of the regional exports are destined for countries without a strong beer culture, including China and the MENA area.

However, it is conceivable that prices for barley could continue to ratchet up well into next year if UK and western European farmers decide to substitute barley with other grains if prices favour crop rotation. Traditionally spring barley, which is sown in early spring, is preferred over winter barley, but that could change if brewers anticipate increased grain substitution for next spring.

A major cost component for brewers, distillers and, indeed, anyone selling into the licensed trade is packaging. A March report published by Rabobank points to a continuous increase in inputs linked to energy, transportation and labour over the next 12 months, although this applies across the spectrum. 

Fears have already been raised that rising prices for vegetable starch, a key ingredient in the packaging process, could lead to shortages going into 2023, with all the attendant negative implications for consumer prices and net profitability across a range of sectors.