Global Economies Adjust to Lower Commodity Prices
Agriculture Economies around the world are feeling the drag of faltering commodity prices in all sectors. Global GDP is expected to slow to 3.1% in 2015 compared to 3.4% in 2014, according to a recent report by the International Monetary Fund (IMF).
The decline in GDP is a result of slower growth in China and in emerging markets. For the past several decades, China has been a major consumer of the world’s energy, building materials, and food crops to fuel its rapidly growing economy. As this slows, exports of major commodities have slowed, and prices have followed demand down to the lowest levels since 2008, the beginning of the Great Recession.
While metals and energy commodities have been hit the hardest, declining agriculture commodity indices around the world are down to mid-2008 levels. Agriculture commodities have declined 8% since February, according to the IMF.
Lower commodity prices reflect lower demand amid higher production for almost all commodity sectors. At press time, oil prices fell to their lowest levels since mid-2004 on slowing demand from China, continued strong supply from OPEC, and huge inventories around the world. Oil prices have fallen 40% since this time last year, when OPEC decided to maintain production despite sliding prices to outcompete strippers (producers of up to three barrels a day) and emerging shale oil businesses in the United States.
Similarly, metal prices have fallen due to slower demand growth from China and substantial increases in the supply of most metals, notably iron ore, the main raw material in steel, which has fallen 75% since late last year. Food prices have also declined as a result of strong harvests during the past few years and high ending stocks for key importing countries, notably China.
“People need to realize that agriculture is getting caught in a global commodity downturn,” says Jim Budzynski, managing principal of MacroGain Partners, an investment manager and consultancy. “Interestingly, a lot of the big producers are in emerging markets, Brazil in particular. For many of these countries, it isn’t about managing the market. It’s about generating revenue for GDP, social programs, and national vitality. So even in the face of the downturn and declining demand from China, we have people cranking out volume to try to make up the difference.”
During the Great Recession, developing economies continued their favorable growth and consequent consumption while developed economies stumbled. Today, the opposite is true. Emerging economies are faltering, and developed economies are performing reasonably well. But it is unlikely that developed economies will be able to absorb the glut of commodities that would have been absorbed by fast-growing developing nations.
8% — Average decline of global agriculture commodity indices since February.
“There will be a lot of ancillary damage from oversupply,” Budzynski says. “I think we are going to continue to go through a period of extremely weak commodity prices. Normally in agriculture we have relatively stable demand, and we have supply disruptions caused usually by weather. Now we are entering a market where there is a slump in demand, partly because all of the emerging markets are in or on the cusp of recession, and when you combine long supply with weakening demand, those are more than cyclical downturns; those are secular downturns.”
The decline in growth in emerging markets — for the fifth year in a row — reflects a combination of factors: weaker growth in oil exporters, a slowdown in China as growth becomes less reliant on investment, and a weaker outlook for exporters of other commodities, including in Latin America, following price declines.
It’s clear that China’s widespread stockpiling of commodities since 2008, turbulent stock market, real-estate bubble that burst beginning last year, and waning consumer confidence have instilled trepidation among investors and businesses around the world. GDP growth in China is expected to decline to 6.8% this year and 6.3% in 2016.
Effects on Input Sales
So what does all this mean for input sales for agribusinesses? For starters, farmers are going to scrutinize every input that is part of their operation, including seeds, fertilizers, and crop protection products. In the U.S., farm incomes are expected to fall to a 13-year low in 2015, according to the USDA.
“One way to cut the cost of production is to switch to less input-intensive crops, such as soybeans and wheat,” says Brandon Kliethermes, Senior Economist with IHS, a research consultancy. “But in the very short term, a producer’s main goal is to cut the cost of production, and that doesn’t mean to wipe the slate clean on the input side; it could mean increasing production on a per-unit basis. We want to grow more bushels per acre. Farmers probably won’t seek to improve yield, but they still want to produce bushels per acre on par with recent years.”
Kliethermes, who is also a row-crop farmer in the United States, says on his operation he will look to treat pests on more of a reactionary basis instead of preemptively. This mentality could stifle the growth of emerging technologies and non-critical inputs, such as micronutrients and biocontrol products. Also in jeopardy are discretionary fungicide treatments, which farmers might wait to apply until pest scouting proves they are needed.
Fertilizer applications could fall off, too, depending on a host of factors. Global fertilizer prices are falling, and farmers might wait to see just how low they go. The NPK value chain is stocked full of higher-priced inventories, so the waiting game could impact final sales and consumption. In the meantime, production hasn’t tapered, putting additional downward pressure on prices. Additionally, some farmers could try to mine nutrients from their soils instead of using new applications, primarily for phosphorous (P) and potassium (K).
Seed choices might be tested for the first time in the GMO era as well, Kliethermes and other sources say. Farmers are not expected to abandon leading GMO technologies entirely, but they might become more selective about the stacked traits they are selecting to minimize cost and technology fees. Seed treatments could be cut back too as farmers look to save on preventive technologies in lieu of scouting and reacting to pest pressures as they arise.
121 Million — Number of global soybean hectares planted in the 2015/16 growing season, a 2% increase from last year and 7% rise from the 2013/14 growing season. Strong production will continue to put downward price pressure on agriculture commodities.
The Southern Hemisphere’s growing season will further affect prices. Strong plantings could push prices lower and affect how farmers in the Northern Hemisphere respond.
“The next question after inputs is: Will the U.S. producer respond to these negative margins right now and reduce plantings in the spring? If we happen to get a decent spring weather event, I think we will see some extremely strong plantings next year, which could further decrease prices,” Kliethermes says, adding that production in the Southern Hemisphere will play a role in 2016 prices.
At presstime, USDA-FAS was reporting an increase in 2015/16 global soybean plantings to 121 million hectares, a 2% increase over this year and a 7% increase over 2013/14’s 113 million hectares. Soybean yields, however, are expected to be about on par with this 2014/15 season. Production of wheat and oilseeds are expected to climb in the 2015/16 planting season as well. Total grains are expected to fall back to 2013/14 production levels of about 2,472.8 million metric tons.
Corn plantings and production are expected to fall back to earth after record global production last year of 5.65 million metric tons. The slight decrease is unlikely to move commodity markets without a weather event that limits production.
Strong production during the past several years have resulted in strong ending global stocks that are predicted to continue to rise for every major commodity crop with the exception of rice. The rising inventories are outpacing demand, which is expected to prevent a price rebound and put more pressure on farmers’ input use.
“What we worry about is that stocks-to-use ratio is going up, and that means that inventories are larger; when you continue to stay large, there is going to be less chance for price recovery,” says Dr. Michael Boehlje, Distinguished Professor of Agricultural Economics at Purdue University (Indiana, U.S.) “So the futures are showing basically flat with some slight uptick in corn in 2016 and 2017.”
With little reprieve on the horizon, suppliers will need to justify inputs in the context of growers’ yield management strategies. It will be important for input suppliers to make sure they have the evidence and the information to support their performance numbers in terms of yields, Boehlje says. Farmers will require more evidence, especially products they don’t have as much experience with.
“It is going to be really important for farmers and suppliers to talk about their cost structure on a per-bushel basis instead of a per-acre basis, and input suppliers must help farmers understand that pulling back on a particular input might result in yield loss,” Boehlje says. “You might have a lower cost per acre if you cut an input, but you might actually have a higher cost per bushel because of lost yield.”
But no matter how well a value proposition is articulated, there likely will be some price erosion for crop protection and products alike.
“Crop chemical prices drifted upward along with the general economics of the farmer, and they are sticky and don’t come down immediately,” says MacroGain’s Budzynski. “But eventually they will come down, and we are entering a situation where the farmer is financially strained, and companies will not be able to extract the kinds of premiums they’ve extracted during the past three to four years over the next three to four years.”
Budzynski says the correction in both commodity prices and product prices are overdue as investors and governments reconcile agriculture’s strong boom times with a world that has lost its appetite for agriculture investment.
“Our biggest frustration (as an investment company) is that we are in suspended animation. Eventually we will be better served as humans to take our lumps and clean up our balance sheets and get our houses in order: Then a new era of growth and prosperity can start,” he says. “But it’s not going to start with three-times GDP of global debt. That isn’t the beginning of a bull market. That is the end of a growth market. The party is about over.”