China Price Index: The Beginning of Change in the China Agrochemical Industry

Terminator of the Omicron in China

BY DAVID LI
CONTRIBUTOR

In 2023, after a year of COVID-19 control, China gradually began to return to normal life beginning in December 2022. Unlike the lockdown in Shanghai at the beginning of last year, the gradual opening is more certain in the face of a possible future surge in the number of new Omicron infections. In line with the general pattern of epidemics, the number of Omicron infections in China is expected to rise exponentially over the next three months before plummeting. A gradual link with the world is the solid path that China will have to take in the future, with a gradual return to normalcy and a revitalized society in the offing.

The double control policy at the end of 2021 pushed up the price benchmark for agrochemicals in China. But the real average price increases started in the second quarter of 2021. The Federal Reserve’s quantitative easing monetary policy implemented at the beginning stages of the COVID-19 outbreak in 2020 and the overlapping inflation caused by supply shortages in 2021 spurred price increases for bulk raw material products such as crude oil, etc. The double control policy at the end of 2021 briefly affected Chinese supply.

The onset of another “Black Swan” event following the COVID-19 outbreak prompted buyers to bet that Chinese supply would not recover in the near term, which in turn contributed to strong exports of Chinese agrochemical products in the first half of 2022. In May 2022, the volume and value of Chinese agrochemical exports deviated for the first time since September 2021. After May 2022, China’s average agrochemical price index fell directly back to US $8,000/Mt, which is a definite upgrade from the 5,000-point benchmark prior to Q1 2021. The main consideration here is the indirect impact of global inflation on China active ingredient (AI) prices generated by the global commodity benchmark under the quantitative easing monetary policy and COVID-19 epidemic. With the fall in overseas demand, China’s average agrochemical price index will also show a low hovering trend.

Chart 1: China Agrochemical Price Index by Average Prices

Opportunities Arise with the Shift from
a Strong to a Weak Dollar

The dollar index peaked in the third quarter of 2022. And current trends suggest the strong dollar is starting to turn downward. The U.S. Federal Reserve’s (Fed’s) monetary policy is generally ahead of the increase in the amount of trade between the U.S. and China. The Fed’s quantitative easing monetary policy in 2020 was one of the key reasons for China’s strong exports in 2021. As the U.S. current trade deficit continues to widen, the U.S. dollar will trend closer to the downside in the next few years, and with it, a depressed global demand. Freight rates on the China-U.S. maritime route are now down to pre-pandemic levels. Tightening monetary policy by the Fed in 2022 prompted a return of global dollar liquidity in the U.S. The Russia-Ukraine war has spurred even more dollar repatriation from Europe and other countries.

The Fed’s suppression of demand through interest rate hikes will also be an impediment to the path of global growth in 2023. A weaker U.S. dollar will allow the risky asset like agriculture commodities to sustain high shocks through 2025. Early 2023 will be the beginning of the process of separating agriculture commodity prices from the U.S. dollar index. In the mini-cycle of the post-pandemic era after 2020, we expect the dollar to complete its weakness process in 2025 and the world economy to recover gradually as demand stabilizes. Until then, however, the risk of stagflation in the U.S. remains high and recession might be avoidable, but shrinking demand might be a fact that must be faced.

Chart 2: Soybean Price Trend & DXY
(The United States Dollar Index)

According to data released by the General Administration of Customs of China on Dec. 7, 2022, in November 2022, the total value of China’s imports and exports was US $522.34 billion, a decrease of 9.5%. Among them, exports were US $296.09 billion, down 8.7%; imports were US $226.25 billion, down 10.6%; and the trade surplus was US $69.84 billion. The combined effect of global trade contraction and higher trade volume in the same period last year caused a further decline in the growth rate of China’s exports since the fourth quarter. This side effect confirms that the U.S.’s current trade deficit due to the strong dollar is gradually moving back toward a correction.

The economies of key global countries, especially the U.S., are shifting from inventory replenishment to de-stocking. Due to the long cycle of agricultural production and the two-year shelf life of agrochemical formulation products, inventory depletion is likely to continue for two to three years. Therefore, it is foreseeable that 2023 will be a year dominated by the de-stocking of agricultural inputs. The development of 2023 sales strategy cannot only consider the increase of acreage; down-to-top marketing strategy will be a more effective way.

For Chinese agrochemical companies, it may be more pragmatic to increase market share through investment in the channel or deep penetration into farm demand. The supply chain disruption caused by COVID-19 brought more dividends to the supply side from 2021 to 2022. In 2023, all players will be directly confronted with supply chain reshaping and industry changes affected by the “China Plus One” sourcing strategy, a factor to consider when Chinese suppliers do business with customers.

Chart 3: JPMorgan Global Composite PMI

The downward trend in global Purchasing Managers Index (PMI) is now a problem that every emerging manufacturing economy will face. Europe, the U.S., Brazil, and other key markets for crop protection are continuing to contract demand due to inflationary pressures and tight monetary policies. The overall trade contraction trend may continue to drag down the world’s major economies’ GDP growth in 2023.

According to the International Monetary Fund (IMF), the global economic growth forecast for 2023 is 2.7%. 2023 will see a widespread global slowdown in growth, with around a third of the global economy experiencing economic contraction this year or next.

According to the IMF’s growth projection by region, the U.S. economy’s growth in 2023 is forecasted at 1%. The EU’s economic growth rate will be down to 0.5%. Due to the possible rebound of China’s economy, the country’s economic growth rate could be 4.4% in next year. The LATAM region’s economy might experience a drag. Brazil’s economic growth rate could be down to 1% as well in 2023, even though Brazilian activity has been resilient, and inflation is now coming down. We can say that China’s economic growth will remain an important influencing factor for the global economy to remain stable in 2023. With the easing of Omicron controls, the 2023 recovery in China will gradually lead operations downstream to a strong rebound in agricultural farming, especially in South America.

Chart 4: Latest World Economic Outlook Growth Projections by IMF

The Logic of Evergreen Demand

As mentioned earlier, with a basic understanding of macro trends, crop protection industry players should focus on farmer consumption behavior for the 2023 growing season. According to Purdue University’s AG Economy Barometer, in an environment of interest rate hikes and high farm input costs, investing in farm inputs on a large scale is not the optimal solution for North American agricultural practitioners at this time. The potential for strong bulk food prices in 2023 may continue to increase farmers’ willingness to invest in farm inputs.

In the South American market, soybean production hit a record high during the planting season, according to Datagro data from September of this year, cited by Reuters, which said it expects the area to expand to the highest level ever. According to Datagro’s first estimate for the new crop, South American farmers will harvest about 219.34 million tons from 66.09 million hectares (163.3 million acres) of soybean acreage in 2022/2023. If confirmed, future South American soybean production will be 21% higher than the estimated 2021/2022 harvest, with Brazil accounting for 70% of South American production.

Some of the Brazilian crop was affected by drought in 2021/2022 season, and the impact of this extreme weather is likely to occur in 2023 as well. Crop acreage in South America, especially in Brazil, is continuing to expand. And the losses to farmers from extreme weather, if it occurs, would be incalculable. This is the underlying logic behind the rapid development of biologicals, technologies to increase crop resistance, and digital farming technologies in South America. With a global population of over 8 billion, the demand for basic foodstuffs will surely increase. Trade in agricultural products between China and South America will be the anchor for the growth of trade in crop inputs between Chinese manufacturers and South American countries.

Chart 5: The Spread of Soy in South America from 2003-2019

Era of Resilience: The Advance of
Chinese Pesticide Companies

McKinsey & Company released the “2023 McKinsey China Consumer Report: A Time of Resilience” in December 2022, in which McKinsey identified Chinese consumers as being more resilient, more deliberate in their shopping decisions, and increasingly focused on quality and functionality when choosing products. This change in consumer behavior will allow companies that can “respond quickly to change” to win. I would also like to quote the word “resilience” mentioned in this report, not just by Chinese consumers, but by the resilience of the Chinese people as a whole, which has enabled the nation to gradually recover after several changes. A very important question for Chinese pesticide suppliers’ strategies in 2023 is how to find the future potential of the market in the face of weakening demand. 2023 is not a year for long-term strategy, but rather a short adjustment period, as the end of an era of stability and the beginning of a period of change. Long-term needs should be developed in a relatively stable political and economic environment. And 2023 will be the beginning of a rapid change in the world landscape. In such an uncertain environment, we need to think about where the “resilience” comes from.

There are currently 20 generic AIs in China’s supply market that are in absolute oversupply.

The future capacity of glyphosate, glufosinate, and other burndown herbicides or the capacity of their key intermediates will greatly affect the product profitability in 2023. In the future, new key prodrugs such as chlorantraniliprole and prothioconazole will also face the same status. Even though the 14th Five-Year Plan for the agrochemical industry was released to give the industry a forward-looking guideline, new production capacity, driven by strong sales and substantial profit margins, is growing dramatically with the growth of fixed asset investment and the development of local industry clusters, which have unimaginable amounts of investment. The red sea of competition for AIs will continue in 2023. Conversely, with the uncertainty of overseas production due to the Russian-Ukrainian war, the addition of short-term and flexible capacity in China would be the best sub-optimal solution available at this time. This is why certain herbicide varieties are in short supply in the short term, with price references but no goods available.

In manufacturing, resilience is very difficult to obtain. For China’s agrochemical supply, resilience comes from two sources. One factor is a consistent and stable supply of low-cost raw materials. For a giant economy like China, which is based on manufacturing and lacks crude oil as well as natural gas, energy security and controlled costs are the cornerstone of the country’s continued economic stability. Another factor is people. I have touched on this issue on various occasions. After China’s policy of easing controls on the Omicron, the Zhejiang government began organizing nearly 10,000 companies to fly overseas to develop their businesses on Dec. 4, 2022. In the three years of COVID-19, business managers from China have built tremendous momentum toward developing the global market. These entrepreneurially minded Chinese have only one goal: to make up for three lost years. The passion and confidence of those in the crop protection industry are sufficient indicators of the future resilience of Chinese manufacturing.

In a recent meeting of the Central Political Bureau, the Chinese government analyzed and studied the economic work for 2023. Two of the policy directions are very attention-grabbing: one is to vigorously boost market confidence, and the other is to effectively prevent and resolve major economic and financial risks. China’s easing of the Omicron control policy should boost market confidence as important measures by the end of 2022. The intensification of fiscal policy, precise monetary policy, opening up and greater attraction of foreign investment will be the focus of preventing economic and financial risks. It is predicted that the CNY exchange rate will remain stable within a certain range in 2023. The entrepreneurial energy of the whole society will be rekindled. Optimistic estimates suggest that China will likely gradually emerge from the gloom of the epidemic in 2023. The only thing that is hard to forecast at this point is what new hub of China will use to reconnect with the world.  •