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January 19, 2010
 
When pigs stop feeding fish: Record fishmeal prices & a dying substitution effect
 
Using oil seeds as safety valve, markets redirected increasingly scarce fishmeal from livestock farms to aquaculture, thereby limiting price increases. The exhaustion of this trend has inflationary implications for fishmeal prices.
 
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by Eric J. BROOKS
 
 
Long expected to be in short supply, fishmeal is starting to reveal its alarming scarcity. Starting five years ago, experts predicted that amid flat, gradually declining catches and rising aquaculture production, fishmeal prices would rise at an average 7% to 8% a year. Instead, from the start of 2005 to January 2010, it rose at an average annual rate of more than 17%.
 
 
Hyperinflating amid new price records
 
The Lehman/AIG panic, which shot down most commodity prices 45% to 70%, barely made fishmeal drop 20%. Recently, it has risen 56% in just one year, breaking one price record after another over the last three months. Only oil, which has not broken any price records, rose by a greater amount over the last year.
 
The whole trend is driven by ever-widening supply-demand imbalances. On one hand, fishmeal-dependent aquaculture continues to grow faster than any other protein line. Unlike livestock, aquaculture has no substitute for fishmeal. On the other hand, 2009's world fishmeal catch fell for the fifth straight year, with four of the top five producers (Chile excepted) producing less fishmeal than in 2008.
 
The situation may be tighter than it looks. Officially, the International Fishmeal and Fish Oil Organisation (IFFO) reports that Peru produced 867,000 tonnes of fishmeal in the first half of 2009, which is down from 895,000 tonnes in 2007 and 885,000 tonnes in 2008. However, in her bi-yearly, January 2010 UN FAO Globefish report, Helga Josupeit states that, "Some 830,000 tonnes of fishmeal were produced by Peru, 5% less than in the same period of 2008." Given the desperate tightness of fishmeal markets this year, it would not be surprising if some anchovy catch and fishmeal production numbers are later revised downwards. Late 2009 and early 2010 catches are being impacted by a El Nino, whose warm water that usually drives fish away from their catching areas.
 
Furthermore, for the second year in a row, Peru only managed to increase exports to its main customer, China, by digging into inventories and selling less to its leading western clients, which were mired in recession. Indeed, the cupboard is increasingly bare, not just with respect to inventories but also in terms of the fishmeal that aquaculture can squeeze out of livestock feed markets.
 
 
Nothing left to squeeze out of livestock feed?
 
After fishmeal catches started declining, for many years, aquaculture's hunger for fishmeal was partly sustained by livestock. That is, at one time, almost all fishmeal was consumed by land animals. Yet, right from the start, when aquaculture took off in the 1980s, its fishmeal consumption grew faster than that of livestock.
 
Later, as fishmeal catches peaked and declined, high prices induced livestock farmers to substitute alternative protein meals such as soymeal, meat-and-bone meal and whey in place of fishmeal. For many years, this partly offset declining fishing catches'impact on aquaculture fishmeal supplies.
 
However, by 2009, over 60% of fishmeal was being used up by aquaculture, with the lion's share of this finding its way to China. With wild catches on a downtrend and very little fishmeal left to transfer from livestock to aquculture, the crisis is entering a new level with several implications.
 
First, despite the steep rise from near US$200/tonne in the late 1990s to over US$1,560/tonne today, things would have been a lot worse if livestock, particularly the poultry sector, had not stopped using fishmeal en masse. The last decade's dramatic price increases would have been far worse if livestock moved away from fishmeal in tandem with global aquaculture's expansion.
 
 
Fishmeal de-linking from other protein meals?
 
Second, with less and less fishmeal left to substitute away in livestock feed, there are indications that it is de-coupling itself from the larger protein meal complex. Traditionally, the fishmeal to soymeal price ratio stands between 2.5 and 3.0 but this has been less true in recent year.
 
Previously, when this price ratio goes above 3.0, usually soymeal rises in price or fishmeal becomes cheaper. When it falls below 2.5, either fishmeal rises in price or soymeal becomes cheaper. In theory, the substitutability between these protein meals was supposed to moderate their price swings. A quick glance at an accompany graph indicates that this relationship apparently has apparently broken down, with fishmeal exceeding its upper ratio boundary for increasingly longer periods in recent years.
 
In 2006, a strong El Nino warm water current cut the Peruvian anchovy harvest, causing the fishmeal: soy ratio to rise over 7.0. Fishmeal set a new price record but it had risen too quickly relative to soymeal. In the middle of the last decade, there was still enough fishmeal left in livestock feed that substituting soy in its place could impact prices. Most of the fishmeal then used in livestock feed was then duly cut out, in favour of soy and other oil seeds. Naturally, this helped raise oil seed demand, transferred fishmeal from pigs to fish and tempered its price inflation.
 
Not surprisingly, after fishmeal set its 2006 price record, soy then played catch-up, breaking own price records and cutting the fishmeal: soymeal ratio to below 3.0 by early 2008. Meanwhile, with its high price encouraging cheaper soymeal to be substituted in its place in livestock feed, fishmeal consolidated back into the US$950-1,150 range, where it stayed for most of the next two years, including during the Lehman/AIG crisis.
 
 
Saying 'sayonara' to soy
 
Yet, a look at the price trend shows that fishmeal actually was on track to break its old price record just before the financial panic hit. Its momentum was temporarily broken, but not halted by last year's financial crisis. Was late 2008's return to the old fishmeal:soymeal price ratio just a side-effect of the year-long financial panic? It must be noted that underneath those credit paralysis induced price drops, fishmeal catches kept declining year-on-year even as Chinese aquaculture's appetite for it kept growing.
 
More importantly, with livestock now accounting for a shrinking minority fishmeal consumption, there is very little additional scope for substituting oil seeds in place of fishmeal in livestock feed: Sometime after 2005, the days of tempering fishmeal prices by transferring scarce fishmeal from livestock to aquaculture quietly faded: If not already, then very soon, there will be too little fishmeal still being used in livestock feed for the soy-fishmeal substitution effect to work efficiently.
 
This means that in the future, barring any technical innovations in the use of oil seeds in aquaculture, soy can no longer be easily substituted in place of fishmeal when the latter's price rises. That implies both higher fishmeal prices in the future and a breakdown of the traditional 2.5:1 to 3.5:1 ratio between fishmeal and soymeal prices. This now appears to be happening.
 
In early 2009, during the first half of the post-crash commodity market recovery, the fishmeal to soymeal price ratio actually fell into the 2.5 to 3.2 range. Soon however, while soy put in a stronger than expected performance in H2 2009, fishmeal developed legs of its own. With so little fishmeal now being used in livestock, a once-near liquid substitutability between oil seeds and fishmeal is vanishing. There was simply too little fishmeal left in livestock feed to redirect to aqua feed mills. Although rapeseed and cottonseed can be partly substituted in place of fishmeal, their markets, like those for most non-soy oil seeds, are currently tight.
 
With China's accounting for over half of global aquaculture and fishmeal export demand, its rapid recovery sustained fishmeal demand amid a smaller catch. Hence, after mid 2009, soy prices moderated but the substitution effect failed: Fishmeal kept going its own way, rising more strongly than in the first half of the year.
 
For the last six months, moderating soymeal costs and rising fishmeal prices bumped their price ratio well above 3.5. If the old 2.5:1 to 3.5 price ratio rules have any value, this should have put the brakes on fishmeal prices. Instead, fishmeal prices shot up even faster as the fishmeal:soymeal price ratio climbed. By early 2010, fishmeal was breaking one price record after another while soymeal prices languished and their cost ratio jumped to 4.5. Evidently, with their substitutability at an end, a high fishmeal price relative to soy no longer implies a break in price momentum.
 
 
Pre-booked sales anticipate higher prices
 
Indeed, despite the sky-high prices, buyers continue to pre-book fishmeal before its source fish can even be caught. Wayne Bacon, president of Hammersmith Marketing Pte wrote in his January 10, 2010 weekly report that, "Fishmeal production in Peru has now been almost totally sold for this [June - December] fishing season and producers are starting to book business from major buyers for the May - June period. It looks like the large pre-season sales trend of the last couple of years will continue in 2010."
 
Bacon adds that, "The word in the market is that the sales for next season are at about the same level as current price levels." For rational buyers to purchase fishmeal in advance at today's record prices, they must be assuming that its price will go even higher. Although buyers are aggressively looking for substitutes to fishmeal, barring any quantum innovative leaps, the scope for further reductions in its usage is limited.
 
Bacon stated that, "Even if the percentage of fishmeal in feed formulations can be reduced, the total demand will probably still remain very strong as the world feed production industry is growing every year --- so a smaller percentage of a bigger market can still mean that there is a shortage of fishmeal."
 
 
Holding back aquaculture?
 
Over the years, everything from trash fish to krill, maggots to carefully formulated, enzyme enhanced oil seeds have been touted as fishmeal substitutes.  Up to now, all have disappointed the market. To feed farmed fish, many pigs and chickens now mostly make do without fishmeal.
 
With output falling every year, a fish-poor El Nino due and no more livestock-destined fishmeal for aqua feed mills to raid, the situation is rapidly coming to a head. All things being equal, in the absence of an adequate, mass-market substitute, there is little to stop prices from hitting US$2,000/tonne within eighteen months or less.
 
The wild card in such a bold prediction is market liquidity, as there exists a very high probability of another, commodity shaking financial crisis occurring between the 3rd quarter of 2010 and the 4th quarter of 2011. That might give fishmeal prices another rest, perhaps even restore the traditional fishmeal:soymeal ratio for a little while longer.
 
Even so, a recent UN FAO report expects world aquaculture output growth to taper off. It looks increasingly as if fishmeal shortages will adversely impact global aquaculture production.
 
 
Impact on China's pigs & fishes
 
As it accounts for 67% of world aquaculture output and over three fifths of Peruvian fishmeal exports, all eyes are on China. For if an adequate, sustainable, mass-market substitute for fishmeal in aqua feed does not materialise, it has grave implications for Beijing's policymakers.  Up to now, China has been meeting its protein meal deficit via mass soy import volumes. With respect to both fishmeal and soy, it buys up over half of internationally available exports.
 
China however, is further along than most countries in removing fishmeal from livestock diets, yet its aquaculture demand grows faster than that of the rest of the world combined. This means that despite its record soy imports, the country's scope for further substitution of oil seeds in place of fishmeal is mostly exhausted.
 
This implies that within a few years, China's policymakers might grappling with two serious protein challenges at the same time: Coincidental shortages of corn and fishmeal simultaneously hampering their ability to produce both livestock and seafood. With the substitution effect's link between fishmeal and soy fading away, simultaneous deficits of fish protein and coarse grains would profoundly impact China's capacity to raise both pigs and fishes.
 


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