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COMMENTARY & ANALYSIS

April 7, 2017
 
Salmon farming enters Chapter #3: Scarcity for the first time since the days of wild catches
 
By ERIC J. BROOKS
 
An eFeedLink Hot Topic 
 
  • Forty years of abundant salmon and falling prices have given way to an inflationary market
  • Instead of rising gradually, unanticipated disease control problems in both Chile and Norway has pushed up floor prices by 50% in just one year
  • Mainstream supply forecasts are too optimistic while demand forecasts are too pessimistic. This implies strong price inflation in years to come
  • After freeing us from limited wild catch supplies, salmon farming now faces serious, long-term resource constraints of its own
For the first time since farmed salmon overtook wild catch as the main supplier of consumer demand, the world finds itself chronically short of this seafood species.
 
Salmon's average selling price jumped over 55%, from NOK40/kg (US$4.80/kg) in 2015 to NOK62/kg (USUS$7.44/kg) in 2016. This however, does not capture the true extent of inflation or market volatility: Atlantic salmon traded above NOK75/kg during peak demand times with larger fish touching NOK85/kg (US$10.20/kg). All this is more than 100% above its 2012 to 2015 price level.
 
It then entered 2017 at the whopping level of NOK75/kg (US$9.00/kg) before settling back to the historically high NOK62/kg (US$7.44/kg) level at the time of publication.
 
Despite record high prices, producers find themselves incapable of boosting production. Led by a Nordea Bank AB estimated 5.1% drop in Norwegian farmed salmon production and a 17% decline in Chilean output, 2016 saw the world grow a whopping 7.4% less Atlantic salmon than in previous year.
 
For a world market that used to 6.4% annual farmed Atlantic salmon production increases from 2004 through 2014, that was quite a shock to the system. Granted, industry observers had warned that output increases would decelerate into the 2% to 3% range in the latter part of this decade.
 
Even so, the years 2010 to 2015 inclusive had seen average annual supply growth in excess of 5% --one year later, the biggest output drop in salmon farming's forty-year history occurs. Everyone expected the reaching of Norwegian and Chilean production limits would lead to a gradual, long-term increase in prices. No one had not anticipated such steep output drops, the hyperinflation that followed or the prospect of even more to come.
 
What led to today's supply-short, crisis dominated market? Essentially, we are experiencing a stormy introduction to world salmon farming's third development phase. Chapter #1 stretched from the invention of commercial salmon farming in the 1970s through early 2000s.
 
The entire period was keynoted by gradually falling unit production costs. When Norway started approaching production limits, Chile entered the world market. Even today, they supply 75% to 80% of exports. Large annual increases in productivity, 10%+ annual output increases made for abundant supplies and constantly falling salmon prices.
 
From the early 1980s through the early 2000s, feed costs stayed low for an exceptionally long time and salmon productivity was constantly rising.  In the latter half of this era, Norway's substitution of vaccines in place of antibiotics significantly improved salmon performance and lowered unit costs while augmenting its reputation for food safety. Eventually, once expensive salmon became cheaper than high end beef cuts such as striploin steak. Throughout this period, prices behaved cyclically, with a tendency to trend downwards over time.
 
This happy medium began to show signs of strain in salmon farming's Chapter #2, which spanned the early 2000s through 2015. During this time, the supply of new production frontiers within Chile and Norway started to dwindle.
 
This was also the era when the cost of fishmeal hyperinflated by 450% in ten years and soymeal price records were repeatedly broken. Consequently, from the late 2000s and into the early 2010s, sharply rising feed costs offset rising salmon productivity.
 
The mid-2000s was also when Chilean salmon farmers encountered serious disease control problems for the first time. With rising feed costs only partly offset by rising salmon performance and Chilean supply growth tapering off, it made for an era of cyclical prices with a slight upward bias over time. From the early 2000s to the late 2000s, salmon's floor price rose from around NOK20/kg to NOK25/kg. It was the first time since commercial salmon farming began in the 1970s that its price level (adjusted for inflation) refused to fall.
 
Alongside growing production difficulties, consumers began to focus on salmon's nutritional characteristics at a most unfortunate time: The substitution of plant-based inputs in place of increasingly scarce, expensive fishmeal made critics note that farmed salmon's omega 3 fat levels were falling.
 
In 2012 and three years that followed feed costs touched record highs and subsequently retreated. In retrospect, this last phase of salmon farming's Chapter #2 could be called, 'the calm before a storm': 2012's feed cost inflation and record fishmeal prices pushed salmon's trading range from NOK25/kg to NOK33/kg to above NOK36/kg and thereafter, the market appeared to settle down.
 
After late 2012, a 50% fall in soymeal's cost, 35% drop in fishmeal prices and increasing use of plant-based feeds made for several years of flat production costs. Feed costs retreated to mid-2000s levels but demand was high enough to keep prices significantly higher than they were at that time.
 
Relief from feed cost inflation coincided with a strong (though short-lived) recovery in Chilean salmon output. Amid flat costs and recovering Chilean production, world salmon output increased 5% annually with prices staying at a NOK38/kg to NOK41/kg plateau for approximately three years.

During these three years of relative market calm, analysts warned that with future supply increases being limited to 2% to 3%, the post 2012 era of flat prices would not last: Rising Asian demand would ensure that demand would outstrip supply. From around NOK38/kg, salmon's price floor was forecast to rise an average rate of roughly 3% per annum from 2015 onwards. In retrospect, the industry's new, widely predicted Chapter #3 occurred faster and far more dramatically than anyone expected.
 
When a new wave of serious Chilean disease outbreaks occurred in late 2014, it coincided with Russia's boycott of Norwegian salmon. Traders assumed that disappointing Chilean supply growth would be counterweighted by Russia's drop in salmon demand. That kept prices steady until late 2015, when the full extent of Chile's disease control problems and new Norwegian sea lice outbreaks became known.
 
Within a few short months during Q1 2016, the industry went from the idea that output would increase slowly to the reality of steep, intractable production shortfalls. Consequently, instead of rising gradually over a few years, the average salmon price rose 50% in one year. NASDAQ data indicates that from approximately NOK40/kg in both 2014 and 2015, salmon's price jumped 52%, to an average of NOK61.80/kg in 2016.
 

This however, is merely an average and does not show the full extent of last year's hyperinflation. Selling prices were in the NOK64/kg to NOK75/kg range for over half the year. With disease decimating both Chilean and Norwegian farms, the price of larger fish went over NOK85/kg in the second quarter of 2016 and traditionally high demand fourth quarter.
 
In response to these new disease outbreaks, Norway is limiting production increases to 3% a year and Chile is setting new production quotas 30% to 50% below peak levels. On one hand,
 
To make matters worse, farmed salmon encountered a growing number of consumer marketing and public relations problems. Desperate to control disease outbreaks, Chilean farmers pushed antibiotic use to levels that got their salmon removed from leading supermarkets like America's Costco. The ban was accompanied by negative publicity on the role played by high antibiotic levels in producing disease resistant bacteria.
 
Norwegian salmon did not suffer from such a serious food safety issue but its nutritional credentials are increasingly under fire. A reputable 2016 Scottish study found that the level of omega 3 fats inside salmon farmed in countries like Norway had crashed 50% in just ten years. Goaded by such studies, wealthy, educated consumers seeking healthy lifestyles and heart disease prevention are increasingly shunning all farmed salmon in favor of wild caught fish.
 
Going forward, industry analysts expect recovering Norwegian production to sink prices into the NOK50/kg (US$6.00/kg) to NOK55/kg (US$6.60/kg), before rising back up to around NOK70/kg during the high demand fourth quarter.
 
Beyond 2017, some believe there is reason to believe the worst is over. Nordea Bank for example believes that world farmed Atlantic salmon production will grow by 3.2% this year, to 2.24 million tonnes. While this puts 2017 output 4% below 2015's peak of 2.34 tonnes, it is confident today's higher price level has destroyed enough consumer demand to bring the average price of salmon to NOK57/kg (US$6.84/kg) this year and to the still historically high but significantly lower NOK51/kg (US$6.12/kg) by 2019.
 
The problem is that Nordea Bank's forecast assumes that world salmon production will grow by 8.8% in 2018 and 7.5% in 2019. –But with Chilean salmon farming now banned from increasing stocking densities, its production will be lower in 2017, 2018 and 2019 than it was in 2014!
 
Consequently, Nordea's forecast assumes that Norway will carry the entire world market on its shoulders, by boosting production 9% in both 2018 and 2019. That in turn assumes that Norway –which already has higher stocking densities than Chile– will somehow use the rest of 2017 to successfully develop ways to boost the number of salmon it grows per square meter by over 15% without running into disease control problems.
 
Unfortunately, the latest industry reports state that not only did Norway fail to get sea lice under control, but that these production problems have spread to British salmon producing regions in Scotland. With every day that goes by, the lack of a ground-breaking innovation makes it less and less likely that Norway can achieve the following miracle: Achieve near 10% salmon output growth that it could only do before 2000, when new frontier regions were being opened.
 
There is also (in our opinion) a flaw in Nordea Bank's demand forecast: It does not fully appreciate the implications of Asia becoming an important driver of salmon demand. Unlike the west where salmon is widely consumed, Asian salmon consumers tend to be in the top 10% of income and wealth. –This is a consumer demographic segment that will not cut back their food purchases even when prices increase.
 
Thus, Nordea Bank's assumption that the high price level will destroy enough demand to balance the market may not hold true. At the very least, even if western consumers have cut back their demand for salmon, this sea food's new, wealthy growing consumer base in the Far East have a history of boosting their consumption of red meat even in the face of record high prices. There is no reason to believe they will cut back their demand for pricier salmon.
 
Given that Nordea Bank's post 2017 supply forecast is overly optimistic and its demand prediction appear overly pessimistic, it stands to reason that after taking a breather and trading in the NOK51/kg to NOK66/kg range in 2017, salmon, while not hyperinflating as badly as before, will continue see its price floor rise towards the NOK60/kg level.
 
From a longer-term perspective, the problems with disease outbreaks, stocking densities and falling omega 3 fat levels all point to the same conclusion: After liberating us from the limited supply of salmon that could be caught from the sea, farmed salmon is now facing chronic, critical resource constraints of its own.
 


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