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August 11, 2016

The end of abundance: The world salmon market enters a new era


An eFeedLink Hot Topic
  • World salmon output fell 10% in 2016 and will only equal its 2015 peak in 2019
  • Chile's reduced production capacity has curtailed world supplies by up to 300,000 tonnes
  • The resulting supply shock triggered unprecedented price inflation, extreme market volatility
  • Currency movements, productivity growth has given Norwegian salmon a huge cost advantage
  • Large productivity differences between Chilean, Norwegian exporters resulted in profits, losses of equally extreme magnitude
  • Say good-bye to the era of cheap salmon
After years of steady, predictable growth, world salmon markets are groaning under the weight of new circumstances. An unprecedented rally that boosted salmon prices by 100% to all-time highs in six months, free fall market deflation, record price gaps between fish of various sizes, huge earnings gaps between producers: All these are symptoms of unprecedented upheaval in the industry's fortunes, profitability and long-term supply dynamics.
On one hand, the current market trend has been long anticipated: After 30 years of falling unit costs brought salmon's price to levels comparable to that of red meat, the post-2005 exhaustion of new aquaculture frontier areas had long been projected to keep supply more slowly than demand from 2015 onwards.
On the other hand, while everyone expected demand to overtake supply, no one expected it to happen so quickly or chaotically –in particular, Chile's production capacity has been unexpectedly slashed by 300,000 tonnes or 31% from its peak levels of just two years ago. This year's salmon market hyperinflation is due to Chile's inability to boost productivity or stocking densities.
Coinciding with the exceptionally fast growth of its salmon production at the time, Chilean feed costs stayed consistently below those of Norway from the late 1980s through the mid-2000s. This enduring secular trend ended when feed cost inflation coincided was followed by a steep 30% devaluation of the Chilean peso. With Norway's currency tending to rise over time, Norwegian feed costs fell at the same time those of Chile increased.

According to Fishpool, in 2005, requiring US$2.40/kg to grow salmon, Chile enjoyed a 16.7% advantage in unit production costs over Norway, where it cost US$2.80/kg. By 2015 however, Norwegian salmon's unit production costs had risen by 17.9% --and this is far less than the cost of feed, which rose by approximately 50% from 2005 levels.
By comparison, by 2015, Chile's salmon production unit costs had skyrocketed by 75%, to US$4.90/kg –and Chilean salmon went from being 14% cheaper to grow than its Norwegian competition to costing 50% more. Moreover, this new, wide cost gap between Chilean and Norwegian salmon is not entirely caused by the fall in Chile's currency.
With both producers importing most of their feed inputs, the past decade's depreciation of Chile's peso and concurrent appreciation of Norway's krona only explains 60% or US$1.00/kg of Norwegian salmon's 33%, US$1.60/kg cost advantage. At the Fishpool/DNB seminar in Brussels, Belgium on 25 April 2016, Dag Sletmo, an analyst with DNB Foods & Seafood, noted that when adjusted for inflation, Norway's salmon production costs should have risen 39% or US$1.10/kg, from US$2.80/kg to US$3.90/kg. Instead, Norway's salmon input costs only increased 18% or US$0.50/kg, to US$3.30/kg.
This is because Norwegian salmon growers have improved their productivity by more than 15%, but their Chilean competitors haven't. In fact, the latter are still using mid-20th century methods to achieve balance between stocking densities and fish health: Based on figures supplied by Sletmo at the Fishpool/DNB seminar, Chile uses four hundred times more antibiotics than Norway to produce half as much salmon.
Raul Sunico, Chile's undersecretary of fisheries and aquaculture stated that nearly US$1.00/kg of production costs are accounted for by antibiotics –and that makes for an interesting implication: On one hand, if it stopped using antibiotics, Chilean production costs would fall from US$4.90/tonne to near US$3.90/tonne.
On the other hand, had Norway failed to boost productivity, its production costs would now be US$3.90/kg instead of US$3.30/kg. –This points to a damning conclusion: If over the last decade, Norway had not boosted its salmon farm productivity and Chile had learned to grow salmon without antibiotics, their production costs would be nearly identical at this time.
The latter find themselves besieged by currency inflated feed costs and are unable to bring their animal health costs or disease losses under control. Moreover, Norwegian salmon's lower cost base has induced a profound divergence in the fortunes of Norwegian and Chilean salmon growers.
According to Sletmo, two years ago when world salmon output began to level off, Norwegian suppliers had average earnings before taxes NOK13/kg (US$1.08/kg) while their Chilean competitors where only earning NOK5/kg (US$0.42/kg). By Q1 2016, with world salmon prices racing toward record levels, Norwegian salmon growers were earning NOK18/kg (USUS$1.50/kg).

By comparison, Q1 2016 saw Chilean farms losing -NOK15/kg (-US$1.25/kg), with their loss margins steadily widening over the past two years. While part of this loss was due to an algal bloom that killed a huge number of salmon, even if the red algae bloom had not occurred, the average Chilean salmon grower would still have lost -NOK9/kg (-US$0.75/kg) in the first quarter of this year. Ironically, this happened even though Norwegian exporters were far more impacted by Russia's economic boycott, which resulted in broken export commitments and huge oversupply problems.
Indeed, it is Chilean salmon's inability to sustain a net profit position at higher production volumes that recently prompted its government to restrict stocking densities to 27% below current levels. According to Subpesca, the Chilean government's fishing and aquaculture regulator, this could cap 2017 salmon production 24% below the average level of the last four years. Thereafter, any given salmon farm can (if it fulfills sanitary criteria) only increase production by no more than 3% annually. Clearly Chile's days of 5% to 10% annual growth in salmon output are now over, as are any dreams of it overtaking top producer Norway.
This implies that by 2020, Chile's highest possible salmon output will in the 660,000 tonne to 680,000 tonne range, far below its peak production of 955,000 tonnes. It is the same volume of salmon produced by Chile in 2012-13, even though world demand will be at least 15% higher by that time.
Limiting Chilean salmon's output to this level also implies a loss of approximately 275,000 tonnes or 12% of world output from peak 2014-15 levels. –And it should be noted that salmon supplies were expected to tighten up and prices to firm up even before this loss of Chilean output was announced. Coinciding with Norway's difficulties in controlling sea lice earlier in the year, it was this massive, permanent loss of Chilean salmon output which hyper inflated salmon prices to twice their usual levels.
While other suppliers are taking advantage of high prices, none can make up for Chile's output loss. At the same time, with no unexploited water resources left, higher stocking densities and disease risk are the only way to boost output. Unfortunately, with Norway's output so close to the limit of what is technically possible, its marginal costs of boosting salmon production are also rising sharply. –Since bottoming out near NOK18/kg (US$1.50/kg) in the mid-2000s, Norwegian salmon farm operating costs have risen by 39%, to NOK25/kg (US$2.08/kg) this year.
On one hand, Norway's government has announced a more liberal maximum allowable biomass (MAB) policy, especially in years when colder ocean water temperatures prevail. With this year's output running up to 6% below capacity, a higher MAB allowance could allow Norwegian salmon output to rise by 10% in 2017 before settling back to a slower 3.5% pace.
Over the short term, barring any more supply shocks, that should stabilize prices and tame market volatility in 2017. –Over the longer term, once Norwegian output approaches 100% production capacity, leading growers like Marine Harvest openly doubt whether they can sustain production increases above 3% without encountering serious disease control problems.
On the other hand, under the new rules, Chile's salmon output will still be nearly 300,000 tonnes lower in 2019 than it was in 2014. With salmon output in Britain, Canada and the rest of the world growing by less than 2.5% annually, Bank Nordea estimates that 2015's peak salmon output of 2.6 million tonnes will not be exceeded before 2019.
If the resulting imbalance between topped out salmon supplies and rising Asian demand weren't enough to push prices higher, the marginal cost of increasing production is even higher outside of Norway. While Norway's total unit production costs are up by more than a third in ten years, at NOK31/kg, its salmon production costs remain far below those of second ranked Chile (NOK44/kg), third leading producer Britain (NOK47/kg) or fourth ranked Canada (NOK43/kg). With all major exporters operating near their technical maximum stocking densities, unit costs have nowhere to go but up.
Needless to say, economics clearly states that a commodity's longrun price must equal or exceed the marginal cost of the market's most expensive supplier. This implies that even long after 2016's topsy-turvy salmon market rally ends, the days when salmon's export price fluctuated in the NOK30/kg to NOK45/kg (US$3.60/kg to 4.80/kg) range are long gone. With salmon's price floor rising towards NOK45/kg (US$5.40/kg), we can expect this premium seafood to cost significantly more in years to come.

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