October 19, 2017
Big corn importer-in-waiting? The long-term implications of China's corn market liberalization
After making ridiculously wrong predictions about China becoming the world's biggest corn importer, Beijing's policies are putting it on track for just such a fate. Here's why.
By Eric J. BROOKS
An eFeedLink Hot Topic
China's corn market has long baffled market observers, created false hopes and made fools out of so-called experts. Ten years ago, countless analysts (including this one) wrongly predicted that by this time, China would be importing 15 to 20 million tonnes of corn annually. Our analysis of Chinese supply and demand was correct but failed to factor in an important non-quantitative consideration: Beijing's geopolitical imperatives.
Historically, America supplied 50% to 66% of world corn exports in any given year -and China did not want its consumption to become precariously dependent on America, its geopolitical rival. It took steps to avoid this fate.
Starting in 2007, Beijing set a very high floor price for corn and provided extremely generous corn growing subsidies. With Chinese corn frequently selling at 1.5 to 2.5 times the world price, it strictly controlled foreign purchases: Companies were only allowed to import foreign corn with official permission, which was not readily given.
State reserves were periodically auctioned to off to avoid the seasonal shortages which would otherwise arise from such a protectionist policy, then restocked at the next harvest. Instead of becoming the world's largest corn importer, Beijing opted to boost corn prices to the point that near self-sufficiency was achieved -but at a great cost.
Outwardly, China's protectionist corn policy was a success: Whereas corn harvests trailed consumption growth before 2007, within a few years after the corn policy was introduced, they stayed well ahead of it. By 2015, Beijing held over half the world's corn reserves but problems were mounting further down China's agribusiness supply chain.
Saddled with some of the highest hog production costs in the world, China essentially substituted imports of red meat in place of corn, becoming the world's largest beef and pork importer. While failing to become the world's leading corn importer as predicted, it also became a world-leading importer of alternative, lower quality feed grains such barley, sorghum, DDGS and cassava. According to China's state-run Peoples Daily, by 2015, these alternate feed grains had been substituted in place of 40 million tonnes of corn over seven years -and played a large role in keeping the latter's import volume to a nominal minimum.
Concurrent with state-sponsored pork market dumping (which depressed hog prices), protectionist corn policies inflated feed costs and put its swine sector into a depression that it is yet to recover from. This was accompanied by world record corn inventories well in excess of 100 million tonnes -but livestock growers clearly made their preference for higher quality imported corn clear, with only strict government controls keeping it out of the country. The resulting low hog rearing returns made China's pork production fall behind demand for the first time since its economy was liberalized in the early 1980s.
Amid such mounting opportunity costs, China announced in early 2016 that it would liberalize its corn market. What did that mean in practical terms? The government made clear that it would let supply and demand determine the price. At the same time, it gave no fixed date for achieving this or even a roadmap for doing so.
While seasonal corn auctions continue, the government will no longer be the main actor in the corn market, and allow diverse buyers and multiple distribution channels. While the corn floor price has been gradually lowered and prices are inching towards world levels, policymakers made clear this would be done gradually, with no fixed date or time for when the process would be complete –the best guess being this would take several years, to 2020 and possibly beyond.
At the same time, Beijing kept an eye on domestic politics and keeping peace with rural residents: Knowing that a removal of subsidies would result in massive corn farming losses, it choose to reform corn growing subsidies rather than outright remove them: Going forward, subsidies for farmers would be a flat rate, independent of the corn. In order to keep domestic peace and liberalize the market at the same time, it opted to give farmers cash payments rather than keeping corn prices at artificially high levels.
After two years, these policies have yet to impact the world market –and will not do so for several more years. Even so, both official statistics and ground level reports clearly show that these policies are impacting China's farmers, its domestic corn market –and one day, the world.
According to USDA statistics, from 1997-98 to 2007-08 China's corn planted acreage increased 19.7%, from 23.8 million ha in 1997 to 28.5 million ha in 2007-08, when the protectionist corn self-sufficiency policy was introduced. Up to this time, China's corn acreage and corn yields grew at roughly the same rate.
After 2007, a domestic corn price two to three times world levels and a raft of subsidies further boosted corn acreage. It rose 33.7% in eight years, peaking at 38.1 million tonnes in 2015-16. Over the next eight years, planted acreage grew significantly faster than corn planted acreage.
Since the gradual shift to market-based corn prices was introduced in 2015, acreage has fallen sharply in two years, to a USDA estimated 35.0 million tonnes in the current growing season. While corn yields continue to grow, they cannot match the yearly decline in planted acreage underway.
Is there any reason to believe that China's corn planted acreage could continue falling more swiftly than expected? At the very least, ground level reports imply that China's corn planted acreage –and possibly harvests– will fall more swiftly in years to come.
Heilongjiang province –which traditionally grows most of China's soy -saw a lot of acreage converted to corn cultivation. With the government allowing market fundamentals to assert themselves, this has now started to reverse itself.
According to a ground level survey by Grain and Oil News (www.grainnews.com.cn/b/youzhi/2017/06/15-57018.html
), the past year has seen a lot of Heilongjiang acreage revert back from corn to soy cultivation. In northern Heilongjiang regions near Bayan and Heihe cities, they estimated acreage under corn cultivation to have fallen by up to 80% in some counties.
According to a report in Dim Sums Rural Chinese Economics blog (http://dimsums.blogspot.sg/search/label/corn
), in Hailun city, a major Heilongjian soybean-producing region, 2016 soybean plantings last year were 113,300ha and corn plantings were 80,000ha. In 2017 soybean area increased 59% to 180,000ha while corn acreage fell by a third to 53,300ha.
In neighboring Jiusan (no. 93) state farm area, 113,300 ha of corn and 108,600 ha of soybeans were grown 2016. This year, corn acreage nosedived 65% to 39,300 ha, and soybean plantings rose 41%, to 153,300 ha. The same blog reported that "A seed dealer in northern Heilongjiang said his sales of soybean seeds are up 35% from last year and corn seed sales are down 65%."
Only in the warmer, more southerly part of this major Chinese feedgrain production region does corn cultivation continue as before, as warmer climate and soil conditions make it naturally conducive to doing so.
Even so, despite southern Heilongjiang's better corn farming returns, the Grain and Oil News article claims that the province's corn farmers would not earn a profit at current prices were it not for subsidies, which at current exchange rates amount to US$170/acre. They currently earn approximately US$90/acre but without the subsidy would incur a net corn farming loss of US$80/acre.
That has profound implications, as China's corn price of US$6.55/bushel is still nearly twice that of CBOT corn (approximately US$3.50/bushel) -and has nowhere to go but down over the next few years. While China's government is unlikely to completely eliminate subsidies, there is a longer-term issue at work here: If Chinese corn prices continue falling towards international levels, losses could be too great for even the current level of subsidies to cover.
To understand what the role of corn subsidies implies, we need to look at longterm Chinese corn acreage and yield trends. From 1997 to 2007, the area harvested increased at a 2.2% and corn yields at a 2.2% annual rate, causing the harvest to rise by 3.9% annually.
From 2007 when the protectionist corn policy was introduced to 2015 when its long-term scrapping was announced, yields continued to rise at a 1.6%. However, with subsidies greatly boosting corn farming returns, many acres were converted from soy cultivation to the golden grain. With acreage rising 3.3% annually, corn harvests rose 5.0% annually through these eight years.
It has been an entirely different story since 2015: At 2.0% per annum, the past two years has seen Chinese corn yields rise significantly faster than in the previous 18 years. Even so, with corn cultivated area falling at a 6.3% annual rate, corn production will have fallen a projected 3% annually for the two years ending in the 2017-18 marketing year.
The growing gap between current subsidy levels and the falling domestic corn price could lead to a large drop off in Chinese corn acreage and harvests within a few years. Since the corn liberalization policy was introduced, harvest size has fallen 4.3%, from 224.6 million tonnes in 2015-16 to 219.6 million tonnes last year. Contrary to the USDA estimate of 215 million tonnes, the above Reuters article states that officials expect a 210 million tonne crop this year, making for a 6.5% fall in harvest size over two years.
More telling is what has happened to the supply-demand balance: One year before the policy was announced, China's corn harvest exceeded domestic consumption by 13.6 million tonnes. One year after corn market liberalization, China's corn consumption raced 12.5 million tonnes ahead of production. This year's expected 210 million tonne harvest will trail projected domestic consumption of 240 million tonnes by a whopping 30 million tonnes.
No need to worry over the short-term: While China's corn inventory may have fallen from 111 million tonne peak of two years ago, it is poised to close at a world-leading 74 to 79 million tonnes even after this year's inventory drawdown. Even so, it could be in a position where American corn inventories overtake China's in one or two years. Should that coincide with a fall in America's own corn inventories and a resumption of Chinese imports, a feed cost inflation spiral could be sparked.
Even if subsidies are maintained, this day could come sooner than expected: In a reversal of its previous dim view of biofuels, September saw Beijing announce plans to roll out the nationwide use of E10 (10% ethanol content) car petrol by 2020. In a 13 September 2017 report in Malaysia's The Star newspaper, Li Qiang, chairman of JC Intelligence, expects 10 new ethanol plants to be built in China's northeastern corn growing regions within a year. Li predicts that "Money will now flow in [to ethanol production], including from private and foreign investors."
Based on Reuters estimates, construction of 10 such plants would require approximately US$1.53 billion in new investment by 2021 to keep pace with Chinese demand for fuel. According to the USDA's September 2017 China Grain and Feed Update, "The E10 target implies that China would need to produce 12 million tons of transportation fuel ethanol just in 3 years. This will require 36 million tons of corn [by 2020]."
At the very least, this implies that the current, annual 20 to 30 million tonne gap between corn harvests and demand could easily double by 2020. With inventories currently projected by the USDA to fall to just under 80 million tonnes by August 2018, that is still too high a level for the country to enter the world corn market.
However, when the new ethanol production policy is added to existing supply and demand trends, corn inventories could easily slip below 50 million tonnes by 2019 and see China return to the world corn market in a big way no late than 2020. It should be kept in mind that on current trends, even if current farming subsidies are held constant, falling returns will cause land under corn cultivation to continue falling as fast or faster than yields can increase.
This creates an interesting question.
On one hand, unless corn growing subsidies are increased in proportion to the long-term fall in corn's price, farmers returns could diminish to a point where it is barely economical to grow corn. At that point, planted acreage and harvests could fall off far more steeply than anticipated, accompanied by a sudden, unexpected surge in imports.
On the other hand, that would require ever-growing government payouts to farmers, which could greatly strain China's finances –particularly at a time when national debt levels are rising sharply and economic growth is decelerating. It is doubtful that as Chinese corn's price drifts to internationally traded levels, Beijing would be willing to make such a huge portion of Chinese corn farming revenues little more than government welfare payments.
Finally, there is a very good reason why China could not accept importing 20 million tonnes or more of corn ten years ago -but is prepared to do so today.
Since 2010, the proportion of world corn exports accounted for by the United States has fallen from its traditional 50% to 65% proportion and into the 35% to 40% range. With corn production in countries ranging from Brazil to the Black Sea growing far faster than in America's maxed out corn acreage, the United States' share of the world corn market is headed for below 30% sometime next decade -and that makes it possible for China to import tens of millions of tonnes of corn annually from Brazil, Argentina or Ukraine without ever having to buy US corn.
As world feed corn's supply dependence on US exports fades, China will no longer take geopolitical considerations in its corn import strategy. This is already the case with soybeans, where Brazil and Argentina's combined exports outweigh those of the US. As it becomes possible for China to import tens of millions of tonnes of corn without relying on the United States, the following economic, non-geopolitical imperative takes over:
It makes far more sense for China to produce higher-value-added meat domestically and import lower value corn than to do the opposite -something it is doing today, as the world's largest importer of beef and pork. Even though it is currently the world's biggest red meat importer, China's policymakers know that it makes far more economic sense be self-sufficient in beef and pork and import low-cost corn.
With fears of US geopolitical corn market dominance fading, it will soon make as much economic sense for China to import tens of millions of corn annually as it does for it to buy 80 million+ tonnes of corn? Is the world ready for that day? Probably not, but one thing is for sure: A repeat of the previous decade's feed cost inflation will occur, especially if India enters the world feed crop market at the same time.
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