FEED Business Worldwide - March, 2012
Will the wheels fall off China's agribusiness miracle?
by Eric J. BROOKS
Quietly and without much fanfare, China's feed and livestock markets are slipping into an new era of supply-side crisis. Of course, we appreciate that this sounds like a bold and controversial statement, especially since this vast market's demand-side fundamentals remain as strong as they have ever been.
After all, in the half century from 1960 to 2010, China successfully boosted its population from 800 million to 1.4 billion and per capita meat consumption from 4kg to 60kg - all while staying mostly self-sufficient in feed crop supplies.
The average Chinese urban dweller eats significantly more meat than wealthy Koreans, Taiwanese and Singaporeans –and the rural half of the population has yet to double its per capita consumption. Using a constant, limited land area to boosting meat production by 2,500% over 50 years, while remaining self-sufficient in all feed materials except soy is a remarkable achievement, worthy of admiration and praise.
However, since 2007, cracks have started to appear in the Chinese agribusiness miracle: What could have been a one-off bout of swine market inflation shows signs of turning into an intractable inability to raise hog inventories. Even when higher hog performance and carcass yields are taken into account, hog supplies have been unable to keep up with pork demand.
At the bottom of the supply chain, flattening crop yields and limited land means that feed supplies are straining under the weight of ever-rising meat demand.
High feed and rising labour costs are also beginning to hamstring the more competitive poultry sector, whose exports are being threatened by a constellation of the above circumstances.
Sadly, many of these problems are made worse by populist or protectionist government policies, and their perverse market outcomes.
2007 vs. 2011 inflation
With all this in mind, the past year provided a second warning of the growing strains challenging Chinese agribusiness: For the second time in five years, China is coming off a bout of swine-led livestock price inflation. And while both the 2007/08 price spike and the past year's have similarities, this latter episode also raises more disturbing questions.
China's initial 2007/08 round of serious meat cost inflation had multiple roots, but the real kicker was overproduction and a subsequent sow over slaughter in 2006. That led to pork and piglet shortages a year later. At the same time, corn and soy costs were also on the rise, coincidentally pushing up feed costs. The latter cost-push component collided with strong demand pull from a then booming economy, leading to a virtual doubling of pork prices.
The 2007 pork market inflation then caused a substitution of eggs and chicken in place of red meat, thereby transmitting upward price momentum into the poultry and layer sectors. However, 2008's rebound in hog numbers and a subsequent recession caused a sharp, though incomplete drop in price levels.
Superficially, the past year's livestock inflation had similar causes, whereby hog shortages coincided with rising feed costs. This again led to high piglet prices, a rising cost base and high pork demand in the face of limited hog supplies.
In theory, 2011 pork prices may have set a record, but jumped by 57%, significantly less than the roughly 100% they climbed in 2007. That may superficially sound but in truth, hog prices never returned to their old, historic levels after 2007. This means that while 2011's hog inflation was superficially not as bad as 2007's, new price records were set and consumer wallets were just as maxed out.
Following the old script, 2011's swine inflation triggered substitution demand for white meat, causing high prices to be transmitted to the poultry, aquaculture and layer lines.
But that is where the similarities end: This time around, hog numbers fell to low levels not due to previous hog market cycle's overproduction but because of more intractable, systemic factors arising from policymaker's choices. Populist policies not only caused this bout of price inflation but imply that this time, prices will not drop by much - and that there might be similar price spikes further down the road.
How 2007's hog policies lead to 2011's inflation
Ironically, much of 2011's livestock price inflation is rooted in feed and livestock policies that were rolled out to control 2007's swine hyperinflation. Since that time, every Chinese New Year and during other peak demand seasons such as the Mid-Autumn festival, the government dumped pork from reserves into China's market. This was politically very popular, as it kept the price of pork low.
However, in the face of rising feed prices, swine prices were not allowed to rise to market levels capable of offsetting a rising cost floor. Government dumping of reserve pork repeatedly slashed hog farmer's profit margins to below market rates. In the four years following 2007, this greatly dented farmers' incentive to expand their swine herds. This, more than higher yields per hog, is the reason why despite growing demand, early 2012's pork inventories remain below their mid 2000s peaks.
This is also why despite historically high prices, with the government repeatedly slashing swine returns during peak demand periods, it became increasingly difficult for hog farms to get a high return –or justify expanding their herds to levels that would balance the market.
Feed crop policies boost production costs
Further up the supply chain, a move created to ensure China's feed grain security has also backfired, further boosting production costs and constraining livestock supplies.
China has long accepted its dependence on foreign soy while trying to avoid importing feed corn at all costs. By the early 2000s, this policy appeared to be successful, with corn reserves of over 100 million tonnes equaling more than a year's worth of feed demand.
However, by 2003, it was clear that feed demand was overtaking domestic corn harvests. Initially refusing to import corn at all costs for more than half a decade, since 2007, China has endured chronic corn shortages and corn costs 50% higher than the world price. All this despite dumping over 100 million tonnes of corn and depleting its corn reserves to dangerously low levels.
This has already boosted meat production costs, undermined the international competitiveness of its chicken exports and slashed livestock farmers' rates of return. At the same time, lower corn prices resulting from years of reserve sell-offs dented domestic corn farmers' incentive to expand their acreages.
Corn shortages also forced domestic hog farms to source feed with quantity rather than quality in mind: Amid persistent shortages, moldy corn that should never have seen the light of a feed mill was used. Evidence is slowly growing that Chinese corn's high mycotoxin levels is behind much sow infertility and weakened immunity. This has led to lower hog inventories, poor sow fertility and more frequent disease outbreaks, thereby putting another constraint on the domestic supply of hogs and pork.
In 2012, five years after the above problems began stressing China's agribusiness sector, the situation has clearly deteriorated. Corn imports are now allowed –but not enough to bring down domestic corn prices, which remain near US$9/bushel, some 40% higher than CBOT corn.
While high feed costs putting a fire under the cost floor of hog farms, the routine dumping of reserve pork deprives hog farmers of a proper return: During the run up to Chinese New Year or Mid Autumn Festivals, the high prices should ensure them a healthy return. Instead, China's government sells of reserve pork during most festive celebrations, depriving them of a decent return. That's one important reason why hog inventories barely increased in the run up to 2012's Lunar New Year, contrary to what would be expected of a centuries-old market cycle.
Unstoppable momentum of two Chinas: Urban and rural
Yet, in their own way, feed and livestock stakeholders are preparing for the future: With laws prohibiting the transport of rapeseed into inland provinces, crushers are ignoring overcapacity to set up new facilities at ports, where they can access foreign oil seed supplies.
All the above challenges, while frustrating to suppliers and meat consumers alike, create considerable pent-up demand in an economy of a billion people where GDP is expanding by nearly 10% annually. And this bring us to the topic of why, despite its many difficulties, Chinese agribusiness enjoys unstoppable momentum.
For one, approximately 49% of China's population still resides rural areas –and they consume only about 50% of the meat per capita of urban dwellers. According to Darren Hoffman, Rabobank's Shanghai-based director of Food & Agribusiness Research and Advisory for China, "if we separate China's meat consumption between the urban and rural population, we get what looks like a comparison between a developed and developing country."
In sum, China is a fast growing developing country with an even faster growing developing market within its own borders: Rural China's 600 million people are a market as large as all of Southeast Asia –and they will spend the next twenty years raising their per capita meat consumption to levels taken for granted in places like Singapore or Taiwan. Indeed, even if China's policymakers hold back its livestock sector, the opportunities implied are too large to be ignored.
Moreover, equally large opportunities will be created in the feed sector by the ongoing consolidation of Chinese agribusiness, particularly its swine sector. According to Hoffman, "The transition to scaled livestock farming in the pig industry alone will be a major swing factor in feed demand. If China were to follow US pig farming models, that alone would raise hog feed demand by 50%. On top of that we are seeing China's absolute animal numbers increase."
Essentially, while China's meat demand growth fundamentals remain as strong as ever, the wheels are starting to come off the livestock sector's supply-side miracle. Growing supply and input shortages, while challenging for China as a whole, also create unprecedented opportunities for stakeholders, both inside and outside China.
In the pages to follow, we look at the primary feed and livestock challenges facing China, and the supply-side options which must be pursued.
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