April 9, 2016
Just another salmon price rally, or is it a major market turning point?
By ERIC J. BROOKS
An eFeedLink Hot Topic
- Due to production losses, salmon prices made two volatile price spikes, one for each supply shock
- Narrowing spreads between large and small sized fish imply the rally is over and that buyer resistance is rising
- Despite their retreat, prices are settling into a higher market floor that reflects poor supply growth
- Unlike the previous era industry of rising output and falling costs, salmon farming's cost base is now rising and output inches upwards, trailing demand
- Chile has the greatest growth potential; it also has significantly higher input costs than Norway
- Average prices to rise by up to 40% over the next five years.
The first quarter of this year has seen a chaotic, topsy-turvy salmon market. Superficially, two supply shocks that arose in the interaction between climate and disease outbreaks.In reality, the volatile price spike followed by a rapid decline and then another, even more inflationary jump, were symptomatic of a market struggle: An unspoken conflict between buyers spoiled by decades of falling prices, and sellers, who are dealing with an entirely new set of supply, demand and cost fundamentals. While the market's present volatility will settle down, there is little doubt that equilibrium prices are settling on to a higher plateau.
Always a problem with farmed salmon, a nasty late 2015 sea lice outbreak has cut Norwegian output, with the country's seafood council now projecting a 5%, 30,000 tonne drop in H1 2016 salmon production. While the amount was numerically immaterial, the impact was felt in qualitative terms: Farmers minimized losses by harvesting fish before they could reach their full grown size.
Hence, the rally was driven by a widening spread between the price of fish above 6kg and those in the 2kg to 4kg range. From a market bottom near NOK37/kg (US$4.80/kg) in October, prices jumped above NOK63/kg (US$8.19/kg) by early January.
Thereafter, the sea lice epidemic abated and Norway appeared poised to enjoy a predictable H2 2016 growing season. At first, prices came down almost as steeply as they had risen, touching NOK48/kg (US$5.76/kg) in early February. Initially, it was expected that prices would ease into a range only slightly higher than their NOK35/kg to NOK40/kg (US$4.20/kg to US$4.80/kg) average of recent years –but it was not to be.
On the other side of the Atlantic Ocean, Chile's exceptionally warm, El Nino heated waters spawned a toxic algal bloom. As a result, up 100,000 tonnes or 12% to 15% of Chile's expected 2016 production was either poisoned to death by algal toxins or asphyxiated by the resulting low water oxygen levels. After enduring two years of negative returns, this toxic algal bloom caused an additional US$800 million in losses.
As Chilean salmon production loss estimates ballooned from the initial 20,000 or 30,000 tonnes to over 100,000 tonnes. –But this is really an understatement of the situation: Between the need to cut losses and the need to avoid stocking density related disease outbreaks, Chilean salmon output was already slated to fall 80,000 tonnes, from 804,000 tonnes in 2015 to 724,000 tonnes this year –but after the algal bloom's losses, observers expect Chile's 2016 salmon output to be somewhere between 560,000 and 600,000 tonnes.
Over the longer term, Chile is producing roughly 200,000 tonnes or 25% less salmon this year than it did in 2014. These losses made the initial production fall caused by Norway's salmon lice epidemic seem small by comparison.
On the back of Chile's shriveling supply fundamentals, a faltering salmon rally reignited. By late February, Norwegian salmon prices were again testing the NOK60/kg level. With farms releasing their salmon to market before they could mature, the rally was led by prices of larger sized fish.
Described by one exporter as, "a race for bigger fish", by late March, prices peaked at NOK67.8/kg (US$8.15/kg), their highest level since the late 1980s. In less than three months, salmon prices jumped a whopping 70%.
But there is one unchanging fact about commodities that is also true of salmon: In the absence of additional, supply-constraining news, prices tend to gradually drift downwards. In salmon's case however, prices did not drift downwards; they dived: For a second time in two months, the post-peak price correction was as sharp and steep.
At the time of publication, salmon prices had fallen for a third consecutive week since their late March peak: Trading at around NOK56/kg (US$6.72/kg) at the end of April's first week, prices deflated 17% in less than 20 days.
Part of this drop was short-term opportunism: With the British pound having fallen 15% against the krona over the past year, Scottish and Shetland Island exporters were happy to undercut rising Norwegian prices.
Over the short term, the opportunism of Scottish exporters left Norwegian traders with unexpectedly large amounts of unsold salmon. Over the longer term, with British salmon output amounting to a mere 13% of Norwegian production, total UK output cannot equal Chilean production losses, let alone those of Norway and Chile combined. Even if they are price competitive, the market impact of smaller exporters is strictly short-term.
–More telling however, price spreads between the largest fish (weighing 6kg or more) and the smallest ones (3kg to 4kg) narrowed from NOK7.00/kg (US$0.84/kg) in mid-March to just NOK3.00/kg (US$0.36/kg) going into April's second week. Moreover, many exporters expected the price spread between 3kg to 4kg fish and those greater than 6kg to narrow further, to just NOK2/kg (US$0.24/kg) in the coming weeks.
Going forward, Undercurrent News reports traders stating that they expect prices to stabilize NOK5-7/kg below present levels. That would put them in the range of NOK49/kg (US$5.88/kg) to NOK51/kg (US$6.12/kg), approximately 25% above pre-rally price levels.
There are several short-term implications to all this. First, the supply shortage of larger sized salmon which triggered the rally, was now being neutralized by lower demand, especially for heavier fish. Second, with the spread between large and small sized salmon going from abnormally large to narrow, this shows that buyers are resisting high prices above NOK60kg –and if forced to, they would sooner sacrifice quality to keep costs under control.
Third, buyers are behaving this way because after decades of falling prices, they have not yet adjusted to new, harsh market realities. In fact, even as buyer resistance is putting a ceiling on the rally, supply-side trends are also raising salmon's longterm floor price –a fact that is reflected in trader's expectations that prices will settle down up to NOK10/kg (US$1.20/kg) above their pre-rally average.
Over the medium term, with over 200,000 tonnes from two countries that supply 70% of world salmon exports vanishing over two years, there is no way second tier producers can boost output enough to make up for the resulting supply shortfall.
From 2.31 million tonnes in 2015, world salmon exports were initially projected to rise 4% to 8% in 2016, into the 2.5 to 2.6 million tonne range. Demand rising by 4% or more has also been taken for granted for most of the past two decades.
Given the production losses in Norway and Chile, shipments now appear likely to drop 4% to 5%, to near 2.1 million tonnes. Furthermore, due to its southern hemisphere growing season, the 100,000+ tonnes of recently lost Chilean exports will only materially impact the world market during the late third quarter. That implies that even if prices fall lower than expected during the second quarter, there is a strong possibility of another rally later in the year.
Over the longterm, for Chile's 2017 output to recover, supply only responds to a profit motive –and Chilean producers have been running losses for two years running.
To a great extent, these losses reflect the fact that world salmon prices are based on Norway's production costs and not those of Chile. As of Q3 2015, salmon feed cost US$1.48/kg in Norway, versus US$2.08/kg in Chile. With feed costs 40% more in Chile than it does in Norway, a salmon price which is profitable in Norway can cause serious net losses in Chile.
As the accompanying chart shows, since 2010 when feed costs increased, the only time Chilean salmon farm earnings before interest and taxes (EBIT) were profitable were those times in 2014 when their salmon export price exceeded US$4.80/kg (NOK40/kg). Since then, with the Chilean peso's devaluation boosting input costs by another 10%, their break-even point has to near NOK45/kg. To boost Chilean salmon farming returns high enough to motivate strong output expansion, a price close to NOK50/kg is required.
Thus, while Chile has greater output expansion potential than any other exporter, it also has significantly higher production costs than Norway. –And on this matter, the laws of economics clearly state the following: Over the longterm, the marginal cost of expanding output becomes the floor price.
In conclusion, for output to keep pace with demand growth, the world market has to start using cost base of Chilean salmon farms as its price floor –not those of Norway. All this implies that over the next year, for supplies to meet demand, salmon prices should average at least 48/kg (US$5.76/kg) to NOK50/kg (US$6.00/kg).
Interestingly, even after Norway and Chile recover from this year's production setbacks, longterm supply trends imply that salmon prices will inch up into the NOK50/kg (US$6.00/kg) to NOK60/kg (US$7.20/kg) range. As the accompanying chart shows, from its 4% to 10% range in the 2000s, salmon output growth has decelerated into a 2% to 3% range since 2013.
This is indicative of a third chapter in salmon farming's evolution. In the first and longest phase, falling production costs and rising scale economies coincided with flat, gently falling feed costs. This expanded output in a manner which deflated prices, but costs were also deflating. That allowed both salmon supply and demand to boom.
In the second chapter, from the late 2000s through 2012, feed cost inflation put an end to falling unit production costs. With feed cost increases offsetting operational productivity gains, salmon's three decade era of gradually declining prices ended.
The third chapter started after 2013. A few years prior to this time, stocking density limits and a dwindling supply of unexploited, virgin waters made it increasingly difficult for Chile and Norway to continue expanding production at the rapid rate of previous decades. Increasing problems with disease outbreaks, Chile's rising reliance on antibiotics and sudden supply contractions are symptomatic of this latest chapter in the industry's evolution.As the accompanying chart shows, after 2012, world salmon output, which had been growing by 10% annually in the late 20th century and by 5% annually in the 2000s, will be lucky to expand by 1% annually in the years 2015 to 2017 inclusive.
With its cost base firming up and output stagnating, supplies are now expanding more slowly than world salmon demand. On one hand, increasingly frequent supply disruptions will be met with buyer resistance, just as it did in this market rally.
On the other hand, with supply poised to rise more slowly than demand through 2020, buyers will eventually have to raise their price expectations: This year's average price will be at least 20% higher than that of the last two years.
To expand global output in a significant way, Chilean salmon farming's higher cost base and greater disease risk must be counterbalanced with higher returns and significantly higher average salmon prices. This implies that by 2020, salmon prices could shoot up another 20%, into the NOK60/kg (US$7.20/kg) level and beyond.
Soon, you will no longer be able to assume that this year's salmon fillet will cost less than it did a few years ago.
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