Russia's New Strategic Industry
- By Richard Ferguson
- May. 05 2008 00:00
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The demand factors are easily identifiable -- population growth, urbanization, rising incomes, changing diets and fuel requirements. With the exception of biofuels, these factors combined present a picture of unrelenting demand for grains -- gradual, paced and persistent.
Supply remains variable and volatile. The loss of 50 percent of the Australian winter wheat harvest during the drought in 2007 had a dramatic impact on wheat prices. Yet, Australia's losses only accounted for some 3 percent of global wheat output in a normal year, while wheat prices rose by 30 percent between September and November. This was a clear indication that prices had become highly sensitive not to the factors driving demand, but to historically low inventories.
Inventories have halved in seven years. To an extent, lower inventories can be attributed to fewer distortions in the agriculture system as well as improved supply-chain management. But as some price distortions disappear, others appear. Export restrictions have been implemented in Australia, Russia, Ukraine, Argentina and Kazakhstan. Therefore, the price hike of wheat from $8 per bushel to more than $12 per bushel in the first two months of this year can be largely attributed to political decisions as grain-exporting countries seek to protect their own food supplies.
Ukraine's decision to lift its export restrictions hopefully negates the possibility that these short-term panaceas might become permanent fixtures. Recent price declines that take the price of wheat back to $8 per bushel can be largely attributed not only to the possibility of a half-decent harvest, but also to the perception that the grain-exporting nations will remove trading restrictions as fast as they imposed them.
A similar theme has emerged in the rice market of late. As the wheat market retreated from its highs at the beginning of March, the price of rice increased from $18 per hundredweight to $25 per hundredweight. Encouragingly, some rice-exporting countries -- including Malaysia and Pakistan -- have cooled expectations that they too might restrict exports. It is expected that rice prices will decline sharply once the current frenzy comes to an end.
Grain supplies are volatile. But fundamental demand increases will likely be met by countries with highly fertile, but underutilized, land. Russia, Ukraine and Kazakhstan top the list of beneficiaries of this changing landscape.
Russia is a good example. In 1992, the country had 120 million hectares of farmland under cultivation. The change from public to private ownership ensured that one of the few advantages of communal ownership -- access to equipment -- was lost. Multiple ownership resulted in a "free rider" dilemma for the new owners of land -- that is, the efforts of individual contributions are shared equally. Consequently, in the last 15 years, some 40 million hectares of rich farmland have been laid fallow. And what is farmed is low yielding. Russia now grows about 2 tons of wheat per hectare, but it has the potential to produce 5 tons of wheat per hectare.
The ramifications are significant. From 75 million tons of cereal output in 2007, Russia could multiply its grain output several times simply by enhancing yield management and bringing fallow land back into production. The country could produce some 300 million tons of cereals without the necessity of producing on virgin land.
This requires long-term planning and investment. Transferring ownership from inefficient multiple parties with no access to capital to large-scale corporate entities with long-term funding is a time-consuming exercise. In addition, repairing fallow land is an expensive business. Finally, to attain higher yields requires lengthy investment in crop rotation. Overall, this process can take from four to six years.
These changes will happen over time and restore imbalances in supply and demand across key cereal markets. That said, the entrepreneurial zeal that is transforming the agricultural landscape would only restore some equilibrium to a dynamic market.
So, while wheat at $12 per bushel might prove to be a temporary blip, $4.50 per bushel is unlikely to be seen any time soon -- even if it rains again in Australia.
Richard Ferguson is a global agriculture analyst at Nomura in London.