Between Dubai’s debt debacle and the upcoming climate change talks in Denmark, weather conditions in America’s heartland might seem of trivial importance to global markets.
But a perfect storm is building in the Midwest that will mean far more to investors than the wording of any press release on carbon emissions that originates from Copenhagen.
Thanksgiving usually marks the unofficial end of the fall harvest season for America’s grain farmers; the top corn-producing states--Iowa, Illinois and Nebraska--all experience bouts of frost and frigid weather long before the fourth Thursday of the month.
In fact, most farmers look to complete their harvest by early November and spend the final weeks before the holiday fertilizing the soil and preparing for the spring planting. In a typical year, US farmers harvest close to three-quarters of the crop by November 1. However, this year Thanksgiving has proved far from relaxing for anyone involved in US agriculture.
As of Nov. 22, 2009, only 68% of the US corn crop had been harvested in the 18 top-producing states. In an average year, close to 95% of US corn would be harvested by that date. The graph below provides further details. (Click to enlarge)Click to enlarge
Source: US Dept of Agriculture
The US Dept of Agriculture (USDA) Crop Progress report issued November 30 indicates that 79% of the corn crop has been harvested--farmers must harvest an unprecedented 20% of nation’s corn in December.
The late corn harvest eats into yields, reducing the total output. Colder weather at harvest time means that corn isn't drying out as it normally would; reports indicate that damp conditions have led to fungus growth in some fields.
On November 10, the USDA released its monthly World Agricultural Supply and Demand Estimates (WASDE) report. Though pundits on business television rarely dissect WASDE data, these monthly reports are eagerly digested by anyone in the agricultural commodity markets.
To reflect the damage caused by the late harvest, the USDA lowered its expected corn yield from 164.2 bushels per acre to 162.9 bushels per acre. Deteriorating conditions also prompted the agency to lower its estimate of the overall corn crop by nearly 100 million bushels. The USDA likewise reduced its expectations for the amount of corn left in storage at the end of the season from 1.672 billion bushels to 1.625 billion.
The next WASDE report comes out December 10. With the US corn crop coming in even later than was expected back on November 10, many analysts forecast that the USDA will further reduce its corn yield and ending stock estimates. Corn prices have rallied sharply from the lows of late summer, thanks to growing fears over the late harvest.
Quality, Not Quantity
The late corn harvest threatens to aggravate an already precarious situation. Despite last year’s global recession and financial crisis, global corn demand remains strong, particularly in emerging markets. While world oil consumption likely fell in 2009 for the second consecutive year, corn consumption jumped 6.5% in the 2007-08 harvest year and is projected to rise 0.7% this year and 3.2% in 2009-10.
In fact, global corn consumption has soared 260% since 1965 and is up by a third since 1999-2000. Over the past decade, global crude consumption has grown at less than half that rate.
According to the United Nations the world's population will increase by more than 50% between 2000 and 2050, from 6.1 to 9.2 billion people.
Feeding people is already a major challenge. But, contrary to popular belief, the biggest challenge isn't growth in the numbers of mouths to feed but upgrading the diet.
Economic growth in developing nations is behind a change in global diets of epic proportions, the likes of which the world hasn't seen since the Agricultural Revolution of the 18th and 19th centuries. As consumers' disposable incomes rise, their diets tend to become more diverse and meat consumption tends to increase.Click to enlarge
Source: Food & Agriculture Organization of the United Nations
The average Chinese consumer’s total daily calorie intake has risen gradually since 1965. However, the more dramatic trend visible here is the change in the composition of these calories. The intake of basic cereals such as rice has declined, while meat, fruits and vegetables have all become vital components of the Chinese diet.
From an agricultural standpoint, this shift presents a problem. Meat, fruits and vegetables are far more agriculturally intensive products than rice and other cereals.
It takes 7 kilograms (15.4 pounds) of feed grain to produce 1 kg (2.2 lb) of beef; 4 kg (8.8 lb) of grain to produce 1 kg of pork; and 2 kg (4.4 lb) of grain to make 1 kg of poultry. As consumers eat more meat, there's a huge multiplier effect--demand for producing grains for feed goes up by a multiple of the increase in meat consumption.
According to estimates by the USDA and other international agricultural organizations, total global demand for grains is likely to triple from its 1960 level by 2020. Much of that jump is due to indirect grain consumption as a livestock feed.
Supply is also a major issue. As countries like China develop and urban areas grow, there's less land available for cultivation. A growing shortage of water also has an impact--parts of China, for example, once suitable for cultivating crops are now little more than deserts with insufficient water to support much plant life.
According to estimates by the Food & Agriculture Organization of the United Nations (FAO), there were more than 0.5 hectares (1.24 acres) of arable land per person globally in 1950. Today the figure is closer to 0.22 hectares, and by 2020 it's going to fall to 0.2 hectares, less than half its 1950 level.
Simply put, the world's farmers will need to grow more food to feed more people using less land. The global agricultural challenge is every bit as acute as meeting exploding demand for energy.
Agriculture is no longer the low-tech activity it was 20 years ago. Meeting the global boom in demand will require the adoption of best-practice farming methods worldwide and increasing use of advanced gene technologies to boost yields per acre and protect against crop failure.
Another implication is that to make the widespread adoption of advanced farming technologies economically feasible, the prices for all sorts of agricultural commodities will continue to rise.
There are several different investment angles, including agricultural services, supplies and technology firms and, of course, actual producers. I’ll focus on one of the most crucial agricultural markets of all: fertilizers.
Crops remove certain nutrients from soil over time and if that process goes unchecked, yields per acre will drop precipitously. To replace those nutrients farmers fertilize their soil. The amount and types of fertilizer used depend to a great extent on varying soil conditions in different parts of the world as well as the type of crops being cultivated.
There are three main types of fertilizer at use in the world today: potassium chloride (potash), phosphate and nitrogen.
Potassium chloride is mined from ore deposits created when oceans and seas dried up millions of years ago. With the passage of time, most of the world’s ores have been covered by earth and are now located deep underground.
To create potash that’s used on crops, the potassium chloride is separated from impurities such as salt and then dried and prepared into either solid pellets or a liquid product.
The largest producers of potash in the world -- based in Canada, Russia and Belarus -- account for about two-thirds of total global output. Because there are only a handful of global producers, about 80% of global potash supply is traded across international borders.
Fruits and vegetables account for nearly one-quarter of global potash consumption. Corn and rice are also big potash consumers accounting for a further 28% of the global market combined.
Phosphate is also mined from underground ore bodies created from ancient sea life. Typically, phosphate fertilizer is combined with ammonia to produce solid fertilizers known as DAP and MAP. Sulphur mainly derived from oil and natural gas refining/processing is a key raw material for converting phosphate rock into usable fertilizer.
As with potash, production of phosphate is concentrated in a handful of countries. China is the largest producer, followed by the US and Morocco. The latter is the largest exporter in the world because the US and China consume most of their domestic phosphate production in their domestic agricultural sector.
Because the big producers of phosphate also tend to be the big consumers, only 20% of global phosphate supplies move across international borders. The crops hungriest for phosphate include: fruits and vegetables (18% of total demand), wheat (16%), corn (12%), and rice (12%).
Nitrogen is the most common element in the air; however, plants rarely make direct use of atmospheric nitrogen. Nitrogen-based fertilizer is made from ammonia that is synthesized from natural gas. In fact, natural gas accounts for as much as 90 percent of the cost of making ammonia.
Urea is the most common form of nitrogen fertilizer accounting for about half the world market. And most nitrogen fertilizer isn’t traded but is used near where it’s produced. The biggest crops for nitrogen fertilizer are corn, rice, and wheat that account for half of total global nitrogen use worldwide.
Given soaring demand for agricultural commodities and the need to grow more crops on less land, farmers the world over are focused on yield, the amount of crop they can grow per acre of land. Because proper fertilization is among the most important factors determining yield, demand for all three types of fertilizer has been on the rise generally in recent years and that trend is likely to continue.
The other side of the equation is, of course, fertilizer supply. Two of the three main fertilizers are mined commodities with relatively limited geographic availability. And check out the table below.
It can take as long as seven years to bring a new potash construction plant on stream, and building a mining and processing facility costs upward of USD2.6 billion. That means that as demand for potash rises, supply can only adjust gradually to that demand.
In order for a USD2.6 billion investment in a plant to be worthwhile, potash prices would have to remain relatively high and stable. Although phosphate and nitrogen fertilizers are a bit less intensive in terms of investment and time, it’s certainly not a simple matter to increase fertilizer output quickly to meet demand.
Constrained supply and rising demand can mean only one thing: rising prices.
Potash prices rose more than four-fold between mid-2007 and late 2008, early 2009 amid an extraordinarily tight market for the nutrient. Since then, prices have fallen sharply and stand at about half their peak level.
But the recent slump is a short-term hiccup, not a long-term cause for alarm. In fact, weakness in potash and other fertilizer prices has helped to push down stocks involved in fertilizer production, giving investors an outstanding entry point.
Disclosure: no positions