Here are some charts and commentary from the BNZ which are particularly useful for New Zealand Trade and the potential growth of the agricultural sector.
NZ’s most significant exports to China are dairy products (39% of total), forestry (24%), tourism (12%), and meat (10%). With the possible exception of forestry, all of these sectors stand to benefit from ongoing urbanisation in China, the continued rise of the middle class, and rising household income and consumption levels. Not only is Chinese demand expected to strengthen further, but domestic production in many cases will fall well short of consumption. Exports from NZ will have a big opportunity in helping make up the shortfall.
Chinese protein demand soaring
There is a strong and well proven link between rising incomes and changes in diet (see chart below). The gradual westernisation of the Chinese diet has seen per- capita consumption of protein soar over the past decade or so. In contrast, per capita consumption of traditional foods such as rice is in decline.
Urbanisation has further stepped up Chinese demand for protein. Compared with the less diversified diets of rural communities, city dwellers have a varied diet richer in animal proteins and fats, and characterised by higher consumption of meat, poultry, milk and other dairy products.
Data from the Chinese National Bureau of Statistics shows per capita consumption of dairy products (excluding butter) has climbed from 7kg/person in 1992 to 20kg/person in 2012. Meat consumption has risen from 13kg/person to 23kg/person over the same period.
Per capita protein consumption for urban households is roughly three times that of rural households.
Bayleys Real Estate Country magazine included an article on the outlook for New Zealand’s agricultural sector which was written by NZX Agrifax.
With regard to the Dairy Industry the effect of the drought in the latter part of 2012/13 season slowed production. This was also the case with other countries as the domestic market seems to have absorbed their output. So this lack of supply combined with a steady growth on demand has resulted in high dairy prices for a sustained period of time. With prices remaining high there is now the chance that milk production will increase especially in the US where their elasticity of supply of milk is fairly elastic. New Zealand is forecast to have a good milk production season as pastures have recovered from the drought. See graph below for forecasted milk prices.
The recovery in lamb prices has mainly been down to the increasing demand from the Chinese market. During the first 10 months of the season, over 80,000 tonnes of lamb was exported there which accounts for 29% of NZ’s total lamb exports. That’s up from 44,000 tonnes over the same period last year. There has been in particular an increase in demand for higher value items such as legs and shoulders. This led to an increase in price as supplies to traditional markets was now reduced.
A move by the European Union to slash subsidies to farmers isn’t as big a deal as it sounds. The EU has announced cut to the subsidies it pays industrial scale farmers of up to 30% – this is part of the Common Agricultural Policy (CAP) which costs the EU tax payers 50bn a year and is 40% of the whole EU budget. This will be of little benefit to NZ farmers as they will still be denied access through tariffs and quotas on sheep, butter, cheese etc.
Objectives of CAP
At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:
1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.
CAP Intervention Price
An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:
1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.
Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.
Time magazine ran an interesting article on the tomato market in the Holland and Greece. The Greeks produces twice as many tomatoes than the Dutch but very little of it is sold in export markets. This is a concern in that it is a missed opportunity for the Greeks to earn income. What is more ironic is the fact that in the summer imports of tomatoes come in from Holland because the Greek farmers are still struggling to grow a crop during the hottest time of the year – Holland employs high-tech green houses and is able to produce significantly more during the summer months than Greece.
However, Greece has the potential to produce tomatoes for domestic consumption as well as for export but only has two harvests a year and is at the mercy of the elements – poor weather = poor harvest. The Dutch in contrast have temperature controlled greenhouses helping to create ideal growing conditions and they can produce 70kg of tomatoes in a square metre of his greenhouse whilst the Mediterranean grower gets approximately 7kg. They can also produce all year round.
Single Currency and Productivity
With the introduction of the euro in 2002 Greece could no longer devalue its currency to control the price of its products. With a weaker currency their exports were much more competitive but this had the effect of making the Dutch work even harder to achieve more efficiency and greater economies of scale. Therefore the only way that the Greeks can now compete is by cutting costs and embracing technology.
But it is not just the tomato market that has been hard hit. Greece’s agricultural sector’s productivity levels are 44% below the European average and labour costs have increased by approximately 90% and this is in contrast to Germany where unions agreed to a 3% rise. What is more concerning is that the acreage given over to growing tomatoes in Greece is 10 times that in Holland but they hardly export any of them. The Dutch have seen their exports increase by 30% since 2005. Some economists have laid the blame on the oligopoly market structure that controls the distribution. These middlemen pay farmers low prices and take a big mark-up on tomatoes even as they have failed to put in place a more efficient distribution system, including for exports.
The Greeks could become a thriving exporter of tomatoes once again but will need to embrace the Dutch technology and make use of its natural conditions – sunshine.
2013 has seen the primary sector of New Zealand continuing at a dual speed. On the one hand dairy and beef prices are up, but sheep and wools prices are making it a real struggle for those farmers. The weather hasn’t helped matters and the North Island is currently very dry but for those in the South Island there has been enough moisture in the soil to maintain reasonable grass growth which ultimately keeps farmers happy.
Dairy Farmers have coped well with the mixed weather and the discovery of DCD in milk. Milk powder has increased in price by 9.8%. With the REINZ farm price index showed farm prices fell 14% from January to August 2012 Fonterra had initially forecast a substantially lower payout for the new season. However interest in farm conversions is still strong.
Sheep Farmers haven’t done as well. World lamb prices have been downward mainly because of the increase in lamb exports from Australia – increase in supply. Like New Zealand, Australia is predominately pasture-based and less affected by higher feed costs. Furthermore favourable seasonal conditions in Australia has resulted in extra stocking and it is estimated that lamb production will increase by 15% in 2013.
* Dairy produces 25% of export revenue in NZ
* It makes up 33% of the world dairy industry
* Fonterra makes up 90% of the dairy industry in NZ
* Fonterra’s annual revenue = NZ$20 billion
* Fonterra opeates in 100 countries and has 10,500 farmer owners.
* 20% of New Zealand Dairy products go to China
Recently Fonterra had made it clear that it is prepared to let non-farmer investors buy in for the first time – they intend to raise NZ$500m with the issue. Why are they looking to non-farmer investor? Although they have made shrewd investments in Asia and Latin America, in more developed markets health worries and higher prices have cut demand. Countries like China are a threat to the Fonterra’s standing on world markets. Furthermore with milk prices down 20% from last year farmers are concerned that non-farming ownership will cut their return further and that there will be a move away from a farmer-owned co-operative.
Brian Gaynor in the Saturday NZ Herald reinforced the belief that borrowing in New Zealand must be in an area that is going to generate growth. He presented the lending figures over the last 10 years for Agriculture, Business and Individuals and made the following points:
1. Export revenue from agriculture has increased from $7.3bn in 2001/02 to $16.7bn 2011/12.
2. Agricultural debt has made a positive contribution to the economy
3. There are very limited benefits of $102.7bn of residential mortgage debt over the past ten years.
4. Additional individual borrowings have been mainly used to push up prices of existing houses, rather than building new homes
5. Additional debt has to be shifted away from existing housing and into the productive sector – agriculture and house construction
6. The government needs to develop policies with regard to overseas ownership of land.
New Zealand has the potential to be the bread basket of the Asia Pacific region and the financial returns to the economy are significant. However there has to be an increase in investment and lending to the agricultural sector if it is to be successful.
Having just taught the Developing Economies topic at the UNITEC A2 revision course I couldn’t help noticing this graph that was in The Economist last week. This was extremely useful when you look at how developing nations are locked out of the trading system by the subsidies given to those developed nations agricultural sectors. For years the World Bank and the IMF have forced developing nations to stop subsidising their agricultural sector.
Government support for agriculture in the mostly rich countries of the OECD amounted to $252 billion in 2011, or 19% of total farm receipts. Although there is a move away from support linked directly to production, it is still about half of the total. The general trend is downwards: compared with the second half of the 1990s subsidies fell in all countries. But levels of support vary widely. In Norway, Switzerland and Japan, more than half of gross farm receipts in 2009-11 came from support policies; for producers in Australia, Chile and New Zealand, it was less than 5%. Commodity prices will stay high for some time, suggests the OECD, so markets will provide the farm income that many governments have tried to prop up.
The New Zealand Farmers Weekly had an interesting piece on the future prospects of farm revenues over the next year. The outlook is not looking rosy mainly because of the high NZ dollar. A NZ$ value of US$0.90 for a full season would slash farm profit to $46,400 according to the Beef & Lamb NZ Economic Service. However the crucial time for the exchange rate is when the vast majority of produce is actually exported namely between November and June.
With regard to destinations for NZ beef they are the following:
- 50% of beef goes to North America
- 9% Japan
- 8% South Korea
- 6% Taiwan
The New Zealand Herald last Saturday had a useful article on the importance of the rural sector to the growth of the economy. Brian Gaynor talked of the confidence of the rural environment compared to that of their urban counterparts who are struggling in a very competitive environment. New Zealand’s exports have increased from $7.9bn in 1983 to $46.7 bn today whilst the contribution of meat, dairy and wool have decreased from 53.8% to 37.5%. Although this gives the impression that the rural economy is not holding its own one has to remember that:
Meat, dairy and wool’s contribution has increased from 34.5% to 37.5% during the last 10 years.
If logs, oil, fruit, wine, fish, casein and Tiwai Point’s aluminium are added then exports from the non-urban sector accounts for around 60% of total exports.
The rural sector has a trade surplus with the rest of the world but the urban sector runs a substantial deficit. The increase is residential house prices has been 8 fold but the problem here is that in borrowing to buy a house they are accessing overseas banks. This means that we need to export more and more rural products just to pay the interest on these overseas loans.
There is mention in political circles that the UK is keen to abolish subsidies to its agricultural sector. They have already insinuated that they intend to freeze agricultural spending at 2013 levels until 2020 with the long-term goal of eventually abolishing all assistance to farmers. The EU currently spends €55bn for the farm budget each year and this accounts for 40% of its total budget – more than any other sector.
This action would certainly put New Zealand on a level playing field with the UK and make its produce much competitive than previously. With New Zealand going through the same process of removing subsidies nearly two decades, the UK will agricultural sector will find it difficult to adjust. However it has allowed New Zealand farmers to be far more focused on the essentials of the market rather than being driven by the subsidies from government. Farms became bigger and more efficient as economies of scale became hugely important in maintaining a competitive edge. What the subsidies did in New Zealand was to encourage people to develop land that was not really suitable for any agricultural use. However as they got a subsidy from the government efficiency or quality didn’t feature as a major factor in maintaining competitiveness. Here is what happens when the subsidies are taken away – supply curve to the left.
With the drought that the US has experienced in the last year global dairy prices have risen by 7.8% compared to the sale a fortnight ago. US prices are starting to reflect higher feed costs, which had risen as a result of the drought, and lower milk supply. The average winning price at the auction on Wednesday 15th August was US$3,054 a tonne. These prices are generated by the GlobalDairyTrade which is an auction platform for internationally traded commodity dairy products. How does it work?
GlobalDairyTrade trading events are conducted as ascending-price clock auctions run over several bidding rounds. In each auction a specified maximum quantity of each product is offered for sale at a pre-announced starting price. Bidders bid the quantity of each product that they wish to purchase at the announced price. If the price of a product increases between rounds, to ensure their desired quantity a bidder must bid their desired quantity at the new, higher price. Generally, as the price of a product increases, the quantity of bids received for that product decreases. The trading event runs over several rounds with the prices increasing round to round until the quantity of bids received for each product on offer matches the quantity on offer for the product (as shown in the diagram below). Each trading event typically lasts approximately 2 hours.
Bidders cannot join a trading event part way through: they must participate in round 1 and can only maintain or decrease their total bid quantities from that point. Products can be purchased over different delivery time periods, known as contract periods.
Click below for more information.
For many years China has been trying to guarantee resources for its growing economy. The FT in London recently looked at the Chinese mining company Citic Pacific which has invested huge funds into the Sino Iron mine in Western Australia. Originally hatched in 2006 the level of expenditure has gone significantly higher than expected – from US$2bn to US$7.1bn today. However some have suggested that a US$10bn will ultimately be the cost and this is especially prevalent in that they are two years behind schedule.
It seems that Citic Pacific have put down too much money to pull out – barriers to exit. China imports about 60% of its iron ore and the Sino Iron mine is an attempt by the Chinese to break away from the dependency of foreign suppliers, which Chinese steelmakers accuse of driving prices too high. However Chinese companies have found it difficult to adjust to the foreign working conditions compared to the protected environment in China. Chinese enterprises are often unprepared for the rigours of foreign competitors especially with regard to employment laws and the nature of contracts. China’s mining plans involve the use of Chinese labour as they are cheaper and have a higher productivity. However, overseas labour laws and visa requirements make the use of Chinese labour all but impossible. In Australia truck drivers can earn US$2000,000 a year with three-home housing, free home leave. By seeking control negotiations can become confrontational.
The Chinese were desperate for iron ore when the demand for steel was very high. However Chinese developers realise now that the demand for steel has dropped and prices have fallen. In 2010 China imported less iron ore than the previous year and by 2011, higher interest rates and strict restrictions on property and construction continued to put downward pressure on steel prices. Also for Citic Pacific miscalculations over currency have played a role in increasing costs. The AUS$ has appreciated over the life of the project and controversial hedges that Citic bought went wrong causing a $2bn loss.
Yesterday official GDP figures out of China showed that growth has slowed to 7.6% for the second quarter. This was predicted but as building and infrastructure development accounts for 55% of China’s GDP growth this has a significant impact on demand for iron ore which is a key ingredient in steel.
Further to Jim O’Neill’s talk at the Tutor2u conference one wonders how the Chinese economy is going to land over the next few months. According to the National Australia Bank most believe it is going to be a soft landing given that:
1. The slowdown is desired
2. Policy makers are looking at an expansionary policy to ease the fall
3. Policymakers have a lot of ammunition left to stimulate growth – currently high interest rates (which can be cut) and large surpluses.
Australia’s links with China
The National Australia Bank’s markets weekly looked at the how Australia and China have been closely linked over the last 10 years. They have come up with the following:
Australia is joined to the hip (see graph – Australian GDP Growth – Correlations
Rolling correlations of real quarterly growth) with China given they are its largest export destination. China growing at 8% or 7.5% is probably inconsequential and to materially change the direction of the Australian economy China would need to land so hard that commodity prices would fall sufficiently to turn off many of the big resource projects that are underway. It is naive to think that a recession in China will bring a similar scenario in Australia.
In a small open economy like Australia, the floating $A exchange rate is arguably the most important macro stabilising tool – more so than interest rates. So a Chinese hard landing should mean lower commodity prices and a much lower $A which in turn would help promote growth in some sectors (like tourism) just as the high exchange rate is now curbing these sectors.
Last week there was good news for farmers in New Zealand with the Global Dairy Trade (GDT) prices on the up after some concerning months. It is now of the opinion of some analysts that prices have bottomed out and it will be an upward trend from now on.
What caused the price reduction over the last few months has been the bumper season for dairy farmers in New Zealand and the surge in European production. However since then a couple of indicators suggest that prices will be on the rise:
1. US production has slowed
2. EU production has peaked
Below are the GDP results which show an interesting correlation between the amount offered for sale (Supply) and the tonnage sold (Demand), also notice the surplus and the price. Source: Dairy News – June 12 2012
Recently prices on Fonterra’s global dairy auction fell but analysts feel that this is not going to be long-term. The fall has been mainly caused by:
Supply increasing significantly relative to the demand – March, April and May tend to be very productive for northern hemisphere farmers as that is when they have peak supply figures. Furthermore over the summer in New Zealand we have had excellent growing conditions with soil moisture levels being very high for the time of year. This transfers into an increase in available feed for dairy units and increased milk output.
The graph below shows the Global Dairy Trade Weighted Average Prices and it is believed that this drop in prices is not a re-run of the global financial crisis when prices dropped to below US$2,000 a tonne. This was due to stagnant demand which does not seem prevalent today.
It is estimated that a US$1 difference in the milk price between seasons represents about $1 billion in cash flow for Fonterra’s 10,000 supply farms. When you consider the multiplier effect this can translate to 4 times that for the rural sector as a whole.
An initial change in aggregate expenditure can have a greater final impact on equilibrium national income. This is known as the multiplier effect and it comes about because injections of demand into the circular flow of income stimulate further rounds of spending.
Consider a $300 million increase in business capital investment. This will set off a chain reaction of increases in expenditures. Firms who produce the capital goods that are ultimately purchased will experience an increase in their incomes. If they in turn, collectively spend about 3/5 of that additional income, then $180m will be added to the incomes of others. At this point, total income has grown by ($300m + (0.6 x $300m). The sum will continue to increase as the producers of the additional goods and services realize an increase in their incomes, of which they in turn spend 60% on even more goods and services. The increase in total income will then be ($300m + (0.6 x $300m) + (0.6 x $180m). The process can continue indefinitely. But each time, the additional rise in spending and income is a fraction of the previous addition to the circular flow.
The value of the multiplier can be found by the equation 1 ÷ (1-MPC)
You can also use the following formula which represents a four sector economy
1 ÷ MPS+MRT+MPM
MPS = Marginal propensity to save
MRT = Marginal rate of tax
MPM = Marginal propensity to import
If you have read Matt Taibbi’s book “Griftopia” you’ll have come across an example of how the theory of supply and demand doesn’t seem to work in modern times. In the book he talks about the amount of money invested in commodity indices – from 2003 to July 2008 the amount of moeny invested in commodities rose from US$13bn to US$317bn. Not surprisingly commodities on various indicies rose sharply during this time. Oil in particular rose significantly – from US$26 per barrel in January 2003 to US$149 in July 2008.
In May 2008 a top oil analyst at Goldman Sachs conceded that the increase in oil prices was without question the increased fund flow into commodities. The bizzare issue here was that oil supply was at all time high and demand was actually falling.
April 2008 – secreatry-general of OPEC stated that “oil supply to the market is enough and high oil prices are not due to a shortage of crude.” US data showed that oil supply rose from 85.3m barrels/day to 85.6m from the first quarter to the seconad quarter in 2008. At the same time oil demand dropped from 86.4m barrels a day to 85.2m. Furthermore around this time two new oil fields in Saudi Arabia and Brazil were about the start pumping vast amounts of oil. Some analyst stated that the increase in oil price was due to the security issues in the gulf but OPEC officials expressed the fact that not one tanker had been attacked and hundreds of them are sailing every day. Where were the lines at the petrol stations like after the oil embargoes and the Iran – Iraq war in the 1970’s?
The press came to the conclusion that the price increase was due to economic factors:
1. The nervous US dollar – investors were anxious about holding US dollars and prefered to hold commodities.
2. There was an increasing demand for oil especially the emerging nations like China
According to Taibbi, although both of these factors were real, it is very doubtful that they could have had such an impact that oil prices would reach US$149. Chinese consumption did increase – between January 2003 and June 2008 oil consumption in China increased by 992,261,824 barrels. However during the same time speculators bought 918,966,932 barrels of oil – according to the Commodity Futures Trading Commission (CFTC). By December 2008 the bubble had burst and oil proces plummeted along with the price of other commodities – oil was trading at US$33 per barrel. So now the process has started all over again. Will we see oil tankers just sitting in the gulf waiting for the oil price to go up?
The ASB bank commodities report on the agricultural sector states that despite the uncertain global conditions farmers in NZ are experiencing a good season for the following reasons:
1. Even with the fall for US$ dairy prices NZ farmers enjoyed a record Fonterra payout in 2011.
2. Farmers have enjoyed the best lamb prices ever in 2011 – over $8/kg.
3. Wool prices have reached new highs over recent months.
4. Beef prices remain above average and the outlook is positive for 2012/13.
5. The OCR at 2.5% – 8.25% in 2008 – means farmers benefit from lower borrowing costs.
6. The climate of late has meant favourable pasture conditions. Lamb numbers are expected to rise 5.8% and dairy production 10% higher than last season.
All the above have enabled farmers to deleverage from the high debt levels that built up by 2008 – improvement in the debt to earnings ratio for farmers. See graph.
Long-term with strong demand from developing countries, especially in Asia, for quality food this will be reflected in strong commodity prices and a strong NZ$.
Since 1960’s Holland’s sudden gas wealth pushed up its currency and crippled its manufacturing sector, economists have been wary of easy money, even coining a term – Dutch Disease – for its impact on the rest of the economy.
By 2020 it is expected that Brazil will be producing 5 million barrels of oil a day which takes it into the top 5 oil producers in the world. However the big question is will it succumb, like so many before it, to a lack of investment in other areas of the economy so that when the oil runs out they have other sectors that can contribute to growth.
In order to avoid a Dutch Disease scenario it is imperative that Brazil looks to improve on its productivity of the rest of the economy. According to The Economist it aims to invest in education, culture, science and technology, environmental sustainability and poverty eradication. This seems to be a rather ambitious list of goals, but as with Norway such spending could be worthwhile provided clear targets were set and the money was professionally managed. One of the key areas that needs to be developed is infrastructure for non-oil exporters – upgrades of roads and port facilities. However the sovereign fund, which has been instrumental in the Norwegian success story, might not have sufficient funds to invest even with the oil bonanza. The coastal states of Brazil have in the past received most of the royalties from offshore oil but now the Federal Government want an increasing share. With the Federal share shrinking there will less strategic investment as most of the funds will go into current spending. One wonders about the colour of the overalls worn by President Lula Da Silva and his associates in the picture above – is this a bad omen?
The global economy is in a volatile condition at present with not only debt problems in Greece but also the concern that Italy will now default on its loans. For the New Zealand economy the primary sector is of significant importance as it makes up 56% of our global exports – see pie chart below.
Most textbooks will stress the importance of demand for exports as part of Aggregate Demand – AD=C+I+G+(X-M) in order to acquire foreign currency and an inflow of money. Although the demand for, and price of, NZ exports depends on how the recent crisis affects the Asian countries, there is the simple fact that supply will also impact on producers. Doug Steel from the BNZ “Rural Wrap” made the comment that the amount we have to sell is just as important.
Anticipated lower horticulture production is largely driven by an expected sharp drop in kiwifruit as a result of the Psa disease. There is also downward pressure on production given last year’s very high yields, on average, across kiwifruit, apples and grapes.For example, a return to average grape yields following last season’s bumper crop would see grape tonnage
pullback around 12%. But it is the outlook for kiwifruit that is most concerning.‘There is no greater issue for the NZ kiwifruit industry today than the risk of Psa-V.’ This is as true today as it was when it was printed in Zespri’s July 2011 Psa Status. Update or indeed since the disease was first discovered in NZ a year ago. The outlook for kiwifruit production is negative, as the disease continues to destroy vines. To us, the severity of the situation cannot be overstated. Meanwhile, the intense search for solutions continues.