December 29, 2014

By: Garrett Baldwin

In November, China agreed to remove import tariffs on a range of Australian agricultural products as part of a bilateral free trade agreement aimed at linking the two economies over the next decade.

For the Australian agriculture sector, the agreement is a game changer. The nation’s beef and dairy industries stand to see the most relief from burdensome tariffs. The liberalization of trade will also provide significant relief in other sectors, including financial services, hospitality, and energy production.

According to reports, the free-trade agreement could boost Australian exports by more than $18 billion by 2025.

But despite optimism that Australia could become China’s “bread basket”, investors should understand that this export surge will rely on an aging infrastructure that requires a wealth of new investment to reach such potential.

This sets up an important conversation about where investors can plant capital to boost export levels and profit from the coming Australian “dining boom.”

Breakdown of the Agreement

According to terms of the agreement, 85% of all Australian exports to China will be tariff free. This figure will increase to 93% by 2018, and will hit 95% when both nations fully implement the deal.

The primary losers in the deal are any companies engaged in production of rice, cotton and sugar, three sectors for China that would be highly sensitive to policy changes that could hurt domestic producers.

However, the biggest winners are expected to be the beef and dairy sectors. Beef levies will be phased out over the next ten years, while dairy tariffs, which have reached levels as high as 20%, will also be phased out. Tariffs will also disappear for sheep-meat, wine, horticulture, seafood, and hides, skins and leather.

The deal will also likely have a profound impact on property prices in Australia. According to a principal at Raine and Horne Rural Sydney, land price for dairy, beef and sheep farms could rise by as much as 15%. An expected surge in demand could fuel increased investment in production assets, with the most significant emphasis on beef.

While Australia has been resistant to allowing foreign companies to purchase specific agricultural assets, the beef industry could experience a rush of foreign investment to meet rising demand. China is the fastest growing market for beef today, fueled by stronger wages, increased urbanization (which fuels construction of supermarkets and restaurants) and dietary changes.

But the surge in beef production and ultimately exporting creates new challenges for the Australian economy. With just-in-time logistics and concerns about spoilage central to the export narrative, the nation’s infrastructure requires a boost in capital investment.

Investment Needed to Avoid Problems

Promoters of the free trade agreement argue that Australia stands to provide an immense export boom to China, claiming they could become the one of the leading exporters to Asia.

While this projection is statistically possible, research suggests that current infrastructure limitations prevent such an outcome, as productivity gains will require improved logistics and fewer bottlenecks, particularly at the nation’s ports.

According to the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES), the nation’s exports will be roughly 77% higher in value (from 2007 dollars) in 2050.

However, the basis of this conclusion falls on the assumption that Australia will see increased productivity from existing or new farmlands. In addition, it requires the nation to solve the ongoing challenges it faces from increased use of its aging railroad system, increased competition for space at ports from non-agricultural products, and new regulation.

The decline in road and rail quality has increased safety and transportation costs, and delayed perishable deliveries of many of the products poised to see a boost in exports. According to reports from the National Australia Bank, capacity utilization at grain terminals at some of the nation’s largest ports has been dismal.

Rates have fallen as low as 30%, figures fueled by increasing delays and bottlenecks in the rail system.

Solving the challenges in infrastructure will require an influx of capital. But the most critical projects may not lead to the best return on investment.

A recent report issued by the Australian Trade Commission outlines a number of road, rail, aviation, and energy projects for foreign investors (which can be downloaded here). As of June 2014, the nation has 12 rail projects set for development, with three accepting private capital.

Clearly, freight bottlenecks and ensuring on-time delivery for the bulk of new agricultural products set for export to China will be central to boosting the nation’s productivity.