April 23, 2015

David Gray Special Advisor Altima Partners LLP

From talk of ‘the end of the commodities’ bear market’ in 2007 and early 2008, we are now confronted by a market where corn trades at or below average cost of production in the US and soy trades well below the level needed to justify bringing on-stream new/marginal areas of production. Some people talk of wheat prices that will test 2006 levels later this year.

It is now a cliché to remark upon the volatility we have seen over the past 7 – 8 years in the agri sector. We have seen it manifested in many ways. Crop prices have gyrated. Government policy changes related to movement of goods or ownership of agricultural land, including export bans, have also featured, culminating in the sanctions imposed on, and by, Russia. This has undermined private investor interest in (non-EU) Eastern Europe and has also adversely affected farmers in the EU and elsewhere. At times of high prices, ‘new’ drivers of national policy, including concerns related to food security, have assumed prominence.

There are signs of heightened investor interest in the sector. Some have chosen to ‘play’ commodities directly; others have concentrated investments in farmland. Most funds have focused on listed securities. Private equity also features, but generally up or downstream from the farm gate. Both financial investors and some strategics are seeking to understand valuation and risk as a precursor to actual capital deployment. Because different industry participants pursue strategies or operate in regions that make them in crucial respects noncomparable, investor analysis is more complicated. The range of countries in which the business takes place presents real challenges and risks. The language of producers is out of sync with investors.

Companies in the sector will no doubt have to find a means to bridge the gap. But government policy and other macro considerations also have some role to play and can be expected to influence sector performance over the near to medium term. Changes in subsidy regime priorities in the US and Europe are one example, but there are others. Climate change, and forecasts of rising temperatures and increased pressure on water availability (agriculture accounts for approximately 70% of global water consumption), could cause dramatic crop losses in key US producing regions during this century. The ‘2050 Scenario’ of a global population reaching 10 billion (increasingly urbanized and affluent) people needing larger amounts of safe and adequate food supplies clashes with the imperative to reduce greenhouse gas emissions and challenges the moral basis for using consumable crops to fuel motor vehicles.

Together, expectations of increased demand and volatile supply raise the specter of food price inflation, which is politically unwelcome and is linked to macroeconomic and social issues (notably concerns at low growth rates in wages and disposable income in developed economies and affordability in emerging ones). Rising awareness of inequality, particularly in developed markets, is exemplified by the existence of urban ‘food deserts’ – communities where availability of fresh or healthier food choices is severely limited. Scarcity or potential scarcity pitches science, in the form of use of genetically modified organisms that can mitigate certain climate or other effects in crops, against suspicion, fear and political resistance in key markets, such as China and the EU. All of this exacerbates the emerging ‘politics of nutrition’, which are driven by escalating concerns of health and welfare of people in an age where developed and developing economies face unprecedented levels of obesity and related diseases. Together these open new areas of possible government intervention, some of which we have begun to see, including taxes on high fat or sugary foods (Mexico), attempts to ban certain foods (New York), increased subsidy allocations for ‘greening initiatives’ (EU).

Scandals such as the beef/horse meat scare in Europe in 2014, or the recent High Path Avian flu outbreaks in the US, affect public health or perception and increase calls for tighter regulation and scrutiny of the sector. In my view agricultural production needs more developed and well-managed corporates. These can deal better with market counter-parties, be more clearly accountable to all stakeholders and be more efficiently regulated, particularly as environmental and other regulations have increased in complexity and consumers demand higher levels of traceability. It is ironic that in some areas corporations cannot own farmland, and that in Europe the most recent subsidy regime includes higher payments to smaller and younger farmers, with reduced allocations in many countries to larger operators. Most of the world’s population lives in countries with a structural deficit in food production. Domestic or regional food production needs to be stimulated, able to attract global expertise and adopt best practices. Corporations should also be the best positioned to provide much-needed funding. But building investable companies requires many things, among them the right legal and fiscal environment, capital, management, systems, controls and the time and the opportunity to mature.

Agriculture needs to be able to compete for capital in a market where, despite much investor interest and curiosity, the industry has yet to demonstrate that it is able to deliver sustained attractive risk-adjusted rates of return. Business models will need to adapt to accomplish this in the face of the challenges discussed above. Investors will need to be both informed about and more willing to manage the risks of businesses in emerging, even frontier, markets. Consequently, governments have a substantial duty to formulate policies that stimulate – not preclude or prevent – needed investment, whether by local or international players. This requires both legal systems that safeguard enforceability of rights and ownership and competitive fiscal policies with incentives that will attract investment from incumbents and new entrants, to encourage these businesses to germinate and grow.

David Gray is a member of the speaking faculty for Global AgInvesting 2015 at the Waldorf Astoria New York City, April 27-30.

The opinions expressed in this editorial are the author's own and do not reflect the views of GAI News.