Tuesday, June 2, 2009

The Economist: Outsourcing's 3rd Wave - Buying Farmland Abroad

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We rarely can talk about long term trends anymore since the stock market is all about the tree right ahead of you instead of the forest behind it. Caring about the forest yields you very little nowadays as 'long term' = 'next week'. But this piece in The Economist completely fascinated me as long time readers will know what I was preaching early in 2008. As the world population continues to grow [Jun 20, 2008: World Population to Hit 7 Billion by 2012] and more importantly as more people move away from abject poverty and into some form of "better class", I believe world food supplies will be strained. Year after year... after year... after year. I said if I had one very long term investment it would be arable farmland. I heard Jim Rogers say something similar in the past 6 months... but in this case I am going to take credit for being first. In January 2008 [Jan 21, 2008: Food... Food... Food] I wrote

I think food the next 5 years, will be what crude oil was the past 5. And it is not exactly a product one can cut back on when times get tough - hence my commentary that the potential for social strife if this continues is far far greater than anything crude oil could produce. (Remember those 1 billion rural Chinese)

In February 2008 in [Feb 1, 2008: Starting Position in Powershares DB Agriculture Fund] I wrote:

If I had a way to buy futures contracts on farmland I'd be buying that too. And yes I am very serious. I think values for farmland across the world are going to rocket in the next decade.

Last summer in [Jun 5, 2008: NYTimes: Food is Gold, So Billions Invested in Farming] I wrote

The way things are going, within a decade farmland is going to have more value than ocean front property.

I've said in the past if there was an easy instrument to purchase farmland, I'd like to be in it. Even more so in the former Soviet satellite nations where farmland is much cheaper than the American heartland.


While I am generally well read, I didn't know what a Malthusian was until I was well into writing this blog but this piece in early 2008 spoke to a lot of my own thoughts [Mar 24, 2008: WSJ - New Limits to Growth Revive Malthusian Fears] Now as with all things, I do believe technological improvement will help alleviate shortfalls to some degree - many 2nd and 3rd world farming technology is 30, 50+ years behind what some 1st world countries utilize. For example India has the 2nd most arable land in the world but is producing well below potential [Jun 23, 2008: India Falling Below Potential in Farming]

With the right technology and policies, India could help feed the world. Instead, it can barely feed itself. India’s supply of arable land is second only to that of the United States, its economy is one of the fastest growing in the world, and its industrial innovation is legendary. But when it comes to agriculture, its output lags far behind potential. For some staples, India must turn to already stretched international markets, exacerbating a global food crisis.

The Green Revolution introduced high-yielding varieties of rice and wheat, expanded the use of irrigation, pesticides and fertilizers, and transformed the northwestern plains into India’s breadbasket. Between 1968 and 1998, the production of cereals in India more than doubled. But since the 1980s, the government has not expanded irrigation and access to loans for farmers, or to advance agricultural research. Groundwater has been depleted at alarming rates.

Family farms have shrunk in size and quantity, and a few years ago mounting debt began to drive some farmers to suicide. Now many find it more profitable to sell their land to developers of industrial buildings.


With with the stresses on our oceans, our 'potential' climate change, our urbanization of much of our "good land" (see example in India above)... I expect the stress in the food supply to be a big theme in the coming decades. [Nov 26, 2008: Food Crisis to Resume Next Year?] How it all plays out is unknoweable in terms of conflict or stresses across nations, but we saw a glimpse of what 'stress' can do last year. [Jun 29, 2008: NYTimes - Hording Nations Drive Food Prices Ever Higher] [Apr 14, 2008: WSJ - Food Inflation, Riots Spark Worries for World Leaders] [Mar 31, 2008: Reuters - Tensions Rise as World Faces Short Rations] [Feb 13, 2008: As Asia Food Prices Bite, Analysts Warn of Worse to Come] Now we have the attention span of 4 year old toddlers so as commodity prices fell all these ills were forgotten. But the structural issues were the same, and the central banks (especially ours) are creating even more potential pain for the worlds "non rich"... remember, inflation is the cruelest tax. So as worthless US pesos are printed and sent across the world in search of hard (or soft) assets to bid up, I expect food inflation to begin anew. I am sort amused at what I wrote in my Feb 1st (2008) piece that I referenced above.

I am as convinced today as I was in August the Fed will take every step necessary to bail out the US financial system by flooding the world with dollars.

The Fed is now creating it's 3rd bubble in just over a decade. This is our system now. It is a sad statement on what the Fed has become in my opinion. But that's neither here or there - as an investor I have to figure out where the next bubble will be. My early guesses are commodities or foreign markets. We'll know by 2013 as this bubble bursts and creates the next worldwide crisis.


Sound familiar kids? So please don't read my dismissive attitude of the Fed as anything new - I was calling them out and telegraphing what they would do long ago. How did I know? Because that's all they know how to do now. Kick the can down the road by creating ever bigger bubbles to hide the damage under the surface. Meanwhile we clap like seals because prices are going up - including stocks. But the damage is still happening; it is just a magic show on the surface.

But I digress....

As an investment theme what is old will be new again. And the few things we cannot live without are fresh water [Jun 18, 2008: The Ultimate Shortage --> Water] and food. A few institutional players began down this road last year as we wrote in [Jun 14: Bloomberg: Farmland Reaps Bonanza for TIAA]. As Americans, there is one thing we can lean on as we outsource almost everything else... it would be very hard to export our farmland (but I am sure if large corporations could find a way, they would do so to save on labor costs) [Aug 19, 2008: NYT - Export Boom Helps Farms, but not American Farmers]

Exports are the bright spot this year in an otherwise bleak economy. But the world is not suddenly snapping up made-in-America goods like aircraft, machinery and staplers. The great attraction is decidedly low-luster commodities like corn, wheat, ore and scrap metal.

This
helps explain why manufacturing jobs are continuing to disappear by the tens of thousands and factories are closing even during a miniboom in exports.


So with that intro, let me highlight some of the points from this Economist piece: Outsourcing's 3rd Wave - Buying Farmland Abroad. Basically it appears "rich food importers" have seized on the idea I advanced 2 winters ago. Food will be the new gold... and our world is flattening by the day.
  • Rich food importers are acquiring vast tracts of poor countries' farmland. Is this beneficial foreign investment or neocolonialism?
  • EARLY this year, the king of Saudi Arabia held a ceremony to receive a batch of rice, part of the first crop to be produced under something called the King Abdullah initiative for Saudi agricultural investment abroad. It had been grown in Ethiopia, where a group of Saudi investors is spending $100m to raise wheat, barley and rice on land leased to them by the government. The investors are exempt from tax in the first few years and may export the entire crop back home. Meanwhile, the World Food Programme (WFP) is spending almost the same amount as the investors ($116m) providing 230,000 tonnes of food aid between 2007 and 2011 to the 4.6m Ethiopians it thinks are threatened by hunger and malnutrition.
  • The Saudi programme is an example of a powerful but contentious trend sweeping the poor world: countries that export capital but import food are outsourcing farm production to countries that need capital but have land to spare. Instead of buying food on world markets, governments and politically influential companies buy or lease farmland abroad, grow the crops there and ship them back.
Pro
  • Supporters of such deals argue they provide new seeds, techniques and money for agriculture, the basis of poor countries’ economies, which has suffered from disastrous underinvestment for decades.
Con
  • Opponents call the projects “land grabs”, claim the farms will be insulated from host countries and argue that poor farmers will be pushed off land they have farmed for generations. What is unquestionable is that the projects are large, risky and controversial. In Madagascar they contributed to the overthrow of a government.
  • Investment in foreign farms is not new. But several things about the current fashion are new. One is its scale. A big land deal used to be around 100,000 hectares (240,000 acres). Now the largest ones are many times that. In Sudan alone, South Korea has signed deals for 690,000 hectares, the United Arab Emirates (UAE) for 400,000 hectares and Egypt has secured a similar deal to grow wheat. An official in Sudan says his country will set aside for Arab governments roughly a fifth of the cultivated land in Africa’s largest country (traditionally known as the breadbasket of the Arab world). (that's where all your gas money is going)
So if there is something to buy with America's money, you know China has to be involved
  • It is not just Gulf states that are buying up farms. China secured the right to grow palm oil for biofuel on 2.8m hectares of Congo, which would be the world’s largest palm-oil plantation. It is negotiating to grow biofuels on 2m hectares in Zambia, a country where Chinese farms are said to produce a quarter of the eggs sold in the capital, Lusaka. According to one estimate, 1m Chinese farm labourers will be working in Africa this year, a number one African leader called “catastrophic”.
How much is it in total? In just 3 years the size of all of France's agricultural land has been involved.
  • In total, says the International Food Policy Research Institute (IFPRI), a think-tank in Washington, DC, between 15m and 20m hectares of farmland in poor countries have been subject to transactions or talks involving foreigners since 2006. That is the size of France’s agricultural land and a fifth of all the farmland of the European Union.
  • Putting a conservative figure on the land’s value, IFPRI calculates that these deals are worth $20 billion-30 billion. (i.e. walk around money for China or in our case enough money for 1/6th of a bailout of AIG, or 1/5th of Citigroup or... well you get the idea)
So now we enter a new wave of outsourcing but since we cannot move farmland, it has a different twist. And it's not Americans doing the outsourcing, but it is a lot of OUR money ...
  • What is happening, argues Richard Ferguson, an analyst for Nomura Securities, is outsourcing’s third great wave, following that of manufacturing in the 1980s and information technology in the 1990s.
What else is different in this latest wave? This wave is not about exploiting 'non discretionary' foodstuffs - it is the necessities as the stresses I speak above emerge.
  • Several other features of the process are also new. Unlike older projects, the current ones mostly focus on staples or biofuels—wheat, maize, rice, jatropha. The Egyptian and South Korean projects in Sudan are both for wheat. Libya has leased 100,000 hectares of Mali for rice. By contrast, farming ventures used to be about cash crops (coffee, tea, sugar or bananas).
Private Investors are also getting into the game
  • In the past, foreign farming investment was usually private: private investors bought land from private owners. That process has continued, particularly the snapping up of privatised land in the former Soviet Union.
  • Last year a Swedish company called Alpcot Agro bought 128,000 hectares of Russia; South Korea’s Hyundai Heavy Industries paid $6.5m for a majority stake in Khorol Zerno, a company that owns 10,000 hectares of eastern Siberia; Morgan Stanley, an American bank, bought 40,000 hectares of Ukraine in March. And Pava, the first Russian grain processor to be floated, plans to sell 40% of its landowning division to investors in the Gulf, giving them access to 500,000 hectares.
But they can't match the scale of government; after all no private investor has millions of Americans sending them billions upon billions each month for products (petrol or manufactured). So as we smile about our consuming culture - those with products have our cash. And are doing out of the box things like... investing in the long run. Meanwhile our (borrowed) treasure is furiously bailing out and backstopping our financial oligarchs (and our commercial real estate ones as well). And are creating new bubbles for the populace to pay via higher prices (i.e. "prosperity"). Compare and contrast the policies.
  • But the majority of the new deals have been government-to-government. The acquirers are foreign regimes or companies closely tied to them, such as sovereign-wealth funds. The sellers are host governments dispensing land they nominally own.
  • Cambodia leased land to Kuwaiti investors last August after mutual prime-ministerial visits. Last year the Sudanese and Qatari governments set up a joint venture to invest in Sudan; the Kuwaiti and Sudanese ministers of finance signed what they called a “giant” strategic partnership for the same purpose. Saudi officials have visited Australia, Brazil, Egypt, Ethiopia, Kazakhstan, the Philippines, South Africa, Sudan, Turkey, Ukraine and Vietnam to talk about land acquisitions. The balance between the state and private sectors is heavily skewed in favour of the state.
  • That makes the current round of land acquisitions different in kind, as well as scale. When private investors put money into cash crops, they tended to boost world trade and international economic activity. At least in theory, they encourage farmers to switch from growing subsistence rice to harvesting rubber for cash; from growing rubber to working in a tyre factory; and from making tyres to making cars. But now, governments are investing in staple crops in a protectionist impulse to circumvent world markets. Why are they doing this and what are the effects?
KEY POINT:
  • Food security is not just an issue for Abu Dhabi or the United Arab Emirates,” says Eissa Mohamed Al Suwaidi of the Abu Dhabi Fund for Development. “Recently, it has become a hot issue everywhere.” He is confirming what everyone knows: the land deals are responses to food-market turmoil.
  • Between the start of 2007 and the middle of 2008, The Economist index of food prices rose 78%; soyabeans and rice both soared more than 130%. Meanwhile, food stocks slumped. In the five largest grain exporters, the ratio of stocks to consumption-plus-exports fell to 11% in 2009, below its ten-year average of over 15%.
And it all comes back to the ultimate commodity - water
  • Saudi Arabia made itself self-sufficient in wheat by lavishing untold quantities of money to create grain fields in the desert. In 2008, however, it abandoned its self-sufficiency programme when it discovered that farmers were burning their way through water—which comes from a non-replenishable aquifer below the Arabian sands—at a catastrophic rate.
  • Other Gulf states followed suit. So did China and South Korea, countries not usually associated with water shortages but where agricultural expansion has been draining dry breadbasket areas like the North China Plain.
  • Water shortages have provided the hidden impulse behind many land deals. Peter Brabeck-Letmathe, the chairman of NestlĂ©, claims: “The purchases weren’t about land, but water. For with the land comes the right to withdraw the water linked to it, in most countries essentially a freebie that increasingly could be the most valuable part of the deal.” He calls it “the great water grab”.
I will stick to what I said in 2007 and 2008... the wars of the future won't be over oil; they will be over fresh water.

Now why do the countries who have the land sell it? Well first and foremost politicians in all country are generally of the same stripe... worry about now, reap rewards now, and what happens in the future is for someone else to worry about. And some of these countries are extremely poor so any investment seems like mana from heaven.
  • For the countries seeking land (or water), the attractions are clear. But what of those selling or leasing their resources? They are keen enough, even sending road shows to the Gulf.
  • Sudan is letting investors export 70% of the crop, even though it is the recipient of the largest food-aid operation in the world. (makes sense no?)
  • In developing countries as a whole, the average growth in cereal yields has fallen from 3-6% a year in the 1960s to 1-2% a year now, says the World Bank. This reflects, among other things, a decline in public investment. In the 14 countries that depend most on farming, public spending on agriculture almost halved as a share of total public spending between 1980 and 2004.
  • The investors promise a lot: new seeds, new marketing, better jobs, schools, clinics and roads.
  • China has set up 11 research stations in Africa to boost yields of staple crops. That is needed: sub-Saharan Africa spends much less than India on agricultural R&D.
But in these nations, unlike ours - people seem to care about selling off their futures.
  • Politics of a different sort poses more immediate problems. In Madagascar this year popular hostility to a deal that would have leased 1.3m hectares—half the island’s arable land—to Daewoo Logistics, a South Korean company, fanned the flames of opposition and contributed to the president’s overthrow.
Thankfully, not all the world's sheeple are content to sleep away while they are plundered.
  • The head of the UN’s Food and Agriculture Organisation, Jacques Diouf, dubs some projects “neocolonialist”. Bowing before the wind, a Chinese agriculture-ministry official insists his country is not seeking to buy land abroad, though he adds that “if there are requests, we would like to assist.”
  • Objections to the projects are not simply Luddite. The deals produce losers as well as winners. Host governments usually claim that the land they are offering for sale or lease is vacant or owned by the state. That is not always true. “Empty” land often supports herders who graze animals on it. Land may be formally owned by the state but contain people who have farmed it for generations. Their customary rights are recognised locally, but often not accepted in law, or in the terms of a foreign-investment deal.
  • Customary owners are thrown off land they think of as theirs. Smallholders have their arms twisted to sign away their rights for a pittance.

To end and on a related note, I have not had time to dissect this piece from last month in the New York Times regarding how Smithfield Foods (SFD) is moving into Eastern Europe and completely transforming hog farming (read: destroying small farms and 'industrializing' the process) but if you want a hell of a read - please see here. I'm not one of those guys who show up to protest 'the evils of globalization' but when you read these sort of stories - you truly see the power of global multinationals and how they disrupt local communities. All in the common good (i.e. their profits) I am sure ;)

Old customs and jobs are dying and the air itself is changing, however, transformed by an American newcomer, Smithfield Foods. Almost unnoticed by the rest of the Continent, the agribusiness giant has moved into Eastern Europe with the force of a factory engine, assembling networks of farms, breeding pigs on the fast track, and slaughtering them for every bit of meat and muscle that can be squeezed into a sausage.

[Jan 18, 2008: One Lonely Voice Agrees with me on Food Inflation]
[May 2, 2008: Don Coxe on Food Crisis]


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