Last week, we wrote that commodity markets were signaling that “This Is Not a Drill,” and discussed events driving energy and industrial and precious metals. We deliberately didn’t discuss soft commodities — i.e., foods. Below are some thoughts about foods, food inflation, fertilizers, the potential consequences for food and beverage manufacturers and retailers, and the possible wider geopolitical effects on food import-dependent developing countries in particular.
A Letter We Wish We Didn’t Have To Write
Even though there will be beneficiaries of current developments, we don’t want to reduce this issue to solely an “opportunity” for investors. Food crises are unmitigated humanitarian catastrophes. In a system as complex, interdependent, and unpredictable as the web of global agricultural commodity production and supply chains, catastrophic consequences can follow disruptions in unexpected ways; a case study is the European migrant crisis of 2015, whose effects are still far from exhausted. (Consider the tight polls in upcoming French elections, and the remarkable rebirth of the Front National.)
It is not our desire to find ways to profit from human misery. As we analyze the current inflationary cycle, we recognize that we have an obligation to our clients to be as effective as possible in playing “inflation defense” with those clients’ savings. That means remaining aware of important trends, including trends in agricultural commodities, and navigating them in a way to enhance that defense if possible. Being aware and prepared is one thing — but we certainly hope the worst scenarios do not come to pass.
Food Crisis: Inflation, War, and Fractured Supply Chains
Inflation and supply-chain disruption were already factors in play thanks to the pandemic responses from policymakers — including the lockdowns, shutdowns, confusing signals from government, and of course the monetary and fiscal tsunami. Russia’s invasion of Ukraine has dramatically escalated the effects of these disruptions on global food supplies.
Russia and Ukraine are both critical suppliers of wheat and corn (as well as barley, a less-significant feed grain), as well as important seed oils, including canola and sunflower oil.
Ukraine’s supplies are threatened because perhaps half the country’s agricultural land will not be planted this spring, and even if hostilities are quickly resolved (which seems increasingly unlikely), normalization will take a year or two. (Inadequate seed stocks will hinder planting, as will the potential need to remove mines and military refuse from millions of hectares of farmland.) Further, Ukraine’s agricultural exports mostly depart the country via ports on the Black Sea, all of which are now closed to shipping traffic — and which are particularly desired targets of Russian strategic interest.
Russia’s (and Belarus’) supplies are threatened due to sanctions, and the inability of global supply chains to quickly re-route that supply to willing buyers (e.g., China — which has historically represented a very small destination for Russian wheat exports).
Notably, it is food-dependent Middle Eastern countries which are the most sharply exposed to these export shortfalls, and which will be scrambling to make it up — via price-fueled demand destruction, rationing, the release of strategically held stocks, etc. Turkey, Egypt, Lebanon, and Tunisia are all particularly exposed. As we’ve mentioned before, the last widespread episode of political instability in Middle Eastern countries was occasioned by a food inflation shock in 2011 and 2012. Depending on the trajectory of current events, this has the potential to be a still more severe disruption.
Of course, global hydrocarbon supply issues are central here as well. Russia and Belarus are key suppliers of potash, an essential fertilizer component — but ammonia and urea produced from natural gas via the Haber-Bosch process is critical as well, so fertilizer shortages and soaring fertilizer costs are a further, compounding component of the crisis. Indeed, the current convergence of sanctions, hydrocarbon shortages, production shortfalls, and stranded supplies are creating a “perfect storm.”
Source Bloomberg, LLP
Food Inflation Bubbling Up In the Developed World
Naturally, this negative supply shock will not remain confined simply to food grains and their immediate derivatives, such as seed oils — simply because those grains are essential components of packaged foods worldwide. Indonesian store shelves are already almost bare of the country’s favorite noodles, which are made with Ukrainian wheat. But beyond the developing world, the push in recent years in the developed world towards highly processed plant-based staples has increased the exposure of many large food producers to grain prices, while plastic packaging and elongated supply chains have increased their exposure to energy costs.
As it turns out, developed-world consumer demand for packaged food is quite “elastic” — that is, the ability of brand-name food manufacturers to pass rising costs through to consumers is relatively limited before those consumers will begin shifting towards cheaper alternatives, bargain brands, etc. Margins of packaged food manufacturers will be squeezed — although those brands with idiosyncratic loyalty and high demand might fare relatively better. Brand loyalty is everything in this context.
In discussing packaged food, another item looms large, even after including raw material and energy costs — and that’s labor. We just read that “employees at 540 [California] Ralphs, Albertsons, Vons and Pavilions stores from San Luis Obispo to San Diego will receive raises of 19% to 31% over current levels, while part-time employees — around 70% of the workforce — were guaranteed 28 weekly hours, up from 24.” Union negotiators noted that “the company was afraid of a strike.” This phenomenon will continue and expand, and retailers will see margins decline as a consequence.
All of these components will be adding to the price pressures seen by developed-world consumers at the cash register. This of course is not anywhere near the kind of existential issue that sparked an uprising in Tunisia in 2011 — but combined with the “pain at the pump,” it may have a significant effect on political dynamics in the developed world.
All of that being said, no matter where you are in the world, history suggests that political leadership during a period of declining standard of living often does not remain “leadership.” There is a lot that goes into determining the “standard of living,” but front and center is the availability of affordable food, and it looks like there is lot less of that around. Belt tightening looks like a global trend, but of course some belts will be cinched more than others.
Producers (Who Can Produce) Benefit
Potential beneficiaries include grain producers in other “breadbasket” regions — including the U.S., Argentina, Brazil, and India. Strong planting and export boosts from these sources would help to calm anxiety-driven price spikes, as would any resolution of Russia’s war against Ukraine that permits more planting to occur. The fact that corn’s price is outstripping soybeans suggests a rotation of U.S. farmers from soy to corn.
Which brings us to another issue that will certainly arise: it may be that current events prompt a rethinking of the (to us) unconscionable dedication of so much U.S. corn supply to ethanol production, a policy boondoggle of epic proportions. In a global food crisis, the spectacle of food being burned to power vehicles — especially when ethanol requires a significant amount of energy to produce – may (read “should”) finally become politically intolerable.
And of course, with central banks tightening, the higher price of money makes it more difficult to pencil out capex expenditures that would contribute to an easing of supply pressures.
Investment implications: The stage is being set for rising and possibly accelerating food prices; a base case might see strong prices through the rest of this year, while a less likely case could see higher and longer-lasting price pressures amounting to a global food crisis with complex political and geopolitical ramifications. Packaged food producers will face eroding margins from raw materials, energy, and labor, as will food retailers, and some reliable dividend-paying consumer staples stocks may come under pressure as a result.
