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The Boom Beyond Commodities

A New Era Shaping Global Food and Agribusiness, 2008

Rabobank InternationalFood & Agribusiness Research and Advisory

Author: Brady Sidwell

[email protected]/far

This report has been published in line with Rabobank’s long-term commitment to international

food and agribusiness. It is one of a series of publications undertaken by the global department

of Food & Agribusiness Research and Advisory. ©2008 All Rights Reserved.

Disclaimer — please refer to the important disclaimers at the end of this document.

The Boom Beyond Commodities

A New Era Shaping Global Food and Agribusiness, 2008

Contents | i

ContentsPage

Section 1

Executive Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

”F” Factors Driving Demand and Prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Outlook and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Section 2

Focus on Protein — Meat, Dairy, Seafood and Associated Products . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Developing World Engine for Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Supply/Demand Dynamics Differ . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Protein Exports Concentrated Among few Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Changing Dietary Patterns Pronounced in Emerging Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Higher Costs and Food Safety Major Challenges to Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

Outlook and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Section 3

Focus on Food Processing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Increasing Costs Squeezing Players Globally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Fragmentation Brings Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20


Section 4

Focus on Energy Crops and Commodities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Food Demand Supporting Edible Oils . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Higher Prices Shifting Margins and Plantings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Biofuels Fuelling Commodity Growth, but Future Uncertain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Margin Pressures Soften Strong Demand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Outlook and Opportunities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Section 5

Focus on Agri-inputs and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Challenge of Producing More from Less . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Higher Prices — More Investment in Inputs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Emerging Market Demand Leading Growth for Inputs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37


Section 6

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Previous Publications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Section 1 Executive Summary | 1

The global food and agribusiness industry is set to undergo significant changes in the coming years. Increased demand for food and animal feed, as well as the growing use of crops for biofuels require greaterdeployment of scarce agricultural resources,and have shifted the industry’s valueproposition upstream. As a result of thesedynamics, new opportunities are beingcreated in both developed as well asemerging economies, leading to tremendousgrowth potential that extends beyond the boom in the commodities market.

While much interest in agriculture hasemerged from financial and strategicinvestors alike in recent years, significantattention has been placed on thedownstream segment of the food andagribusiness value chain, where businessmodels are more easily understood byinvestors. Indeed opportunities continue

to exist in the downstream. However,Rabobank believes that the fundamentalsdriving the current boom in agriculturalcommodities have moved some of the best investment opportunities to the up- and mid-stream segment of the value chain(see Figure 1.1).Thus, instead of focusing on the commodities themselves, the aim is to highlight opportunities emerging for food and agribusiness players who are best positioned to benefit from changingdynamics in the world market, especiallyagricultural producers, input and equipmentplayers who support producers, as well asfood industry players whose products arealigned with lifestyle changes which aretaking place most rapidly in emergingmarkets, particularly in Asia.

As is characteristic of commodities,particularly in agriculture, cycles bring peaksand troughs and, as history demonstrates,

1 Executive Summary

Inputs Primary production

Secondary processing

Consumer Primary processing Retail and

food service

Upstream Midstream Downstream

Agri-inputs

Agri-equipment

Energy crops and commodities

Food processingProtein

Source: Rabobank, 2008

Figure 1.1: Opportunities in the Food and Agribusiness Value Chain

2 | Rabobank The Boom Beyond Commodities

the drivers tell the story. In comparison tocommodity booms of the past, one uniqueand substantial driver of the currentcommodity cycle has been the emergence of biofuel initiatives around the world whichhave added an “f” to the factors of demand,namely food, feed, fibre and now fuel.Thus,while commodity highs are followed by lows, we believe the current “f” factors of demand will remain strong over the coming years and support a base shift in commodity prices which will promote a greater deployment of scarce agricultural resources and a further appreciation of real farm assets.

Specifically, Rabobank believes thatopportunities in agriculture are mostpronounced in the following sectors: animalprotein and dairy, food processing, energycrops and commodities, agri-inputs and agri-equipment (see Box 1).This reportdiscusses the factors driving growth in these sectors and focuses on the outlook for opportunities Rabobank believes aretaking shape as a result of a surge in globalfood demand and commodity prices.

“F” Factors Driving Demand and Prices The world of agriculture is rapidly changing.Increasing demand for conventional cropsfrom the “f” factors are pushing globalcommodity prices across the board to all time highs (see Figure 1.2).With this change has come increased investor interest in commodities citing in large part diversification, hedging against inflationand a falling US dollar as the impetus toescape market turbulence, high volatility and uncertainty in global stock markets.Interest from institutional investors has sincespread to the retail level where the attractive

”commodity story”as an investment anddiversification vehicle has begun filteringthrough to investor portfolios. Furthermore,greater reliance on the trade for agriculturalraw materials and products in order to meetfresh demand highs has increased thecorrelation between local and import pricesand contributed to a truly “global”commodityboom. Strategic investors looking to secureresources upstream amid supply/demandimbalances have influenced consolidationand a revaluation of agricultural assets.The result has seen commodity prices reachrecord highs over the past few years that are expected to remain above long-termaverages for the foreseeable future.

Weather-related effects have also supportedthe bullish run in commodities, as smallerharvests are partly responsible for record-lowstocks-to-use ratios for many crops,contributing to increased volatility and,together with the “f” factors, supportingglobal inflationary fears. As a result of thesehigher commodity price levels, food prices are under pressure to respond. In May 2008,the FAO Food Price Index averaged 217.5,over 50 percent above 2007 levels and slightlyoff its March peak.The FAO Cereal Indexaveraged 273, up 84 percent above last yearwhile the Oils/Fats Index averaged 269, nearly100 percent above the same period in 2007.The major contributor to the Food Price Indexin May was meat which, estimated at 145, isthe highest value since March 2005. Dairyprices on the FAO Dairy Index also recordedstrong growth, averaging 265 in May 2008.Projected record world sugar production in 2007/08 led to the softening of the FAOSugar Index which stood at 163 in May 2008,up 24 percent from the year before.Theseremarkable gains in prices have promptedmany governments around the world,

Box 1: Definition of Select Agricultural Sectors and Opportunities

Animal Protein and Dairy

Protein-based goods and products such as meat, dairy and seafood, which have a positive consumption correlation with income growth.

Food Processing

Food ingredients and prepared products which benefit from ”new age”consumer preferences and increased food demand.

Energy Crops and Commodities

Starch sugar and oil-based crops which have food, feed and fibre or fuel (ethanol or biodiesel) applications.

Agri-inputs and Agri-equipment

Inputs for agricultural production including fertilizers, crop protection chemicals (CPCs), seeds and water for which higher quality combined

with application management results in greater productivity, and small- and large-scale equipment used in upstream agricultural production

for cultivating, planting, fertilizer and CPC applications, harvesting as well as the transporting of grains, oilseeds and livestock.


especially in developing countries where foodis a major share of the overall consumer priceindex (CPI), to take steps to fight the so-called“ag-flation”by encouraging imports throughreduced tariffs and/or imposing exportrestrictions on key agricultural commodities.The result of such intervention, however, hascaused uncertainty to food security anddisruptions to market fundamentals whichhelp to restore the supply/demandequilibrium and ease prices.

Underlying these dynamics are several key pillars which are shaping the food andagribusiness industry and driving a paradigmshift in global agriculture.These includeincome, population and urbanisation growth;resource scarcity (land and water); freertrade/globalisation; food safety/traceability,and finally, sustainability (see Figure 1.3).

Increasing demand from the “f” factors caused by global income, population and urbanisation growth have addedincreased pressure to agricultural resources(see Figure 1.4). As a result of this increaseddemand, combined with limited arable land availability per capita and increasedconversion pressure from expanding cities,infrastructure and industrial centres incountries which have the least land to spare, the agricultural industry faces thechallenge of producing more with less.Satisfying this new level of demand can only be achieved through increasedinvestments in agriculture, particularly wider mechanisation in the developing world and greater use of existing and newtechnologies to increase production andmore efficiently utilise scarce resources

0

50

100

150

200

250

300

May-08Mar-08Jan-082006200420022000

Sugar Oils and fats Cereals Dairy Meat Food price index

Figure 1.2: FAO Food Price Index (2000-May 2008)

1998-2000=100

Source: FAO, Rabobank, 2008

Energy

Food

Environment

Income, population and urban

growth

Resourcescarcity

Sustainability

Freer Trade/globalisation

Food safety/traceability

Figure 1.3: Key Drivers Effecting Global Food and Agribusiness



including land, water and fertilizers.With improvements in transportationinfrastructure globally, greater access to previously inaccessible resource-richcountries will result in increased agriculturalinvestments in these areas and appreciationof production assets, primarily in SouthAmerica, eastern Europe and Southeast Asia. Freer trade will also support moreinternational investments in agriculture inthese regions which offer comparative costadvantages. Over time this will continue toresult in a broader distribution of wealth andthus increasing consumer demand in thesemarkets, particularly for higher protein foods— adding further support for the boom incommodities and expansion of the foodprocessing industry.This increased flow of imports and exports has stimulated consumers’ safety awareness about thestandards used to produce these products,particularly when food is concerned, andmore recently the environment. Food safety,traceability and sustainability have thusbecome and will likely remain sensitiveagricultural issues.

Outlook and OpportunitiesThe new demands that agriculture will be expected to meet over the coming years are creating opportunities for increased investment in this industry. As the fundamental demand drivers of increasedconsumption become stronger and morewidespread, the food industry will no doubtneed to expand. In China and India alone,nearly 50,000 people per day over the nextdecade are expected to be added to cities

where consumers demand substantially more energy over their rural counterparts.As income growth drives demand for proteinfoods, a multiplier effect for commodityinputs supports prices. Expanding urbanpopulations which prefer convenience and variety will bring growth to foodprocessing and food retail — which will again boost demand for commodities andinputs. Biofuel industries will also requireincreasing volumes of food commoditieswhich also drive demand for inputs.Together,these factors will create significant growthopportunities which Rabobank believes areset to benefit players in several agriculturalsectors including animal protein and dairy, food processing, energy crops and commodities, and agri-inputs and agri-equipment.

Looking deeper at the demand challenge,steady food consumption growth is expectedto increase at a faster pace than crop yields while the availability of arable land per capita will be limited, declining in some of the highest demand growthcountries such as China over the comingyears (see Figure 1.5).Thus, productivity gains both in China and the rest of the world will be an important factor to satisfyincreased demand from the world’s up-and-coming urban, middle-class consumers.

While the story in the developed world can be characterised by size and relativestability, developing markets are set tocontinue on a strong growth path goingforward, particularly in Asia, which Rabobankbelieves has some of the best potential for

(size of bubble = 2010f population)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

0 2 4 6 8 10 12

Figure 1.4: Global Income and Population Growth

f=forecast

Source: IMF, Rabobank, UN, 2008

Brazil

Argentina

India

China

Russia

Mexico

US

CA

GR

po

pu

lati

on

gro

wth

, 200

5-20

10f

France

Italy Japan

Germany

Income growth, 2008


continued expansion in the years to comedespite recent shocks to the global economyfrom the credit crunch and soaring food andenergy prices (see Figure 1.6).

The China growth story in particular is wellknown, and although not an average case,provides a good reference to pinpoint someof the significant drivers behind the risingfood consumption curve.With over one-fifth of today’s consumers, China is truly shapingthe world of agriculture. Over the next twodecades, food will continue to account for the largest share of consumer spending inChina.With future food production expectedto increase by only 1 percent annually as a

result of increased productivity, the futuredemands on agriculture as well as land andwater resources will be profound. AnotherGreen Revolution in agriculture, whichpreviously resulted in grain production more than doubling in developing nationsfrom 1961 to 1985, making broader and more efficient use of crop technologies and investments, will be key to sustaining the growth in demand anticipated in the years ahead.

0

2

4

6

8

10

12

14

IndiaChinaUnited StatesEuro AreaEast Asia and PacificWorld

2010f2009f2008f2007e20062005

Figure 1.6: Real GDP Growth, 2005-2010f

e=estimate; f=forecast

percent

Source: World Bank, Rabobank, 2008

Asian economies

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

Arable landYieldFood consumption

2014f2011f2008f200520021999199619931990

Figure 1.5: Food Consumption vs. Yield vs. Arable Land, 1990-2014f

f=forecast


Section 2 Focus on Protein — Meat, Dairy, Seafood and Associated Products | 7

As an essential part of our everyday diet,protein is one of the key elements of foodnutrition. It is no coincidence that the world’s most developed societies are also the major source of global demand forproteins including meat, dairy, seafood and their associated products.The correlationbetween wealth and protein intake is bothstrong and cross-cultural. For generations,the socio-economic relationship betweengrowing affluence and changing diets hasshaped the products which companiesproduce and the way they market them to meet the ever-changing needs of thevarious preferences of consumers.This trend of changing consumer needs is fuelled by cultural and demographic differences,such as the westernisation of consumers’diets, urbanisation, as well as the variedcapacities of chilled supply chains and the strengthening of food retail.

Developing World Engine for Growth Food trends throughout the world arechanging in different ways. In the developingworld, changes are oriented towardsincreased protein intake, while in thedeveloped world consumers are morefocused on value and convenience. Knowingyour customer and adapting to changethrough product innovation is of particularimportance in emerging markets wheretrends can change quickly and spending on food is outpacing other consumersegments. However, simply having a goodbrand is not enough in the crowded foodproduct space. For meat players, key success

factors are really more about being a global player and leveraging access tovarious markets to maximise the value of the carcass rather than just productinnovation. For dairy, the emergence ofprivate-label products which offer newconcepts and a unique look and feel areproviding strong competition for shelf space.For seafood, rising labour and fuel costs,concern over sustainability of wild-catchsupplies as well as deregulation in seafoodtrade are supporting the development ofaquaculture production in developingregions such as Asia, to supply increaseddemand both at home and abroad.

Consumer preferences for processedproducts which offer convenience have been driven in part by the strengthening of organised food retailing which best suitsthe needs of today’s fast-paced, dual incomehousehold. Growth in foodservice spending is also gaining share of consumer purchases,and is fast expanding in the developing world as a safe, consistent choice which also offers convenience and a western variety. Demand for meat, dairy and seafood from the westernisation of diets and increased eating away from home has brought about new consumers in the protein space.

Higher Prices for FoodRising food prices in 2007 and into 2008 have been the result of significant growth in commodity and fuel prices, which are important feedstocks for protein.Decade-high consumer prices in many

2 Focus on Protein — Meat, Dairy, Seafoodand Associated Products


markets have pressured governments tointervene, particularly in emerging marketswhere expenditures on food make up asignificant share of consumer’s income.Of the food categories, meat price inflationhas recorded some of the biggest gains inmany developing countries. High commodityprices, along with disease outbreaks, exportbans and weather-related effects have allcontributed to significant year-over-yearincreases in meat prices. However, rising food prices and inflation do not necessarilymean higher margins for these companies.Tightening margins for many meatcompanies over the past year imply that these companies have had limited success inpassing on higher input costs to consumers.This is especially true in the developing world,where governments are responding toinflationary pressure with controls on foodprices, as consumers in these regions areparticularly price sensitive. Furthermore, withraw materials making up a larger share of theproduction costs for meat in the developingworld, increasing input costs more quicklyaffect consumer prices in these markets. Meatprices in developed markets such as the USare likely to see increases in the near term asinput costs are transferred through the valuechain. For dairy, increasing prices typicallyresult in softer demand, especially for “newage”dairy consumers.The situation is similarfor wild-catch seafood players for whomrising fuel costs have been the major squeeze factor. Aquaculture, on the otherhand, suffers primarily from higher feedstock costs, particularly those using fishmeal.No doubt higher food prices are one of thekey challenges to demand growth for protein,

particularly in parts of Asia amid the currenthigh inflation environment.

Looking ahead, nominal food prices areexpected to remain firm over the next decade as growing demand from the “f” factors support elevated commodity price levels which will add pressure to theprices consumers pay for food (see Figure 2.1).Consumers globally are feeling the impact of rising food prices.With food as an everydayneed-to-have rather than an occasional nice-to-have, rising food prices are front and centre on the minds of consumers as well as governments. Oil prices, which have reached new highs, will continue to be a major contributor to rising commodity as well as food prices.

FeedstocksFor proteins, beef, pork, and poultry representa significant ”share of stomach”as well asdemand for the grains and oilseeds used toproduce them. Of animal proteins, poultry islikely to be the least impacted by higher feedprices due to a more efficient feed conversionratio, although margin pressure from higherinput costs will impact poultry players in a similar way as it impacts other animalproteins. Poultry has long been the fastest-growing animal protein in the world andremains so today. Despite avian influenza’s(AI) impact on global poultry numbers,healthy prospects remain for this industry.Beef and pork players will be impacted themost by higher costs in the short term givenlonger production cycles, more fragmentedvalue chains, less production flexibility andhigher per kilogram costs of production.

0

10

20

30

40

50

BeefRaw sugar

OilseedsWhite sugar

Vegetable oil

WheatPoultryCheeseCoarse grains

RiceButter

Figure 2.1: Global Food Price Projections, 2016f vs. 2001-06

percent (real prices, USD basis)

f=forecast

Source: OECD, FAO, 2008


For dairy, expected production increases incountries such as China, India and Argentinawill put pressure on animal feed demand as herd sizes grow.This will serve as anotherstrong fundamental supporting grain andoilseed prices. Increased input costs willdeteriorate margins of smaller players and encourage consolidation. Companiesbest positioned to take advantage of these industry dynamics will be those with upstream access to quality herds/genetics, feed supplies, economies of scaleand a proper cool chain to maintain qualitythroughout the collection, storage anddelivery of milk, combined with continuousinnovation of new product concepts.

The expansion of aquaculture hassignificantly increased demand for aquafeed.With limited feed substitutes available forcarnivorous farmed fish, prices for fishmealare expected to continue on an upward trend. Higher input prices are likely toencourage the production of vegetarianspecies as well as increased use of grain- and oilseed-based aquafeeds for vegetarianaquaculture.This shift should help to more closely align the seafood industry with commodity prices as is now the case for the other animal proteins.

Market PotentialSome of the world’s largest protein andprotein-related companies are takingadvantage of the demand growth potential in the developing world. From meat andseafood processors to feed manufacturers,partnerships and acquisitions between local companies in developing countries

and multinationals are underway. Localcompanies offer established sourcing anddistribution networks as well as market accessthrough local licensing, while multinationalsbring new technologies, managementexpertise and a strong international salesbase.These tie-ups are sure to continue at a more rapid pace going forward as local companies are keen to increasecompetitiveness, and multinationals aim to diversify from limited growth potential at home.This will help drive consolidation in the industry and create opportunities for both financial and strategic investors.Recent investment activity in the globalprotein industry further highlights the growth potential seen in this area.

Supply/Demand Dynamics Differ MeatThe US, the EU and China together make up over 60 percent of global meat demand(see Figure 2.2). Here China features as theheavy weight representing 30 percent of global demand due to the sheer size of its population and a traditionally meat-based diet.

The majority of meat production isconcentrated among a few major supplybases which also represent a significant share of global consumption. Currently the US, Brazil, the EU and China account fornearly 70 percent of beef production, whileChina alone represents over half of globalpork production and, together with the EU,accounts for nearly three-quarters of theglobal pork supply (see Figure 2.3). For

Beef

million tonnes (size of circle indicative of volume)

Pork Poultry

Source: FAPRI, Rabobank, 2008

Figure 2.2: Global Meat Demand, 2007

US 16%

Mexico 3%

Brazil 8%

Argentina 2%

EU 17%

Africa 2%

Russia 3%

India 2%

China 28%

Japan 3%

Korea 1%

Oceania 1%

13 9 149 21 8

2 0 2

2

1 2 2

1 2 1

2 0 2

3

44

1 1 1

7 12

3

3 2 3

7 2 7

3 0.3 1


poultry, the US, China, Brazil and the EUaccount for 72 percent of global production.As protein demand in emerging markets such as Brazil, Russia, India and China (the so-called BRIC economies) grows, so too will production in these countries. However,supply of animal protein in these countries is not expected to increase at the pace ofdemand and thus, trade from the majorexporting nations of the US, Australia and the EU will persist, especially for value-added products.

DairyEspecially in the developing world where Asia leads the pack, dairy consumption isgaining favour among consumers as a resultof increased affordability, awareness of health benefits, greater capacity both in at-home and supply-chain chilling capacity,as well as support from government school milk programmes.Traditional markets will see limited growth particularly for fresh milkwhile modest, but stable growth is expectedfor cheeses and processed products. Of all the product segments in dairy, functionalbeverage players and low-cost, tailoredingredient suppliers are likely to benefit most from the opportunities ahead in the dairy industry.

With more children today drinking milk andconsuming dairy-based products at schooland at home, primarily in growth marketswhere dairy has not traditionally been part of the diet, a whole new class of dairyconsumers is emerging. As these new,younger generations of consumers becomeadults and continue consuming more dairy-based products, they will develop into moreprominent dairy consumers and demand a

greater variety and nutritional value from the products they choose.Thus, expectationsfor dairy demand are high — especially forfunctional product categories catering to the emerging markets in general and Asia in particular.

SeafoodSeafood, considered by consumers as ahealthy food choice and a good source of Omega-3, is set to gain from consumers’preference to eat healthier foods, particularlyamong middle- and high-income earningconsumers. Seafood currently representsapproximately 20 percent of global animalprotein consumption and its share isclimbing. Per capita consumption of seafoodin Asia is already high, but further increasesare expected as Asian consumers move up the income ladder (see Figure 2.4).For example, in China seafood consumption in high-income earning households hasincreased over 150 percent in the past seven years.

Protein Exports Concentrated Among few Countries MeatFor animal protein exports, only a fewcountries dominate global trade. Brazil,Australia, India and the US currently accountfor 71 percent of beef export volumes (see Figure 2.5). (Note here that Indian beefexports are primarily lower grade meatexported to regional destinations, whichwould become apparent from export valuefigures, rather than volume.) Brazil aloneaccounts for one-third of global beef exportswhich have been growing fast in recent years,aided to some extent by ongoing restrictions

percent (volume basis)

Source: USDA, Rabobank, 2008

Figure 2.3: Top Meat Producers, 2007

US 22

US 10

US 26Mexico 4

EU 15

EU 23EU 13

Brazil 3

Brazil 17

Brazil 16

China 14China 51

China 17

India 5India 3

Argentina 6

Argentina 2Australia 4

Russia 3Russia 2

Russia 2

Canada 2Canada 2 Vietnam 2

Japan 1

Japan 2

Philippines 1Mexico 1

Thailand 2

Mexico 4

Other 4Other 13Other 8

BeefTotal: 54.5 million tonnes Total: 94.7 million tonnes Total: 62.9 million tonnes

Pork Poultry


on US beef exports. For pork, the US, the EU,Canada and Brazil represent 85 percent ofexport volume.With China producing half of the world’s pork and exporting very little, it is apparent how significant porkconsumption in volume terms is in China.Poultry, the lower-cost animal protein,is one of the most concentrated in terms of exporters with Brazil and the USaccounting for three-quarters of globalpoultry export volume.

Looking at trade, exports contribute toprosperity in the protein sector in twofundamental ways:

1) Export markets represent an additionaloutlet for production; access to marketsoutside of the domestic one increases thenumber of consumers who have access tolocal meat products.The total size of themarket is thus increased.This theoretically

represents an increase in demand, whichshould translate to higher average orequilibrium prices.

2) Exports allow the industry to maximise thevalue of the carcass by arbitraging globalmarket opportunities — this relates to theconcept of an export premium. Consumers in different countries have uniquepreferences for meat based on incomelevels, product availability, culturalpreferences and tradition. Consumerstherefore value cuts differently dependingon where they live. Open and free tradeaffords an industry the ability to sell eachcut to the highest bidder, therebymaximising the value of the carcass or the cutout value.

The characteristics of the global proteinindustry suggest the importance ofdiversifying beyond domestic borders,

0 10 20 30 40 50 60 70

Vietnam

Russia

Indonesia

US

Canada

China

Thailand

Norway

Korea

Hong Kong

Malaysia

Japan

Figure 2.4: Seafood Consumption in Selected Countries, 2006

kg/capita/year




Figure 2.5: Top Meat Exporters, 2007

US 9

India 10

US 27

US 35

NewZealand 7

EU 2

EU 25

EU 10Brazil 14

Brazil 32

Brazil 40

China 1

China 9China 5

Argentina 7

Argentina 2

Australia 19

Uruguay 5

Australia 1Kuwait 1

Canada 20

Canada 6

Chili 3Canada 2Mexico 1

Thailand 4

Other 1 Other 1Other 1

BeefTotal: 7.5 million tonnes Total: 5.2 million tonnes Total: 7.2 million tonnes

Pork Poultry


especially for companies in developedmarkets. Over the coming years, highercommodity input costs and a concentrationof growth opportunities in the developingworld will make having an internationalstrategy ever more critical.

DairyMilk and dairy product prices have risensignificantly around the world over the pastyear. As a result of higher prices in the order of 20 percent to 60 percent depending on the product, consumer demand has softened.Increasing supply encouraged by thesehigher prices amidst weakening consumerdemand resulted in dairy prices coming off the highs from the end of 2007.

Dairy exports are thinly traded with only a few regions representing the majority of exports, namely the EU, New Zealand,Australia, the US and recently Argentina.Thus, disruptions in supply can have a major impact on prices as we have seen over the past 12 months. However, due to strongdemand in the emerging markets where local supplies make up only a smallproportion of consumption amid high prices for substitutes and inputs, export prices for dairy products are expected to trade well above average over the coming years.

SeafoodToday, Asia accounts for approximately 90 percent of total aquaculture, led by China, the only country where farmed fishproduction exceeds wild catch volumes.Aquaculture has been growing elsewhere aswell and has penetrated the seafood supplychain, currently representing over two-thirdsof salmon supply and over half of fish forconsumption. Farmed pangasius (giantcatfish) from Vietnam exported to the US and EU has seen tremendous growth in the past several years which is expected tocontinue, provided no trade restrictions ordisease outbreaks surface. In fact, seafood is now Vietnam’s third largest export by value.Such examples of emerging market exportsare likely to increase over the coming years as freer trade and improved infrastructureallow companies to take advantage of cost competitiveness in these countries as well as the promise of their growingdomestic markets.

Changing Dietary PatternsPronounced in Emerging Markets Within the global food and agricultureindustry, proteins exhibit some of the

highest growth potential. Elevated prices for commodities which serve as inputs for the production of protein may have anadverse affect on players in this space andadmittedly so in the short term. However,in the longer term, the significant growth in protein demand (particularly meat) inemerging markets, combined with a greaterfocus on healthy, functional foods andbeverages (seafood and dairy) will helpplayers in these protein sectors, particularlyup- and mid-stream players includingingredient and primary processingcompanies, to overcome the potential short-term margin squeeze. Fast-moving consumergoods companies with cost-efficientoperations, innovative products and globalaccess to raw materials will be best placed to benefit from the expected consolidationover the next few years.This is particularlytrue for emerging markets where foodinflationary fears have resulted in governmentinterventions such as restrictions on foodprices and exports of staple commodities.However, the factors that will driveconsolidation and movement along thesupply chain in different markets will vary.In developed markets for example, the trend is for companies to focus on highervalue-added segments of the value chainwhereas in emerging markets such as Asia, companies are going upstream toaddress concerns over low quality andinconsistent supplies.

MeatMuch growth potential exists in Chinaparticularly for pork and beef. Consolidationin China, where this industry is typically quite fragmented, is expected as a result of increasing input costs, competition fromdomestic and foreign players as well asinterest from strategic investors.Withconsolidation prospects high and greaterpotential for Initial Public Offerings (IPO)among Chinese companies which have thedistribution network and available productsto capture expected demand growth, capitalfrom industry players as well as those seekingfinancial return will play an increasinglycentral role in this sector.

Strong growth expectations for meat demandthroughout the developing world will alsohelp to support elevated commodity pricesand further pressure this consolidation tooccur (see Figure 2.6). Integrated players with strong upstream linkages as well asdownstream distribution will be bestpositioned to take advantage of the demandgrowth and expected corporate activity.


No better example of protein opportunities inthe major growth markets exist than in China,the world’s largest pork market. Not only isChina’s meat consumption (in volume terms)expected to grow by a steady 3 percent CAGRover the next 15 years, the quality and valueof product demand will become much moresophisticated as well as processed based,thereby benefiting companies with safe,reliable and certified products. In value terms, demand in China will grow much faster than the rest of the world. At present,approximately 10 percent of China’s meat is processed which is expected to increase to 80 percent over the next decade.

DairyDairy is another protein sector which offersattractive global growth potential. Stabledemand for dairy products in the westernworld and stronger growth from Asianmarkets where diets are becoming morewesternised, as well as the appeal of dairyproducts to “new age”consumers across alltime zones, makes dairy an attractive areawithin protein.

India, as the world’s largest dairy producer,and China, with a rapidly expanding industry,are the key growth stories in dairy both froma production as well as consumptionstandpoint. Emerging middle-class consumersin both of these markets will continue to drive demand. In both India and China,product penetration into the second-tiercities will be key wins in these largelyuntapped growth areas.

Despite lactose intolerance among many ofAsia’s consumers, a widening variety of dairyofferings and related products are providingchannels for “new age”consumers to adddairy to their diets. Cheese is seen to havesome of the best growth potential due againto the westernisation of diets, especiallythrough foodservice, increased consumptionof wine and most importantly, the fact thatcheese contains very little lactose. Similarly,flavoured yoghurts are gaining popularity inAsia and are seen even more as a nutritionalbeverage than dairy item. Shelf-stable dairyproducts which can reach consumers indeveloping countries where long-distancetravel and chilled supply chains are limitedhave niche opportunities.

Today, the dairy industry is at the crossroadsof many important consumer trends.Themost notable of these trends are whatRabobank believe make up the three majorreasons why consumers will continue to have a strong preference for dairy products.Firstly, milk and milk-based products containvitamins and other desirable nutrients whichare needed to maintain a balanced diet.The second reason driving consumers to purchase dairy is convenience. Many dairyproducts today are sold as single servings in supermarkets and small retail shops whichallow rushing urban consumers to get desirednutrients from, for example, a low-fat, high-calcium, strawberry flavoured, yoghurt-baseddrink on the fly. And finally, indulgence.Theconsumption of products such as ice creamand high-end specialty cheeses is a trend that is catching on in the more nontraditionaldairy markets.

0 20 40 60 80 100 120 140

India

Indonesia

Thailand

Philippines

Japan

South Korea

China

Taiwan

Australia

Hong Kong

Figure 2.6: Per Capita Meat Consumption Growth in Asia, 2006 vs. 2016f

kg/capita/year

f=forecast

Source: OECD, 2008

2006 2016f


SeafoodThe recent growth in global aquaculturehas added a new dimension to the seafoodindustry. As demand for seafood swells,particularly for fresh items amid depletingresources, aquaculture has emerged as thealternative to fill a widening supply/demandgap. Continued pressure on aquaculture tohelp address declining wild catch volumesand sustainability concerns will help theaquaculture industry to realise its scalablepotential.The strong positive correlationbetween income and seafood consumptionoffers attractive prospects for seafood inmany markets. Consumers at lower incomelevels first demand product availability and affordability to meet their main goal of satisfying nutrition. Only when this need is fulfilled do consumers focus on productsafety and only then do product qualityfeatures become part of the purchasingdecision. Health, added value, convenienceand excitement are the quality featuressought by the most developed consumermarkets. Finally, the most affluent consumersbecome concerned with ethical issues such as sustainability, which is seen as the ultimatequality distinction. As consumers in Asia move up the income ladder, the seafood/aquaculture industry will professionalise.

Higher Costs and Food Safety MajorChallenges to GrowthMeatWhile there are many growth opportunitiesfor players in the protein industry, challengesalso exist. Stagnant demand growth in manydeveloped markets coupled with export bansdue to Bovine Spongiform Encephalopathy(BSE), commonly known as “mad-cow disease”,has led to reduced cutout value therebyhurting the bottom-line for packers andexerting some downward pressure on cattleprices, particularly in the US. Meanwhile, thissituation has created ripe opportunities inrecent years for US competitors, primarilyAustralia, New Zealand, Brazil and Argentina.Continued restrictions on US beef exports,most notably from large importers Japan andSouth Korea, as well as other foot-and-mouthdisease (FMD) trade restrictions in much ofthe world will prolong disruptions in globalmeat trade and favour only a handful ofexporters as well as other animal proteinswhich are free of similar trade restrictions.

Food exports from China are now highlyscrutinised in many countries due to severalcases of food contamination, tainted productsfrom chemical residues and the list goes on.

Disease has also created hardships for China’s meat players and supported rising inflation. In 2007, China’s so-called porcinereproductive and respiratory syndrome(PRRS), commonly known as “blue-ear disease was responsible for the death, culling andslaughter of millions of pigs, and the resultingslump in feed demand.Though these cases of disease and contamination are often short term and isolated, the fact that China is exporting more processed foods does leave its meat players open to the risk of tradebarriers should food-safety concerns continueunabated. However, China is taking aggressivemeasures to apply international foodstandards to its food industry. Consolidationwill help bring about stricter standards which will not only benefit exporters but also allow industry players to capture thehigher value which “safe”products can be sold for domestically and indeed in theinternational market.

DairyAs the major growth in dairy demand remainsisolated to countries which have limited scaledomestically industries, the short term is likelyto see many dairy products being importedinto these markets. Over time, as local dairyherds are developed, the global dairy industrywill change. In anticipation of this maturationof the industry in developing countries,multinational (MNC) dairy players are quick toestablish a presence in these markets throughpartnerships with evolving local playerswhich have access to production, distributionand marketing channels in the major cities.These MNCs now offer some technologies,management practises and brand knowledgethat is available but limited locally, which overtime will begin to be more widespread.

SeafoodWild-catch volumes, which peaked in the year2000, have remained flat for several years andhave since started a slight decline.The Foodand Agriculture Organization of the UnitedNations (FAO) estimates that 75 percent ofwild fish species are now over-exploited.Aquaculture will indeed help to offset the fall in catch volumes though not without itsown risks — particularly disease and food-safety concerns arising from hormone use in intensive farming, as well as high feed costs and, finally, sustainability. As sources for wild catch have declined over the pastyears, seafood processors have started tomove to developing economies, primarily to lower their production costs. As a result,overcapacity in these markets has become an issue, contributing to deteriorating


margins and leading to consolidation in the seafood processing industry.Companies positioned in the higher-end,luxury seafood segment can afford to pay the higher fishmeal prices for theiraquaculture operations and are doing well by playing the role of consolidators, buyingout smaller players that are suffering from the margin squeeze. Consolidation willcontinue and will likely be most pronouncedamong European players.

Outlook and Opportunities Opportunities in the protein space providesignificant potential to the whole of the foodand agribusiness industry from farm to fork.Strong expected growth in global proteinconsumption will drive demand for thenecessary inputs and periphery industrieswhich support production.“New”demand for protein in the developing world inaddition to growth in traditional markets,is creating opportunities for suppliers,processors and those delivering these products.

MeatWith global meat demand expected to growby 25 percent in volume terms by 2015,the protein industry is forecast to undergosignificant evolution (see Figure 2.7).While“size”markets for protein with slower, steadygrowth continue to be in the developedworld, high growth opportunities in thedeveloping world, particularly China,present unique opportunities for investors to take advantage of the growth which is yet to come.

Asia, with over 50 percent of the globalpopulation, 60 percent of which are urbanites,is expected to offer some of the bestopportunities for meat players in the comingyears. Growth in the daily consumption ofmeat in addition to demand for higher valueproducts from more upmarket consumers,especially new urban migrants in thesecountries, will test supply chains and createopportunities for companies with the abilityto deliver. It is estimated that rural-urbanmigration in China will reach 30,000 peopleper day over the next decade and 20,000 inIndia. Added demand for land and water tosupport expanding urban centres may be key constraints to growth which will likelyresult in greater trade of animal proteins andopportunities for cost competitive exporterssuch as Brazil and Argentina.

Strong demand growth for animal protein is also creating opportunities in upstreamproduction agriculture. Increasing demand for meat and thus inputs such as feed applyadded pressure to domestic grain and oilseedsupplies and may result in more imports of animal feed, especially in high growthmarkets with limited resources to expandproduction of feedstocks. In order to identifywhere the best opportunities as well as risksexist, it is important to consider the optionscountries have to satisfy a growing need formeat.The option is either to import greaterquantities of meat or the commodities used in animal feed to support domesticproduction of meat. For Asia, it is expected to be somewhat of a mixed bag as severalcountries are likely to continue to be

0

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2015f200519951985

Figure 2.7: Global Meat Demand, 1985-2015f

Beef

f=forecast

million tonnes

Source: FAO, FAPRI, USDA, Rabobank, 2007

Pork Poultry

+34%

+29%

+25%


significant net importers of meat (Japan,Korea, Malaysia) whereas others, whileremaining meat importers, will also beginimporting more commodities used in animalfeeds in order to boost domestic meatproduction (primarily China and Thailand).The former provides opportunities formultinational meat exporters with low-cost structures (such as those in the US and Brazil) while the latter providessignificant opportunities for meat producers and processors locally, as well as multinational exporters of feedstocks with large-scale production operations(primarily the US, Brazil, Argentina,Australia and eastern Europe).

Several factors play in to a country’s decisionto develop domestic industries versus greaterreliance on imports not the least of which arefood self sufficiency, safety, security, inflationand trade balance. Higher commodity pricesand rising food inflation have seen severalcountries making attempts to keep staplecommodities local in order to feed the needs of local consumers, rebuild stock levels and “control” inflation. However, withthe greatest supply potential for commoditiesand arable land allocation concentrated in the major export markets, stronginternational demand and market prices will only serve to benefit grain and oilseedproducers in export countries and thosesupplying the agri-inputs needed to produce these crops.

Today, Asia represents just over one-quarterof global beef production and over half ofglobal pork production, growing at a CAGR of 3 percent and 2 percent, respectively, overthe past decade. Going forward, demandgrowth for beef in Asia will provide somesupport for local herds, as well as imports,and firm demand for animal feeds. Increasinghalal beef demand from expanding Muslimmarkets in Southeast Asia and the MiddleEast, will also support demand growth.

DairyOver the next decade, dairy demand growthin traditional (i.e.,“size”) markets such asAustralia, the US and the EU is expected toslow.This trend has been further witnessed bymajor players from these developed marketsemploying aggressive strategies to enter the Asian dairy scene. Strong governmentalsupport throughout Asia to develop domesticdairy industries has encouraged local playersto invest in technology and best practicesthrough foreign partnerships which can bring capital and know-how to help increase

productivity and efficiencies in a relativelyshort time period. Milk powder demand inAsia has grown given its longer shelf life ascompared to liquid milk and also given that it does not require refrigeration due to its low moisture content. In Southeast Asia forexample, milk powders are taking marketshare away from condensed milk and otherproducts which have a short shelf life andrequire a seamless cool chain. Strong demandfor whey protein to meet explosive demandfor milk powders in Asia is one specificopportunity for foreign players given nearlynon-existent cheese production in Asia.Themajor use for whey in Asia, however, is stillfrom the massive animal feed industry, mostnotably in China.The importance of whey in animal feed became quite apparent when the whey price dropped dramatically as a result of falling feed demand from thepork industry after the “blue-ear”diseaseoutbreak in 2007.

Healthy demand growth for dairy in Asia has improved the outlook for upstream dairy companies throughout the region (see Figure 2.8). China and India feature as the most interesting opportunities withproduction gains expected to exceed a CAGR 4 percent by 2010. Argentina’s milkproduction is also expected to grow over aCAGR of 4 percent over the next several years.However, demand for fresh milk will largely be met by local or regional players giventransportation limitations in shipping liquid milk over long distances.

All in all, dairy is an exciting sector of theprotein space with such a diverse range of products and applications. It is used in milkat the breakfast table, in yoghurts as a snack,in fortified milk products and powders as ahealth food, in ice cream or high-fat cheesesas an indulgence and in specialty cheese orfast food cheddar as entertainment.Theexcitement for dairy in the consumer space is growing and even beginning to attract the attention of the world’s largest beverage companies.

SeafoodSeafood offers a variety of opportunities.The occurrence of diseases in beef (FMD, BSE),pork (PRRS) and poultry (AI) in recent yearshave somewhat played to the advantage ofseafood which has been little effected by anysignificant outbreaks.With wild catch fleetsand total allowable catch (TACs) decliningamid growing global demand and record-high fuel costs which have a significantimpact on fishermen, aquaculture is expected


to continue strong growth particularly incountries with cost competitive labour tohandle and process raw seafood into filletsand prepared products. Intensive fish farmingdoes however increase the risk of disease aswell as contamination from hormone use and has had a marked impact on severalexport-oriented aquaculture countriesrecently, including China and Vietnam.

At present, much of the aquaculture industry in Asia is highly fragmented and will therefore come under immenseconsolidation pressures. Upstreamaquaculture opportunities across Asia are available though investors have beenreluctant to take action due to fragmentation,the specialisation required and the diseaserisks and difficulty in securing pathogen-free(so-called Specific Pathogen Free or SPF)brood stock for various species.The seafood-processing segment, which is somewhat lessspecialised though labour intensive, is also

likely to experience further consolidationamid slim margins and rising input costs.One of the key bottlenecks for Asian playersstriving to become global seafood suppliersand exporters will be in convincingconsumers and food retailers in developedmarkets that food-safety and traceabilitystandards have been sufficiently addressedand consistently upheld.

Figure 2.8 Milk Demand Forecast for Select Countries, 2000-2016f

2000

Source: FAPRI, Rabobank, 2008

f=forecast

kg/capita fluid milk consumption and percent CAGR growth

2006 2016f

EU

USAustralia

China

India

Thailand

Vietnam

Malaysia

1.8%

43.9

5.3%

8.6%

11.9

5.6%

4.1

18.4

2.3%

-0.2%

-0.4%

2.3 98.7

-0.5%

88

75.7

Section 3 Focus on Food Processing | 19

Food processing is one of the broadest and largest industries in the food value chain. From the wide variety of food productsavailable to consumers to the ingredientswhich are used in their production, foodprocessing is a global industry that is as varied as the consumer preferences it serves.Changing dietary patterns as a result of population, income and urbanisation growth continue to shape the foodprocessing industry. As the purchasing power of consumers becomes stronger,so too do the preferences they demand.Convenience, variety, health and food safety are several important preferences that consumers demand from food as they gain affluence, all of which can be achievedthrough some variation of processing.Thus,the result of global income and populationgrowth particularly in the developing worldhas been an expansion of the global foodprocessing industry as well as the distributionchannels and formats, such as retail andfoodservice chains, which make theseproducts available to end consumers. In Asia, which boasts 60 percent of the world’spopulation and some of the fastest growingeconomies, increasing per capita income isdriving demand for greater protein intake,the westernisation of diets as well asincreased spending away from home, all of which are placing pressure on the foodprocessing industry to expand.

In terms of market size, global processed foodsales per year are currently estimated at wellover USD 3 trillion, or around three-quarters

of total world food sales.While the majority of this value in food processing resides in the developed world, dietary and lifestylechanges in the developing world promise the most growth, which Rabobank believeswill be most pronounced in Asian markets.As the processing segment of the food chain continues to expand, so too will theingredient players which supply them.Thus, the ingredient segment of the foodprocessing industry, including sugars,starches, amino acids, flavourings, sweeteners,food enzymes and additives, will also be a growth area in the coming years.

Increasing Costs Squeezing Players GloballyFaced with rising costs for labour,commodities, fuel and other inputs, nearly all food processors have been feeling themargin squeeze over the past few years.With varying abilities to pass these highercosts on to consumers, sizable foodprocessors are inter alia focusing greaterattention on high growth markets inemerging economies.These markets not only offer growth potential for sales and diversification, but can also serve as a lower cost base for sourcing, processing and shipping transport-stable finishedproducts internationally.

The US, the EU and Japan together accountfor over 60 percent of global retail processedfood sales.Though these developed marketsconstitute the largest turnover in terms ofvalue, the highest growth remains in low-

3 Focus on Food Processing


to mid-tier income countries (see Figure 3.1).In these developing markets, diet upgrades of busier, wealthier urban consumers arefocused on increased demand for processedfoods. For example, compared to manywestern nations where an average of 75 percent of food is processed, only an estimated 30 percent of food in China is processed.With current economicdevelopment in China mirroring the growthof developed countries which consume moreprocessed foods, the growth potential ofChina’s food processing industry is enormous.

Increased ethnic diversity in cities all aroundthe world as well as added demand for ethnic foods among local consumers are also creating international opportunities for food processing companies in emergingmarkets that satisfy the increasing food-safetyand traceability standards and certificationsin importing countries. Some of the largestcities in North America and Europe forexample are home to a wide array of ethnicgroups as well as locals in search of morevariety both of which create export demandfor traditional products as well as entryopportunities for food processors from these markets.

Fragmentation Brings Opportunities One of the key differentials for foodprocessing in the developing versus thedeveloped world is the scale of the industry.Though China and India, for example, haveenormous food processing industries overall,food processing as a business remains ratherfragmented. However, the westernisation of diets driven in part by rapidly expandingfoodservice, is encouraging the production

of a greater variety of processed foodproducts, which is driving growth in thesemarkets. Amid rising input costs and greateremphasis on food safety and productconsistency, smaller food processors will likely loose out to large-scale operators with economies of scale, large distributionnetworks and the product suite to meet fast moving consumer preferences.Thoughmuch of the demand for processed foods inChina is still primarily for local consumption,significant potential for export-orientedprocessing exists.

Typically, the food processing industries in emerging markets are characterised by fragmentation, making it easier forestablished players to enter into the market.However, entry barriers in the form ofnontransparent regulations, licensing anddistribution are not to be underestimated.Furthermore, the lack of infrastructure andcold chain logistics may create bottlenecksand require significant investments in orderto improve distribution with limitedassurance of smooth operation.

To encourage scale and further advancementof food processing in developing countries,governments may find it worthwhile to focuson investments in infrastructure to ensureintra-country distribution costs and wastagedo not create incentives to source these sameproducts from abroad as the case has been in many developing countries.

Food Retail Influences the Food Processing LandscapeThe expansion of global food retail is alsoinfluencing the food processing industry.Further penetration of food retailers and their

0

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Low incomeLower incomeUpper income

Middle income

High income

Figure 3.1: Global Food Retail Sales Growth by Income Class, 1996-2007

percent

Source: Euromonitor, country classification per the World Bank

Section 3 Focus on Food Processing | 21

direct and global sourcing strategies is likelyto consolidate buying desks and linkconsumer preferences to producers andsuppliers more directly. In this sense,concentration creates power (see Figure 3.2).The effects of such sourcing initiatives will see retailers developing links with largesuppliers (food processors in many cases)with the capacity to deliver large volumes of consistent products at competitive pricesto multiple locations in various countries.

As food retail continues to mature andconsumers demand more convenience in their food choices, the food processingindustry will be set to ride a rising tide.In fact, growth in large-scale food retailing in developing countries has coincided withincreased investments by food processorsdue to the importance of the latter to asuccessful retail operation. In this sense,the EU and the US are the most developedthough emerging markets are fast expanding,

particularly in Thailand which has one of the world’s most concentrated retaillandscapes (see Figure 3.3).

Outlook and OpportunitiesAs with any product close to the consumer,food safety in processed foods is of primeimportance; food safety has become an even more critical factor in recent years withseveral cases of contaminants in exportedproducts tainting the situation. China hasbeen in the middle of several of these caseswhich have resulted in tighter restrictionsfrom many of China’s trading partners.Thefragmented nature of food processing inChina and other developing economiesmakes food-safety and traceability standardsmore difficult to implement as well as tomonitor. International certifications such asHACCP1 and GLOBALGAP2 (formerly known as EUREPGAP) have thus become the rulerather than the exception for companies

1 Hazard Analysis and Critical Control Points

2 Global Partnership for

Good Agricultural

Practice

Farmers/producers

Suppliers

Semi-manufacturers

Manufacturers

Buying desks

Supermarket formats

Outlets

Consumers

Figure 3.2: Concentration Creates Power — European Case

size of bar=number of players

Source: Planet Retail, Rabobank, 2008

0 10 20 30 40 50 60 70 80

France

Netherlands

Germany

Canada

United Kingdom

Spain

Thailand

US

Poland

Mexico

Japan

China

Figure 3.3: Concentration of Top Five Retail Players in Select Countries, 1999 vs. 2004

Source: Planet Retail, Rabobank, 2008

percent

2004 1999


which engage in food exports. Further suchcertifications for exporters will likely emergeover the coming years as food-safetyrestrictions tighten.

Despite the short-term squeeze from higherinput costs that many food processors are experiencing around the world, strongdemand from changing dietary and lifestylepatterns will benefit the global foodprocessing industry in the longer term.These shifting patterns will indeed havedifferent effects on the food processingindustry in developing versus developedmarkets, the former of which presents someof the best organic growth opportunities.In the short term, the current margin squeeze may uncover some good buyingopportunities for established players —which will help to drive consolidation,particularly in markets like China and India, which are highly fragmented.

Although the most significant opportunitiesfor growth will be in emerging markets, localand foreign food processing and ingredientplayers which are able to deliver largevolumes of consistent quality products which match the changing preferences of consumers will find the greatest potential.

The fast growth of food retail particularly in developing countries will continue to havea marked effect on the food processingindustry. Sourcing strategies of the largestretailers which go more direct to the supplybase and aggregate product orders willpromote closer integration betweenprocessors, retailers as well as producers.In the coming years, particularly in many of the developing economies where foodretail is beginning to gain foothold,Rabobank expects demand for processedfoods through organised retail to be one of the most important drivers influencing the food processing industry.

Section 4 Focus on Energy Crops and Commodities | 23

Commodities have experienced major price increases over the past several years on strong demand fundamentals driven by the “f” factors amid weather-inducedsupply shocks and rising fuel costs.The result has been a significant deterioration of global commodity stock levels creatingvolatility and a run up in prices. By mid-June2008, corn prices had climbed 249 percentabove January 2006 levels, wheat prices areup 164 percent, soybeans are up 162 percentand rapeseed up 114 percent, attractingbillions of dollars in speculative positions inthe commodity futures markets and helpingto support a bull run or rather bull sprint andincreased volatility in commodities, on the

back of already greater demand. Edible oilprices have also experienced gains, doublingsince the start of 2006 and in the case ofcrude palm oil (CPO), trebling. (see Figure 4.1).The significant increase in the level of pricevolatility in commodity futures marketsduring this period has been impacted byinvestment from nontraditional players such as fund managers and global investmentbanks looking to diversify risk and capturehigher returns.This has reduced the influenceof supply/demand fundamentals on short-term price movements, although longer term a rebalancing of supply/demand willeventually win out.

4 Focus on Energy Crops and Commodities

CBOT Wheat

Figure 4.1: Soft Commodity Price Index, Jan 2006-Jun 2008

Jan 2006=100

Source: Bloomberg, Rabobank, 2008

ICE NY SugarCBOT Corn Euronext Rapeseed CBOT Soybeans

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Destocking of global grain inventories driven in large part by China has significantlyreduced the supply buffer for many crops and contributed to record-level price volatility(see Figure 4.2). Global stock levels for wheat,for example, reached 30-year lows with thecarryout stocks-to-use ratio falling to all-timelows. Rice prices in the first few months of2008 reached critical levels, creating anxietyamong consumers and governments,especially in Asia where rice is a main stapleconsumed at breakfast, lunch and dinner.Although only about 7 percent of global riceproduction is traded, governments aroundthe world have constructed new/additionalexport barriers and relaxed existing importtariffs in an effort to quell domesticinflationary fears which only provide short-term relief at the expense of longer-term price volatility.

With grains and oilseeds being the primaryingredients in feed rations, increased proteinintake has a multiplier effect on demand for these raw material commodities. Risingcommodity prices which have a direct knock-on effect to feed prices have made timesdifficult for many animal protein players as well as feed manufacturers, especially forcountries reliant on imports. Pressure from higher input costs will help driveconsolidation among animal feed and animalprotein manufacturers, especially in thedeveloping world where fragmentation is most prevalent. In the case of China, strongfood and feed demand is likely to result in atrade deficit for grain in the coming years.China already imports nearly half of theworld’s traded soybeans.

Food Demand Supporting Edible Oils On the edible oil front, strong global demandprimarily for food use over the past 15 yearshas doubled the traded volume of edible oils (see Figure 4.3). CPO and soy oil haveaccounted for much of this gain driven largelyby food demand in China and India.Today,CPO and soy oil represent nearly half of global demand for edible oils. Due inter alia to its relatively lower price over past years,demand growth for CPO has outpaced that of the other edible oils, increasing from 14 percent in the early 1990s to 25 percent in 2007. Strong demand for CPO for food inChina and India have accounted for much of this increase. On the whole, the globaldemand for CPO has more than trebled since 1990.

China is today the world’s largest importer of CPO, consuming one-fifth of traded volumeand growing at a CAGR of 16 percent, themajority of which is used in food processing.Together, China, India and the EU importabout 80 percent of traded CPO volume.Malaysia and Indonesia are the world’s largestproducers of CPO representing 87 percent ofsupply and 92 percent of exports.The year2007 marked a new all-time high for output in Indonesia and the first year that Indonesiaovertook Malaysia as the world’s single largestCPO producer. No doubt this significantgrowth in demand is supporting higher CPO prices and encouraging expansion inSoutheast Asian palm plantations, particularlyin Indonesia.

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2007/082006/072005/062004/052003/042002/032001/022000/011999/20001998/991997/98

Figure 4.2: Global Stock Levels for Grains, 1997/98-2007/08

USChina


EU India Canada Australia Russia Other

million tonnes (including corn, wheat, barley, and rice)


Higher Prices Shifting Margins and Plantings As the old adage rings, higher prices are the cure for higher prices. Agriculture isdifferentiated from many other industries inthat relatively short-term production cycleswithin one cropping year allow producers toshift plantings to crops with higher expectedmargins.This substitution effect in the currenthigh price environment and tight supplysituation has thus created an intense “battlefor acres”between crops.The USDA reportedin its Prospective Plantings report at the endof March 2008 that the increased margins for soybeans on the back of strong demand,less planted acres and high prices in 2007,resulted in US soybean planting estimates

for 2008 to increase by over 18 percent. Cornacreage is expected to decline by 8.1 percentyear-over-year (and could decline evenfurther considering wet weather conditions in the US corn belt which have extended well into the 2008 crop year) while wheatplantings are largely in line with averagemarket expectations, except for Spring andDurum wheat which were slightly aboveplanting expectations (see Figure 4.4). Suchincreased flexibility in the producer’s plantingdecision is also a result of policy reform — for example, in the EU the revisions to the EU CAP3 away from support prices for wheat towards more market fundamentals.Thus, further dynamics are expected on the supply side.

3 Common Agricultural Policy (CAP)

Soybean 19

Soybean 24

Other 40 Other 27

Rapeseed 11

Rapeseed 12

Sunflower 10Sunflower 7

Palm kernel and coconut 6

Total: 80.5 million tonnes Total: 159.4 million tonnes

Palm kernel and coconut 5

Palm 14

Palm 25

1990/91 2007/08

Figure 4.3: Edible Oil Demand by Oil Type, 1990/91 vs. 2007/08f


f=forecast

Source: FAO, Oil World, Rabobank, 2008

2008

f

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

100

120

140

160

180

200

220

240

Total oilseed area Total wheat area Total corn area

Figure 4.4: World Grain and Oilseed Plantings, 1980-2008f

million hectares

f=forecast

Source: USDA, 2008


In discussing commodities and the ”battle for acres”which has ensued to produce them in ever-greater quantities amid scarceresources, Brazil has significant potential to become the food basket of the world.At present, agriculture accounts for 75 millionhectares of land in Brazil, and it is estimatedthat another 100 million hectares of land(currently pasture) is available to be cultivatedfor production agriculture. Pressure andcompetition for arable land from expandingcities will be much less significant in Brazil as compared to a place like China and otherdeveloping countries. For instance, Brazil ishome to approximately 190 million people,85 percent of which are urban compared toChina’s 1.3 billion people, only one-third ofwhich are urban at present.Thus, Brazil’sexport potential to supply increased demand for commodities in emergingmarkets is likely to constitute one of the keyshifts in agriculture over the coming decade.Companies positioned to capture this exportpotential while addressing the challengesthat exist in Brazil, most notably the cost oflogistics, will be in a good position to benefitfrom this significant expected growth.

When discussing developments incommodities, we cannot ignore the growingimpact of the emerging biofuel industry on supply/demand fundamentals, particularlyin the major commodity producing and exporting countries. Demand forcommodities used in biofuel production,particularly energy crops such as grains,oilseeds and sugar, has increased significantlyover the past few years. Driven bygovernment policy targets which continue to evolve, biofuels are expected to continue

rapid growth, exerting further supply pressurefor grain, oilseed and sugar feedstocks.

The US, as a prime example, represents one-fifth of global grain production and one-quarter of global oilseed production (see Figure 4.5). More specifically, the USproduces 43 percent of global corn supplyand accounts for two-thirds of global exports.

For soybeans, the US supplies one-third ofglobal volumes and accounts for 37 percentof exports.The increased US demand forethanol and biodiesel which consume thesecommodities may prove to have an evenmore marked impact on available exportvolumes of corn and soybeans in the comingyears — leading to a tightened trade situationsupporting higher prices.

Biofuels Fuelling Commodity Growth,but Future UncertainBiofuel initiatives have emerged throughoutthe world with the greatest support in the US,Brazil and the EU.Various combinations of(rural) economic development, environmentalawareness and energy security can be founddriving the use of biofuels in differentcountries (see Figure 4.6).

Provided that the production of oilseeds doesnot increase dramatically and biofuel targetsbeing set today are maintained using today’scommercially available technology, it isestimated that by 2012 nearly one-fifth of the global demand for oilseeds could comefrom global biodiesel production — whichRabobank expects could reach 32 milliontonnes by 2012, a CAGR of 29 percent from2006 (see Figure 4.7). For feedstocks, nearlyone-quarter of CPO production could

US 20US 24

EU 17

EU 6

China 16 China 14

Other 14

Other 6

BlackSea

Region10

Black SeaRegion 5

India 7

India 8

Canada 3

Canada 4Indonesia 2

Brazil 3

Brazil 14

Argentina 3

Argentina 12

Mexico 2Pakistan 2 Pakistan 1

Malaysia 1Nigeria 2

Total: 1,559 million tonnes Total: 389 million tonnes

Grains Oilseeds

Australia 1Australia 1

Paraguay 1

Philippines 1

Figure 4.5: World’s Largest Grain and Oilseed Producers, 2007


Source: USDA, 2008


potentially be used for biodiesel by 2012,depending on the development of thebiodiesel industry in Malaysia and Indonesia,as well as Europe’s appetite for using CPO in its biodiesel production. For ethanol,28 percent of global sugar production and 15 percent of global corn production may be used as feedstock by 2012, primarilyin the US and Brazil, to achieve a forecastglobal ethanol production quota of 96 billion

litres. (Note that this forecast was preparedbefore the Renewable Fuels StandardProgram in the US which will require a specific volume of renewable fuels in the US market.) However, there remains muchuncertainty about the future of biofuels and indeed production forecasts due toinconsistent policy implementation, elevatedfeedstock prices and recent negative publiccampaigns towards biofuels.

Figure 4.6 Global Biofuel Initiatives


Canada• 5 percent renewable energy target by 2010• Canola, waste oils

U.S• Focus on ethanol; world’s largest producer• Biodiesel growth potential is huge due to only 1 percent

diesel car penetration• Mandatory biofuel use of 7.5 billion gallons by 2012;

primarily ethanol• 36 billion gallons of biofuels by 2022 with strong next

generation ethanol (cellulosic) requirements• Blenders tax credit of USD 0.51/gallon reduced to

USD 0.45/gallon in 2009 and 2010• Tariff on imported ethanol of USD 0.54/gallon• State-based blending laws above federal requirements

Brazil• Leader in ethanol production for 30 years (now the US) due

to ethanol programme including high blend targets• Introduction of flex-fuel cars in 2003 able to use 100% ethanol• B3 (2008) and B5 (2013) targets introduced for biodiesel• Aim: rural support (palm, castor oils); small-holder biodiesel projects

receive tax breaks• Reality: primarily soybean oil; large-scale biodiesel projects

Argentina• Blending target as of 2010• Export focused; primarily to the EU• Export tax system encourages exports of biodiesel over vegetable

oils or soybeans

The EU• Focus on biodiesel; world’s largest producer• 5.75 percent indicative target by 2010; 10% mandatory by 2020 is proposed• Broad suite of support; differing amongst the 27 states• CAP reform includes support provisions for energy crops• Tax breaks slowly making way for mandatory blending• Sustainability is becoming a key issue • Focus slowly shifting towards environment and energy security with less

emphasis on agriculture

China • Targeting 15 percent energy supply from biofuels by 2020• Mandatory ethanol blends in 10 provinces • Intention to grow energy crops on 10 million hectares• Many initiatives under discussion; primarily aimed at biodiesel

(jatropha or waste-oil based)• Ban on using food crops in new ethanol plants

India• Infant industry; policies under preparation• So far have displayed an inconsistent approach• Biodiesel: jatropha-based• Ethanol: sugar/molasses-based

Malaysia & Indonesia• Aim to set-aside 40 percent of palm oil production for biodiesel

for exports – specifically to EU)• Malaysia – 5 percent blend (voluntary) of palm and diesel• Indonesia – B2 mandatory target by 2008• Both countries are pulling back considerably due to high

feedstock prices and sustainability concerns related to palm oil

0

20

40

60

80

100

120

2012f20060

5

10

15

20

25

30

35

2012f2006

EU

Figure 4.7: Global Biofuel Production, 2006 vs. 2012f

billion litres

Ethanol Biodiesel

million tonnes

f=forecast

Source: Rabobank esimates in Q3 2007

North America South America Asia Australia Other


The US government’s corn-based ethanolpolicy has changed the structure of the USgrains and oilseeds market and impacted the global market, with nearly 25 percent of US corn production being used for ethanolproduction in 2007. It is expected that thisamount will need to increase to at least 30 percent in 2008 and to around 40 percentwithin five years in order to meet governmentmandated targets. In late 2007, these targetswere increased under the US EnergyIndependence and Security Act (EISA, the2007 Energy Bill), which calls for a renewablefuel standard of 36 billion gallons by 2022,with a maximum of 15 billion gallonsproduced from corn-based ethanol.Theremaining 21 billion gallons is required to be produced from advanced biofuels (so-called “next generation”), such as cellulosicethanol.The legislation will increase longer-term demand for corn in the US as well asencourage technological advancements tocommercialise current and future cellulosicethanol technologies.While it remains tooearly to know how realistic the stated timeframe for large-scale cellulosic ethanolproduction will be, Rabobank believes that next generation biofuels will not becommercially available on a large scale until at least 2015. Even if a technologicalbreakthrough were to occur, the time andcapital it takes to develop the necessaryinfrastructure and set up supply chains will slow the establishment of large-scaleoperations. Consequently, the US is keepingits options open regarding ethanol imports,primarily from Brazilian sugarcane-basedethanol, which is currently subject to aprohibitive USD 0.54/gallon import tariff.The US Food Conservation and Energy Act(FCEA, the 2008 Farm Bill) concluded in June extended this tariff on ethanol to the end of 2010, but reduces the tax creditafforded to ethanol blenders from the currentUSD .51/gallon to USD .45/gallon in 2009 and 2010.

In the EU, a biofuel policy introduced in 2003has resulted in tremendous demand growthfor vegetable oils, particularly local rapeseedoil and imported CPO and soy oil.Thediversion of vegetable oils and animal fatsinto biodiesel production has increased by500 percent over the three years to 2006/07,albeit from a low base.This new demand has created additional pressure in an alreadytight supply situation for EU rapeseed and,together with increasing domestic demand,crushing capacity issues, and shifts away from genetically modified (GM) soy oil

usage among others, resulted in an explosive price environment up to 2007.

The EU Commission’s renewable energypolicy proposal released in early 2008 has maintained the longer-term goal ofbiofuel usage reaching 10 percent in all transportation fuels by 2020. In order to ensure that biofuels are produced in a sustainable manner not harming theenvironment, the commission has set adefault value of 35 percent of greenhouse gas savings by 2013 which biofuels mustreach to count against the overall productiontarget. Still, this proposal is under heavydebate and not likely to be agreed uponwithin the next few months, the end result of which could be lower targets and strictersustainability criteria.

In Brazil, the domestic market for ethanol is big and growing.The current 25 percentmandated ethanol blend on petrol combinedwith the rapid expansion of so-called “flex-fuel”cars which can use any mixture ofethanol and petrol, are driving the market.In 2007, one-fifth of Brazil’s car fleet and 85 percent of new car sales were flex-fuel (see Figure 4.8). Given Brazil’s costcompetitiveness in ethanol production and its position as the world’s largest sugarproducer and second largest ethanolproducer (after the US), the potential toexpand ethanol production and exports is considerable. Owing to this tremendousgrowth potential in the domestic market aswell as the promise of growing export flowsin the mid to long term, there has been asubstantial wave of investment in newcapacity in recent years. A few companieshave already launched Initial Public Offerings(IPOs) while various strategic players havecome in with an integrated investmentapproach. For domestic market sales,tremendous potential exists for ethanol inBrazil. In regard to exports, growth is onlyexpected in the medium term, as thosemarkets with the greatest potential forBrazilian ethanol exports are those with eithersignificant protections (such as the US andthe EU) or are slow in getting established and resource constrained (such as Japan).

Margin Pressures Soften Strong Demand The significant margin premium that cornreturned in 2007 has largely been eroded due to the appreciation of both soybean and wheat prices and the sharp lift in fertilizerprices which has increased the cost base for corn.While corn yields far outpace


substitute crops, there continues to be increased weather risk. Finally, farmers will need to manage long-term agronomicdecisions around crop rotations by makinguse of short-term financial incentives.

For CPO, though prices have lagged much of the run up seen in mainstream vegetableoils, the situation is beginning to change with CPO prices reaching historic highs ofnearly USD 1,400/tonne in March comparedto under USD 950/tonne in January.The spike in CPO prices has attracted investorinterest in upstream opportunities in Malaysiaand Indonesia. New plantings have emergedon strong demand expectations though it willtake several years before these new plantingsbegin bearing productive fruit. Sustainabilitywill continue to be a hot topic as this sector expands.

Similar to the US, the significant shift infeedstock prices has in part resulted in marginpressures for EU biofuel producers. However,other reasons for the margin squeeze feltrecently by biofuel producers have beenstrong growth of lower-priced biodieselimports from the US and finally the fact thatpolicies have not been enforced as much as most parties had anticipated resulting inless demand than expected, i.e., overcapacity.These dynamics have seen EU biofdieselproducers respond by operating at marginalcapacity and in some cases even closingdown.The paradox though is that theindustry continues to expand despite morethan 100 percent overcapacity at themoment.Thus, significant risks remain to the on-going profitability of biofuels while feedstocks remain at such high prices.

For sugarcane ethanol, it is important tounderstand that the world of sugar is drivenby somewhat of a different demand profilethan other commodities.While the othercommodity prices have been surging towardsnew highs over the past 18 months, the sugarmarket has been heading in the oppositedirection. An enormous surplus produced in the 2006/07 crop year put pressure onprices from the start of 2007. Continuedsurplus expectations for 2007/08 furtherdepressed prices which fell from the 25-yearhighs seen in early 2006. Several reasonsbehind the supply/demand imbalances seen in the past few years include a massiveincrease in production from India and the equally impressive growth in productionand processing in Brazil which permitted the country to maintain sugar production and exports despite booming growth indomestic demand for cane-based ethanol.With 2008 now underway, high hopes forimproved prices are anticipated amongsugarcane producers.

Outlook and Opportunities Looking ahead, the overall supply anddemand situation for the energy cropscomplex remains delicately balanced, with a number of the world’s major grain, oilseedand sugar markets heavily reliant on morenormal seasonal conditions in the comingyears to ensure an adequate productionresponse to meet strong demand growth.Greater demand for grains and oilseeds from the “f” factors among scarce resources,which for grain alone could grow 14 percentabove current levels over the next decade,will drive the need for increased productivity(see Figure 4.9).

0

20

40

60

80

100

2007200620052004200320022001

Figure 4.8: Brazilian Flex-fuel Car Sales as a Percentage of Total New Car Sales, 2001-2007

percent

Source: Anfavea, 2008


On pricing, the outlook for agriculturalcommodities over the next couple of seasonsappears more to the upside for thosecommodities with a direct link to biofuelmarkets, given the increasing demandexpectations for biofuels.This link will bemost pronounced for corn and sugar forethanol, and soy oil, CPO and rapeseed oil for biodiesel. However, increasing marginpressure may reduce the demand for thesecommodities from biofuel producers.Nevertheless, at the current pace, biofuels will be responsible for a significant share of added demand for these commodities in the coming years though food will remain by far the primary consumer. Of the 18 milliontonnes of additional edible oil demand

expected by 2012, over 60 percent could bederived from biodiesel, with the remaining 40 percent from food (see Figure 4.10).Though Rabobank believes that biofuelproduction will continue to grow in thecoming years, particularly in the US, Brazil and the EU, a lack of biofuel policyenforcement, high feedstock prices, negativepublic opinion in some countries, uncertaintyamong future policies in the EU andSoutheast Asia at present and finally, a strongsustainability debate create much uncertaintyas to the longer-term potential of biofuels.

Looking ahead, the strong demand prospectsfor global commodities are not withoutsignificant risks.The US and world economic

Wheat

Figure 4.9: Global Grain Demand, 1985-2015f

million tonnes

f=forecast

Source: FAO, FAPRI, USDA, Rabobank, 2007

Corn Rice Barley

0

500

1,000

1,500

2,000

2,500

3,000

2015f200519951985

+10% +12%

+14%

Figure 4.10: Demand for Edible Oils, 2007-2012f

million tonnes

f=forecast

Source: Rabobank estimates in Q3 2007

0

20

40

60

80

100

120

140

2012 est. demandAdd. demand biodieselAdd. demand food2007 demand

1097

11 127


prospects have weakened in early 2008 as recessionary fears have escalated and oil prices have soared well beyond USD 130 per barrel. Rising global inflation has returned to the world scene and becomea major cause of concern as food prices have soared and led to a significant globalimpact on consumers, particularly indeveloping countries which spend a highproportion of income on food.While a USeconomic slowdown poses only a minordemand impact for grains and oilseeds given the relatively inelastic demand for foodcommodities, there may be some impact on biofuel consumption.The major risk in a global economic slowdown is frompotential flow-on effects to commoditydemand in major developing countries.In China for example, even though manybelieve the Chinese economy is now robustenough to withstand a US economicslowdown, weaker US demand will likelyplace increased pressure on Chineseeconomic growth given that demand from the US has been a major driver of China’s export oriented economic expansion.

Section 5 Focus on Agri-inputs and Equipment | 33

Rising demand for food amid increasedurbanisation and declining arable land per capita can have a significant impact on a country’s ability to meet its food needs.Thus, increasing domestic productivityin agriculture is key to successful agriculturaldevelopment and maintaining some degreeof food self-sufficiency. Greater demand foragricultural commodities has encouragedgrowth in investment for inputs andequipment to intensify and expandproduction. As a result of these dynamics,many opportunities are being created in the agri-inputs and agri-equipment sectors.

Global population growth and urban sprawlthroughout the developing world haveresulted in rapid deployment of scarceresources to meet the growing demand of an increasingly urban, middle-classpopulation. In the year 2000, nearly twobillion people lived in cities worldwide, andthis amount is expected to double by 2030.China alone will add some 250 million citizensto its middle class by 2020 and increase percapita income for the whole country by a factor of five. Changing dietary patterns,as a result of a more affluent population,drive demand for more resource-intensivefoods such as animal protein, which willfurther escalate the need to do more with less.Today, China and India support 42 percent of the world’s population on 21 percent of the world’s cultivated land and this gap continues to widen. A wealthier, growing population amid declining land availability per capita

will thus command greater per hectareproductivity in the years ahead (see Figure 5.1).

Challenge of Producing More from Less While long-term trends suggest a steadygrowth pattern of fertilizer consumption in the developed world, the picture recentlychanged and Asia is now leading the growthin consumption. Demand from biofuels hasalso added to crop demand for fertilizers.In the US, increasing demand for corn forethanol production resulted in farmersplanting the largest acreage to corn since1944.They achieved this acreage growth by planting corn on Conservation ReserveProgram (CRP)4 land and by replacing theirusual rotation crops, such as soybeans andcotton, with corn, which is best described as a heavily input-intensive crop.Thistranslates into heightened US demand for fertilizer, particularly nitrogen-basedproducts such as ammonia and urea,which has driven input prices higher.

Land and Water Under PressureGlobal land and water resources are alreadyunder significant pressure to maximiseproductivity amid increasing demand from nonagricultural needs.The world’savailability of arable land per capita hastightened in many regions due to theconstruction of cities, factories and roads.As a result, forested areas have come to faceconversion pressures. For water, agriculture is currently the number one consumer

5 Focus on Agri-inputs and Equipment

4 US Government program in the US

which pays land owners to keep

land out of annual production and

typically in permanent crops such

as grassland or forested areas.


worldwide. Over the last century, global wateruse has grown by more than twice the rate of population. Since 1950, the area underirrigation has doubled and water withdrawalfor agricultural, domestic and industrialpurposes has trebled.Thus, productivity gains from increased land and water usage will be limited going forward, and must be achieved through technologicalenhancements and improved efficiency in the use of these resources.

Productivity Gains in AgricultureOne of the most important means toachieving productivity gains in agriculture in addition to improved farm managementwill come through crop technology and theoptimised application of fertilizers.The three macro-nutrients for fertilizers, namely

nitrogen, phosphates and potassium (NPK)are sourced from different locations aroundthe world due to the localised nature ofmineral and gas deposits. Supplies ofphosphate and potassium are concentratedin a select number of regions or countries,while natural gas, used to produce ammonianitrogen, is more widely available (see Figure 5.2).

Today, China accounts for over 30 percent oftotal world production and consumption offertilizers. Growing industrial usage of grains,especially corn, together with increasedconsumption of meat, fruits, vegetables andother cash crops driven by urbanisation andrising incomes have fueled agriculture growthand strong demand for fertilizers. Fertilizerprices in China underwent a significant

Figure 5.1: Global Population and Agricultural Land Area (ha) Forecast, 1965-2030f

population (billions) hectare/capita

Population

f=forecast

Source: FAO, World Bank, Rabobank, 2006

0

2

4

6

8

10

0.0

0.1

0.2

0.3

0.4

0.5

Hectare/capita

2030f2025202020152010200520001995199019851980197519701965

Today

China 37

Russia 22

Morocco & Western Sahara 32

South Africa 8

Other 11

Brazil 4

Canada 52

US 7

Jordan 5Other 4

Germany 9

Belarus 9

Australia 0.4

Phosphate Potash

Jordan 0.5Israel 0.5

Figure 5.2: Global Reserves of Macro-nutrients

percent

Source: US Geological Survey, Mineral Commodities Summaries, 2007

Section 5 Focus on Agri-inputs and Equipment 35

increase in 2007, up over 13 percent. In 2006,China produced a total of 53.45 milliontonnes of fertilizers, growing at a CAGR ofover 7 percent over the past decade. Fertilizerproduction in China comprises 73 percentnitrogen, 23 percent phosphate and 4 percent potash.

To Till or Not to Till? That is the question.In several developed nations, manyconventional producers have beenconverting to no-till agriculture on the basisthat it protects top soil from erosion, reducesfuel requirements, labour and equipmentcosts, conserves moisture better and reducesrun-off.Whether no-till farming is better forthe environment and yield enhancing or not,chemical companies are set to gain given that CPCs are the only line of defense against pests in no-till farming.Today, about18 percent of US cropland and 30 percent of Canadian cropland is no-till. By the end of 2004, approximately 54 million acres inBrazil, or about half of the cropland, was no-till. Australia also has a large area ofcropland under no-till farm management.More recently, as the storm of climate changeweathers on, discussions for reductions of carbon emissions in agriculture haveemerged. If industries such as agriculture are required to pay for the carbon they emit, no-till farming may become even morepopular as it requires limited fuel use. Further,no-till farming is now eligible for carbonoffsets under the terms of the ChicagoClimate Exchange (CCX) in the United States.

Higher Prices — More Investment in Inputs As demonstrated during the GreenRevolution, agricultural inputs can play asignificant role in agricultural productivitywhen properly applied. Seed biotechnologywhich delivers pest resistance has been aneffective tool in many countries and will likelysee wider global acceptance and applicationwith various added efficiency and healthrelated features in the years to come. Ascommodity prices climb higher, so too will the producers’ incentive to invest more inagri-inputs. However, faced with higher input costs and declining land availability per capita, producers will seek ways to useagri-inputs more efficiently and withincreased economies of scale. A significantpart of productivity and efficiency willtherefore come from the wider use ofagricultural equipment, particularly in the developing world where agricultureremains one of the largest employers.

Fertilizer Fertilizer use is driven by water availability,the type and fertility of soils, farmer’s income,crop type, and policy — including fertilizersubsidies. Demand for fertilizers is cyclical and strongly influenced by agriculturalcommodity prices and seasonal conditions.In contrast, the supply of fertilizer is more akin to the energy and mining sectors than to agriculture. Given significant investmentand the long time frames that are required to develop facilities, supply capacity cannotbe rapidly adjusted to suit agriculturalseasonality in short order. Demand forfertilizers has and will grow at low andpredictable levels with ample supply capacityfor NPK. However, in 2007 limited supply and strong demand for NPK led to substantial international price increases for these macro-nutrients.

Over the past 35 years, global fertilizerconsumption has increased substantially,with the majority of this growth concentratedin developing regions such as Asia and LatinAmerica. Fertilizer consumption (measured on a total nutrient consumption basis) hasgrown at a CAGR of 2 percent from 1972 to 2005 (see Figure 5.3). On an individual basis, nitrogen consumption has grown at 2 percent, phosphate at 1.3 percent and potash at 1.1 percent.

As is expected, fertilizer use in kilograms perhectare is generally lower in the developingworld as compared to the developed world.In the longer term, growth in fertilizerconsumption is expected to remain highest in developing regions. Interestingly, fertilizeruse in the EU has been much greater andmore intense than in other equally developedregions due to the combined influence ofenvironmental and policy factors.

In developed regions such as North America,Europe and Australia, growth of fertilizerconsumption has been relatively flat. In somedeveloped markets, such as western Europe,fertilizer use has been tempered byenvironmentally focused legislation whichhas reduced the intensity of use to preventnutrient run-off. In contrast, the reason forlower fertilizer use per hectare in Australia,for instance, is due to the relatively aridclimate in many parts of the country that only allows fertilizer use at low levels when compared to much of the rest of the developed world. Fertilizer use intensity is constrained by the lack of water whichslows plant growth and fertilizer absorption.


Crop ProtectionAnother important technique used toincrease productivity is yield enhancementthrough loss reduction achieved by usingCPCs and agri-biotechnology. By nature,healthy growing crops attract pests which can severely threaten yields over multiplecropping seasons. CPCs can be used to treatinsects, fungi and weeds. Herbicides are themost widely used CPCs, accounting for nearlyhalf of the global CPC market with theremaining half split between insecticides and fungicides.

While CPCs account for the majority of the crop protection market, agri-biotechnology has become increasinglyimportant, ever since the technology was first applied in the mid 1990s.Agri-biotechnology companies havedeveloped genetically modified (GM) seeds which allow a particular chemical to be sprayed for harmful pests with no effect to the crop itself.The global market value of GM crops in 2007 reached USD 6.9 billion,up USD 0.84 billion over 2006, nearly half of which was GM corn (see Figure 5.4).According to the International Service for the Acquisition of Agri-Biotech Applications(ISAAA), the global area of farmland whereGM crops are grown jumped 57 times in the 10 years to 2006 to reach nearly 100 million hectares.

Agri-equipmentThe global market for agri-equipment is currently estimated at a value ofapproximately USD 66 billion.The Asia

Pacific alone accounts for one-third of thismarket. Greater use of agri-equipment isclearly emerging in China, considering theamount of land being cultivated relative to the number of rural labourers employed in agriculture (see Figure 5.5).This strongdivide continues to widen between cultivatedland area in China and the size of the rurallabour force. Rural migrants seeking higherpaying jobs in China’s expanding urbancentres create added pressure on agriculture to produce more with less. As a result,producers replace man with machinery.Since market-oriented reforms in the late1980s, the agri-equipment market in Chinahas been expanding at a healthy pace,especially for small tractors which betteraccommodate the many small-scaleproducers throughout China.

The situation in India is much the same.Rapid urbanisation and rising demand for food has put considerable pressure on rural farmers who are increasing the use of tractors to raise productivity. Equipmentuse in India’s agricultural industry is currently dominated by small-scale tractors,which account for nearly half of farm poweras compared to only one-fifth in the 1980s.

To-date, the largest agri-equipmentmanufacturers are located in developedmarkets, particularly the US, Germany andJapan. In China for example, these threecountries account for over half of importedtractors, one-quarter of which are from Japan. Going forward, we expect theseestablished players with a diverse range

Figure 5.3: Global Fertilizer Consumption by Region, 1972-2005

million tonnes

Western and Central Europe

Source: International Fertilizer Assn (IFA), 2007

0

20

40

60

80

100

120

140

160

180

200520021999199619931990198719841981197819751972

Eastern Europe & Central Asia North America Latin America

Other Asia

AsiaCAGR 2%(’93-’05)


of agri-equipment, especially those with small tractor models, to do well in supplyingAsia’s growing demand for mechanisation.Further appreciation of the Chinese RMBrelative to foreign currencies will also help to encourage imports into China though it is likely that local players will also emerge to capitalise on local distribution networks in more remote parts of the country.

Emerging Market Demand LeadingGrowth for Inputs The world’s reserves of oil are often discussedin agricultural circles, particularly given therecent rise in prices, which has directly andnoticeably affected the fertilizer sector. Lessfrequently is there a discussion of the supplyand pricing of natural gas, despite its role as a significant, though indirect, input forfarmers. Between 70 percent and 90 percent

of the production cost of nitrogen is the cost of natural gas. For ammonia, 90 percent of the production cost is the cost of the gas feedstock. Despite its relatively wideavailability, the pricing of natural gas makessome regions more competitive suppliersthan others. Over the past decade there hasbeen migration of plant capacity from high-cost production regions, such as the US forexample, to lower-cost production regionssuch as the Middle East.

The US has traditionally been a significantproducer of ammonia and urea. However,in 2001 the costs of natural gas in the USincreased dramatically due to deregulation of the gas industry and cold wintertemperatures, which increased therequirement for heating. High gas prices led to a rise in the cost of nitrogenous

Corn 45

Latin America 17

Soybean 39

Cotton 14

Canada 5

US 71

Rapeseed 2Sunflower 0.1

Other 7

Wheat 0.4

By crop By country

Rice 0.2

Figure 5.4: Agricultural Biotechnology Crops and Market Geography

percent

Source: Phillips McDougall, Rabobank, 2008

Figure 5.5: China’s Cultivated Land and Agricultural Labourers, 1990-2006

million hectares millions of labourers

Cultivated Land

Source: China Statistical Yearbook, 2007

142

144

146

148

150

152

154

156

158

270

280

290

300

310

320

330

340

350

20062005200420032002200120001999199819971996199519941993199219911990

Rural Agriculture Labourers


fertilizer production and US fertilizerproducers responded by closing or idlingplants, thus significantly reducing USproduction and increasing imports.Thisplaced pressure on global ammonia/ureacapacity to supply this new demand.

A longer-term response to high natural gasprices in the US and the EU has been therelocation of substantial nitrogen productioncapacity to regions where natural gas can be purchased at lower prices, such as Trinidadand Tobago, the Middle East and North East Africa. Between 2007 and 2011,TheInternational Fertilizer Industry Associationhas predicted that between 2007 and 2011,world nitrogen (nutrient basis) supply willincrease by 18 percent with the majority of this increase coming from Asia and theMiddle East.With demand through 2011expected to grow but at a slower pace ofaround 8 percent, surplus supply will easeupward pressure on prices in the mediumterm. As a result of relocating capacity,nitrogen is increasingly traded internationally,rather than being produced domestically.Between 1999 and 2005, global urea trade for example increased 24 percent.Increasingly, fertilizer products that have a high nutrient concentration are beingtraded as higher concentration productswhich weigh less, have relatively lowertransportation and handling costs.

Outlook and OpportunitiesFertilizerWhile price increases will encourage fertilizercapacity expansion, this capacity will taketime to build. Meanwhile, demand forfertilizers is expected to continue to grow.In 2008, wheat area is expected to expandsignificantly in response to high prices, whilecorn production in the US will need to remain high to support ethanol production and feed demand.This scenario suggests a continuation of tightness in the fertilizer market.

On the fertilizer front, prices for potash andphosphates are expected to remain high inthe short and medium term, while urea pricesare expected to moderate as new capacitycomes online in 2008. In the longer term,fertilizer prices will continue to be governedby supply side factors such as the availabilityof raw material, and demand side factors suchas commodity prices.

Undoubtedly, fertilizer will remain an essential resource in the continued growth in agricultural productivity. It will increasingly

be consumed in the developing world, asthese regions strive to reach higher levels of production per hectare to feed an evergrowing and increasingly prosperouspopulation. In contrast, in parts of thedeveloped world, increases in fertilizerconsumption will be driven, at least in part,by the biofuel boom. In 2007, the price signals led to significant capital resourcesbeing invested by fertilizer companies in the expansion of existing facilities and development of Greenfield sites.

While fertilizer feedstocks have not yetbecome scarce, the continuing need forimproving land productivity, growth inagricultural production and global demandfor energy will ensure strong demand forthese feedstocks well into the future. Forfarmers, the need for ongoing research intoseed varieties and techniques that increaseproduction while controlling input use andcosts are, more than ever, essential.

Crop ProtectionCPCs will continue to play a significant role in protecting crops from pests, which in turnallows for greater crop yields to be achieved.The key to CPCs is research and developmentspending on new variants that providemaximum protection with the fewest numberof applications and at the least cost to the producer.The need to optimise R&Dexpenditures has been a factor in therationalisation of both segments of the agri-inputs sector. Still further rationalisationmight occur within seeds. For example, whilesales of the 10 largest seed companies are justover 50 percent of total seed sales, for CPCsthis figure is almost 90 percent.

The outlook for the seed business isinseparable from the outlook for the broader agricultural industry.The impact of the biofuel boom on agriculture cannot be underestimated. Ethanol production in the US has expanded almost exponentially,creating a new source of demand for corn.The ethanol industry is seeking corn withmore efficient energy conversion ascompared to the corn traditionally used in feed markets. As a result, seed companiesare investing R&D into the development of new varieties with improved ethanolextraction efficiencies.The boom in biofuels is providing opportunities for traitdevelopment around novel varieties to capitalise on this development.

All players in the food and agribusinessindustry will agree that the outlook foragriculture is equally challenging and


promising. Challenging, in the sense that both food and non-food demand foragricultural production will continue to increase against limited available acreage.Promising, as industries such as the seedindustry continue to innovate and developtraits to improve yields and resistance toadverse growing conditions.

Agri-equipmentAs the global agricultural industry keeps pace with increasing demand for food,improved productivity and efficient use of scarce agricultural resources will be key to sufficient growth. Rabobank believes that greater mechanisation of agriculture in the developing world will be an importantcontributor to achieving the level ofproductivity and efficiency required to meet the future food challenges. Strongexpansion is therefore expected in the global agri-equipment sector in the order of CAGR 5 percent through 2010, driven in large part by Asia.

Section 6 Conclusion | 41

The global agriculture industry is rapidlychanging. Structurally higher demand for food combined with changing dietarypatterns driven largely by emergingeconomies will require greater deployment of agricultural resources to feed a growingand wealthier consumer base.With the added component of demand for biofuels,more acreage of key agricultural commoditieswill likely come under production given thatdemand for grains, oilseeds and other crops is expected to outstrip supply gains achievedthrough productivity increases alone.As a result, more agricultural inputs such as fertilizers, CPCs, seeds as well as agri-equipment will be required. Furthermore,increased trade of agricultural commoditiesand food products is anticipated given thelimited availability of arable land per capita in the key demand-growth markets,particularly in Asia. In other words, more raw materials will be produced outside the domestic borders where demand growth is strongest, introducing newinvestment opportunities.

These fundamentals which have helpedsupport a surge in agricultural commodityprices are creating new value propositions for agricultural assets throughout the foodand agriculture supply chain.With increasedconsumer and industrial demand foragricultural commodities and productsglobally, more raw materials will be required.Some of the best opportunities for growth in agriculture in the coming years aretherefore expected to emerge in the up- and mid-stream segments of the value

chain and in those industries which feed the“f” factors of demand including agri-inputsand equipment, food processing, energycrops and commodities as well as proteins.However, instead of emphasising the physicalcommodities which have attracted muchinterest from investors in recent years,the most interesting developments will be for the players themselves which areinvolved in the upstream segments of thevalue chain and positioned to capitalise on agriculture’s rising tide.

Going forward, the combined effects of income and population growth, freer trade and globalisation, resource scarcity,sustainability and food safety are expected to support structurally higher demand and prices for agricultural commodities.Companies with control and access toresources, be they the major inputs or the physical crop land, will be set to benefitfrom the revaluation of agricultural assets.And although higher input costs will squeezemargins of some segments in the value chain,valuable acquisition opportunities whichemerge and help to drive consolidation in these industries will bode well forcompanies which respond to thesechallenges proactively.With agriculture being a necessary industry to supportpopulation growth, Rabobank believes that it is not a matter of if, but when andwhere the opportunities will arise which has substantially changed the way agriculture is seen as an investmentopportunity and valued as an asset.

6 Conclusion

References

Bloomberg

United States Department of Agriculture (USDA)

World Bank

International Monetary Fund (IMF)

United Nations (UN)

Organisation for Economic Co-operation and Development (OECD)

Food and Agricultural Policy Research Institute (FAPRI)

Food and Agriculture Organisation (FAO) of the United Nations

Planet Retail

Euromonitor

Oil World

Anfavea

US Geological Survey

International Fertilizer Association (IFA)

Phillips McDougall

China Statistical Yearbook

Other Rabobank Contributors:

Thomas Bauer, Singapore

Fiona Boal, USA

Luke Chandler, Australia

Pan Chenjun, China

Auke Cnossen, Hong Kong

Andy Duff, Brazil

Susan Hansen, Europe

Joost Hazelhoff, Europe

Tim Hunt, Australia

Sapna Naik, Europe

Gorjan Nikolik, Europe

Sebastiaan Schreijen, Europe

Michael Whitehead, USA

Peter Zhao, China

These reports, among others, are available for Rabobank clients, please visit www.rabobank.com/far

Other FAR Reports

F&A Reviews2008

Indian Crop Protection Industry

The Indian Wine Industry Uncorked

Indian Poultry Industry

The Dutch Spirits Industry

Indian Agri-biotech Sector

2007

Power Struggle

A Historical Turnaround in Global Dairy

Brazilian Orange Juice

East Asia Seafood

Agri-based Alternative Energy

Palm Biodiesel in Southeast Asia

BRICs and Biofuels

Ethnic Foods in the Netherlands

China’s Animal Protein Sector

Accession of Romania and Bulgaria to the EU

Changing Competitiveness in the Wine Industry

Industry Notes2008

Indonesian Beef

Robusta Coffee in Brazil

World Sugar Outlook 2008

The Promise of Jatropha

2007

The Right to Farm in New Zealand

The Future of the California Wine Industry

Soft Commodities

The South American and EU Beef Markets

New Zealand Aquaculture

Soybeans in MATOPI

Beverage Commodities Costs

Soaring Malting Barley and Malt Prices

The Canadian Pork Industry

Global Seed Business

German Red Meat Industry

Emerging Consumer Trends in the US and Canadian Beverage Industry

The Australian Drought 2006/07

Changing Competitiveness in Wine - France

Changing Competitiveness in Wine - Italy

Changing Competitiveness in Wine - Spain

Changing Competitiveness in Wine - Germany

Changing Competitiveness in Wine - US

Changing Competitiveness in Wine - Australia

Changing Competitiveness in Wine - New Zealand

Changing Competitiveness in Wine - Chile

Changing Competitiveness in Wine - Argentina

Changing Competitiveness in Wine - South Africa

Changing Competitiveness in Wine - China

Changing Competitiveness in Wine - Romania

Changing Competitiveness in Wine - Bulgaria

Can Brazilian Beef Production Meet Growing Demand

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Insofar as this document is issued in Australia the information comprised in this document doesnot constitute personal financial advice for the purposes of the Corporations Act 2001.

This document is distributed in Europe by the London Branch of Coöperatieve CentraleRaiffeisen-Boerenleenbank B.A. incorporated in the Netherlands, trading as RabobankInternational (“RI”).The liability of its members is limited. RI is authorised by De NederlandscheBank and regulated by the Financial Services Authority for the conduct of UK business.Thisdocument is directed exclusively to Eligible Counterparties and Professional Clients. It is notdirected at Retail Clients.

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This document may be distributed in other jurisdictions subject to the relevant laws as may beapplicable and recipients of this document should inform themselves about, and observe anysuch applicable restrictions.

For avoidance of doubt, this document is not intended to be investment research, nor does itpurport to be an impartial assessment of the value or prospects of its subject matter. No reliancemay be placed by a recipient on any representations or statements outside this document (oral or written) by any person which state or imply (or may be reasonably viewed as stating or implying) any such impartiality.

The information and opinions contained in this document have been compiled or arrived at fromsources believed to be reliable, but no representation or warranty, express or implied, is made asto their accuracy, completeness or correctness.This document is for information purposes onlyand is not, and should not be construed as, an offer or a commitment by any Rabobank entity orany of its affiliates to enter into a transaction.The information contained in this document is notto be relied upon by the recipient as authoritative or taken in substitution for the exercise ofjudgement by any recipient. All opinions expressed in this document are subject to changewithout notice from time to time.

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