The article below is an excerpt from our Q1 2022 commentary.
“World Bank warns of ‘human catastrophe’ food crisis.”
- BBC News, April 20, 2022
“Farmers are seeing prices for fertilizers skyrocket. Some may choose to rotate crops or use less nutrients, which could reduce crop yields.”
- CNBC, April 6, 2022
“Fears of a fertilizer shortage are slowing soybean expansion in Brazil, the world’s top exporter, nearly to a halt."
- Bloomberg, March 29th, 2022
“The global shortage of fertilizer is a huge problem. We are facing a problem of catastrophic proportions here.”
- Tony Will, CEO of CF Industries, one of the world’s largest nitrogen fertilizer producers.
CNBC, April 6, 2022
Global agricultural markets are being buffeted by several almost unprecedented forces. Surging natural gas and coal prices last fall severely disrupted nitrogen and phosphate fertilizer production, primarily in Europe and China. Reflecting cut-backs in domestic production, China and Russia banned the export of urea (the solid form on nitrogen fertilizer) and phosphate last fall, which in turn created fertilizer shortages in both Australia and South Korea.
Next came Russia’s invasion of Ukraine. Russia and Ukraine combined represent almost 30% of the world’s exported wheat. Ukraine exports 30 mm tonnes of corn or 10% of global exports. Almost all of Ukraine’s corn and wheat is exported via the Black Sea which is now entirely controlled by the Russian Navy. As of today, Russia continues to block any grain export trying to leave Ukraine’s Black Sea Ports.
Russia’s actions have enormous impacts on global fertilizer markets as well. Russia and Belarus (a Russian ally) supply almost 40% of the world’s potash. All of Belarus’s potash supply (representing 20% of world supply) is shipped by rail through Lithuania and current European sanctions block this supply form leaving the country.
Over the previous 20 years, huge attention has been paid to improved crop genetics and the positive impacts on grain yields. US corn and soybean yields over the last 20 years have grown by 35%. While increases in global grain harvests have been positively impacted by improved genetics and excellent global growing conditions, investors have under appreciated the impact of big increases in fertilizer application that have occurred over the last decade on growing the size of the global grain harvest.
Between 2000 and 2020, global coarse grain production surged by 42%. Over the same time, fertilizer application also grew by 40%. On a shorter-term basis, the same relationship holds. Global grain production grew 18% between 2010 and 2020, while fertilizer application increased 17%.
Fertilizer prices have surged over the last two years. Ammonia prices (nitrogen fertilizer in gaseous form) have gone from under $200 per tonne at the end of 2020 to $1450 today. Phosphate fertilizer prices have risen from $350 per tonne to over $1000, and potash price has grown from below $200 per tonne at the end of 2020 to almost $900 today. In Brazil, where soils are extremely potash deficient, and imported Russian and Belarus supply dominates, potash is priced at $1250 per tonne.
Given the high prices of grain today, farmers in industrialized countries can pay this high price and still earn a margin on their plantings. However, the problem for many farmers is not the price, but the availability. Nitrogen production, driven by production cuts in Europe, is down 5%. Russia is also a large nitrogen fertilizer exporter -- 7 mm tonnes or 30% of the total export market -- and it is unclear how much will be blocked by Western sanctions.
Crop yields are extremely difficult to model given the non-linearity and correlation between variables, including fertilizer application. We tried applying machine learning last year to predict US crop yield with only mediocre results. Despite the difficulty in modeling the exact impacts, it is clear that fertilizer application is critically important. Most investors are underestimating the impact nitrogen availability will have on yields. We trained a machine learning algorithm to attribute changes in crop yields over the last sixty years to various inputs such as fertilizer application, weather, genetics, and other trends. The results were unequivocal: using a technique known as support vector machines, and “Shaply values,” we estimate that as much as 40% of coarse grain yield increase since 1961 can be attributed to increased nitrogen application. We believe that a 5% reduction in nitrogen application could result in an immediate 1 to 2% reduction in global grain supply. Given the existing tightness, such a drop will have an outsized impact on supply-demand balances going into the 2022-2023 planting season. For example, the International Rice Research Institute predicts rice yields could drop as much as 10% this season, causing a loss of 36 million tonnes or 7% drop of world rise supply. The lost rice production would be enough to feed 500 mm people.
As opposed to farmers in industrialized countries, emerging market farmers do not have the available cash to purchase fertilizers that now cost 100% more than last year. Also, outright shortages are reducing fertilizer applications in areas such as West Africa, while in countries such as Peru, Costa Rica, the Philippians, and Brazil, potash shortages are forcing farmers to slow the expansion of soybean plantings.
Since 2000, Brazilian farmers have increased dedicated soybean acreage by approximately 4% per year. Brazilian farmers this year will increase soybean planting by only 0.5% -- the smallest growth rate since 2006. Stories abound of Brazilian soybean farmers cutting back on sky-high potash for the upcoming planting season as well.
A 20% cut in potash application could decrease the size of the upcoming Brazilian soybean crop by 14%, according to industry consultant MB Agro. In 2000, Brazil produced 30 mm tonnes of soybeans. By 2010 this had grown to 57 mm tonnes and today it is estimated that Brazil’s 2022 soybean crop (just now being harvested) will be 125 mm tonnes – or 40% of world supply.
Brazil’s ability to grow soybean production -- a function of both increasing acreage and huge amounts of potash application -- has been a huge input to world grain growth. That source of growth has now come to a short-term end.
The 2022 northern hemisphere planting season is only just beginning and, at this point, it is difficult to make an accurate prediction regarding yield and crop size. However, we should point out that weather conditions have already proved challenging. Drought conditions emerged in Brazil at the end of 2021 and continued into 2022, severely impacting the 2022 soybean harvest. The USDA originally estimated Brazil’s 2022 harvest would reach a record 144 mm tonnes, but estimates have been reduced to only 125 mm tonnes -- a drop of 13% in only a few months.
China enters the 2022 planting season with very difficult growing conditions, especially for the winter wheat harvest, now underway in the southern provinces. At the end of March, China’s agricultural minister made the following comments according to Bloomberg: “China faces big difficulties in food production because of unusual floods last autumn. Many farming experts and technicians told us that crop conditions this year could be the worst in history.”
Record breaking rains in Henan province last fall damaged 2.1 mm acres of winter wheat and delayed the planting of an additional 18 mm acres -- about 35% of China’s total crop.
A scorching spring heat wave is also threatening India’s winter wheat crop. The crop could be negatively impacted by 10 to 15% as excessive heat has damaged the plant in its seed formation phase. India is the world’s second largest wheat producer and has become a significant exporter over the last decade. Original estimates had India exporting 15 mm tonnes of wheat in 2022 -- or about 7% of global exports. Depending on how much damage has been done, India might export little wheat at all this year, further tightening the global wheat market.
North American weather conditions will also have to be watched closely. The western half of the United States and almost all of western Canada are under severe drought conditions. Two very late snowstorms hit the upper Midwest and the southern Canadian plains posing problems as well. Southern Manitoba and western Ontario remain covered in deep snow which could delay the 2022 planting season and impact overall grain yields.
How these weather events will ultimately affect the planting and harvest will have to be carefully monitored, especially given all the other global agricultural problems existing today.
As if the world’s agricultural markets don’t have enough stress placed on them, two additional items will have to be watched.
The first is the emergence of food protectionism, something we haven’t seen since the 1970s. As fears of scarcity and resulting high prices increase, we should expect countries to severely restrict agricultural exports to lessen the threat of shortages. The potential disruption and closing of agricultural trade will drive prices up even further, create shortages, and ultimately lead to empty store shelves in countries dependent on imports.
On April 28th, Indonesia announced that it banned the export of palm oil, one of the world’s most popular cooking oils. The ban follows the sharp rise in global cooking oil prices due in large part to the disruptions caused by Russia’s invasion of Ukraine. Ukraine produces almost 50% of the world’s sunflowers and shortages of sunflower oil have driven up the prices of all other cooking oils, including palm oil.
This export ban is already causing huge problems for other emerging markets. India imports 45% of its palm oil from Indonesia, and the ban has already produced a shortage of cooking oil across the country.
The second is the Biden administration’s announcement allowing the year-round selling of gasoline with 15% ethanol content. Although it is unclear how much the new E-15 mandate will stimulate corn demand, adding any additional demand pressure to corn is the last thing grain markets need right now. Almost 35% of the US’s 15 bn bushel corn crop goes into the making of ethanol, almost all of which is then blended into gasoline.
Making matters worse, we believe weather patterns are becoming more challenging for crop yields. Although highly controversial, we believe we have entered into a long-term cooling trend that will be driven by declining sun-spot activity —a subject we have discussed in past letters, and will again address in our next letter. Cooling trends often produce adverse crop growing conditions which could severely hinder global grain harvest. Although we have had plenty of isolated adverse weather over the last three years (primarily dry conditions here in the US and Canada and a full-blown drought in Brazil and India), overall global growing conditions were actually quite favorable. However, we still believe much more adverse weather conditions may still be in our future.
We continue to recommend investors have significant exposure to agricultural related equities, including the fertilizer stocks. Although these stocks have had large upward moves over the last 12 months, they remain extremely cheap based upon their earning power.
Intrigued? We invite you to revisit our entire Q1 2022 research letter, The Gas Crisis is Coming to America, available below.