Prices for agricultural commodities have been heading sideways at a low level for around four years. This development can be largely attributed to the balance between supply and demand that has increasingly become unhinged, particularly in the harvest years between 2013/14 and 2016/17. While consumption of the Big 3 agricultural commodities analysed by DZ BANK Commodities Research – maize, wheat and soybeans – rose by an average of 3.6% between 2013/14 and 2016/17, the production volume of the Big 3 has recorded an average growth rate of 4.8%. The almost logical consequence of this asynchronous development was a significant increase in the Big 3 inventories from 363 to 566 million tonnes (MT).
The supply-side increase during this period can be attributed to the two primary factors of rising harvest areas and growing yields per hectare, of which the former accounted for around 30% and the latter for around 70% of the quantum leap in production.
„Area factor“: Four key drivers are responsible for the expansion in harvest areas: (1) Prices, (2) USD development, (3) agricultural policy and (4) the weather. The „aftermath“ of the agricultural commodity price boom from 2010-2013 laid the foundation for increased seed planting, mostly in countries with sufficiently large land reserves (e.g. Argentina, Brazil and Russia). These market price-induced seed-sowing incentives were additionally boosted by the accompanying appreciation of the US dollar which caused export earnings (after recalculation into the respective home currency) to mushroom even further. The maize support programme already initiated in China in 2007 (in response to the first high-price cycle) also contributed to the massive increase in agricultural area. Last but not least, the weather factor must also be mentioned in the cultivation area context, as the exceptionally favourable trilateral mixture of temperatures, precipitation and hours of sunshine – viewed on a global scale – led to an above-average „harvest rate“ (ratio of harvest to sowing area).
„Yield per hectare factor“: Three key factors served to boost the yield per hectare: (1) Breakthrough in mechanization, (2) transfer of expertise and (3) the weather. The use of cutting-edge technologies in all relevant agricultural dimensions (e.g. agricultural machinery, seeds, crop protection) generally contributes towards nurturing yield per hectare growth. Since, however, groundbreaking technological advances have long been the exception rather than the rule, the average gain in yield per hectare has gradually declined. The rapid spread in digitalisation in agriculture (keyword: Agriculture 4.0) now appears to have halted this structural „deceleration trend“ – at least for the time being. According to our estimate, the transfer of expertise to viable, second-line „agricultural technology countries“ (Russia, Ukraine etc.) has also gained considerable momentum, particularly in the recent past. However, the most important yield per hectare driver in the 2013/14-2016/17 period was the opportune weather. This resulted in a general absence of serious crop failures, especially in the major growing and exporting nations of the Big 3 agricultural commodities. While global yields per hectare of maize, soybeans and wheat remained – sometimes significantly – below the ex-ante forecast values in seven out of fifteen cases in the five harvest years 2008/09-2012/13 due to unfavourable weather conditions, such underperformance only occurred in one out of twelve cases in the four harvest years 2013/14-2016/17.
Of the six supply-side secondary or background drivers mentioned above, at least three factors have changed significantly in the meantime. Admittedly, no global „surface magnetism“ has been emanating from the (low) prices for some time now. In the course of 2017, this was joined by further „area demotivators” such as a weakening US dollar and the reversal of the Chinese grain policy. China used to generously subsidize its national maize production; now, however, it is demand for maize – following a far too successful „subsidy policy“ – that needs to be supported by state funds as quickly as possible. Compounding this, at least in the gradually ending harvest year 2017/18 and evidently also in the approaching harvest year 2018/19, is the fact that the weather fortunes appear to have been or will be much more neutral in nature.
The fact that production is now driven by fewer factors than the six stated above in combination with the hugely robust demand dynamics recently caused the „Big 3 inventories“ to already contract again by 36 MT to 530 MT (USDA: 557 MT), according to our estimate. In the US Department of Agriculture’s May Report published just a few days ago, in which the USDA traditionally announces its preliminary estimate for the coming harvest year, the US Federal Agency predicts a further decline in Big 3 inventories by 47 MT to 510 MT for the 2018/19 harvest year (DZ BANK: 486 MT). This is still the fourth highest level in this century to date in absolute terms. However, calculated – correctly – in relation to the higher demand, it is only the tenth highest level.
Conclusion: The days in which inventories were permanently building up are over. However, with production influenced by fewer factors and demand persistently strong – with the exception of the „fantastic weather” years – inventories are now more likely to head downwards and prices upwards.