BofAML Explains Why The Ag Economy Isn't Likely To Get Much Better In 2017
The fact that farm incomes have come under increasing pressure over the past couple of years should come as little surprise to our readers (for those who missed our latest update, see: "Midwest Farm Bubble Continues Collapse As Farm Incomes Expected To Crash In 2017"). Unfortunately, at least according to Bank of America's Global Ag Chemical team led by Steve Byrne, farmers shouldn't expect a reprieve any time in the near future.
As BAML points out, the grain commodity farmers of the U.S. are locked in a vicious cycle, the result of which is a perpetually oversupplied market. To summarize the key takeaways, farmers continue to plant so long as cash profits are positive (because depreciation isn't a real cost and who cares about returns on capital anyway...silly finance people) while yield growth continues to outpace demand growth which leaves markets perpetually oversupplied and commodity prices well below what would be required to provide a normalized profit level for farmers.
Meanwhile, since farmers seem to be incapable of unilaterally reducing supply, an external supply shock (e.g. a weather-related event) seems to be the only hope of the industry ever normalizing again.
With that, here is a little more detail on the vicious ag cycle per BAML...
Yield growth per acre continues to average 1-2% per annum...
Yields continue to improve with no sign of abatement as seed technology improves and farmers utilize better information technology (precision ag) to gain better understanding of acreage and maximize yield potential. While weather can disrupt yields year-to-year, directionally yields have improved at a 1-2% CAGR for corn, soy and wheat since 2000. In our view, this will continue to place deflationary pressure on crop prices longer-term, particularly given the extent to which global yields trail yields in more developed ag economies.
...which continues to drive new record highs in production despite an already weak pricing environment.
Global corn production is similarly heading for a new record high in 2016/17, up 7% YoY and driven mostly by an almost equally big rise in yields. The US 2016/17 crop that was just harvested looks especially strong. Concerns over whether ear filling was impeded by the hot and dry summer weather are now fading as the harvest is done and the USDA revised up its yield estimate by 1% to 11.01mt/ha in November. Meanwhile, in LatAm farmers are currently planting for the 2016/17 harvest and production looks even stronger, up 26% on presumed yield normalization and exacerbated by a 7% increase in acreage.
Meanwhile, global corn demand is expected to recover somewhat in 2016/2017 but no where near the expected 7% supply increase.
Global corn demand growth slowed to just 2% per annum in the past two years, due to a drop in global pork production. Corn is the staple diet of the word’s more than 1bn pigs. The decline in pork production was mainly caused by an environmental crackdown in the Chinese farming sector, and the country’s pork production fell by 3% in 2015 and another 5% likely in 2016.
Then in March 2016, China ended its domestic corn price floor, giving relief to pig farmers, and corn demand started picking up again. Corn demand from pig production will continue to rise structurally in the years to come on the ramp-up of new modern mega farms in Northern China. Overall global corn demand can recover to 3% growth this market year (2016/17) and hold up at 2-3% growth annually in the years to come, in our view. However, we have started to see signs of slowing feed demand as elevated corn prices have led to substitution to other feeds, in some instances. Global feed demand levels will be key in determining the aggregate corn demand picture.