Covid-19 and Agricultural Paradigm Shifts
Typically, this time of year we are evaluating the current year’s crop harvests, discussing the fundamentals of supply & demand for each -and begin looking towards next year’s markets and potential profitability. But here in the fall of 2020 with Covid – 19 having turned the world and its markets upside down, and as of now more of the unexpected seems likely to come. The fundamentals of supply and demand, although they still matter, are secondary to not just how the pandemic plays out, but people’s perceptions of it, along with the presidential election year politics, and what the “normal” will look like after all of this passes. In short, it is hard to imagine a market environment with greater short-term (1 year?) uncertainty for so many crops ranging from commodity grains to fresh vegetables to tree nuts.
So, let’s start with some big picture observations and thoughts. We began 2020 with what is in retrospect another ho-hum agricultural market year. Generally speaking, many if not most ag commodities and products had a positive outlook. Many specialty crops, including sugar beets, potatoes, onions, and even high-quality hay were in tight supply after 2019 due to wet weather both during planting and fall harvest. Another was that after two years of diminished exports to China, trade negotiations had produced new commitments for Chinese purchases of US agricultural products, boosting corn, soy & animal protein values. The general economy was booming, and people were both eating out and spending money for perceived higher quality food types such as organics and locally grown.
The Supply Chain Scramble
Then Covid – 19 hit. The shelter in place orders and social distancing requirements due to Covid did not so much destroy agricultural demand as it did shift food types demanded, and thus stress ed supply chains. According to the USDA, in 2019 55% of the dollars spent on food in the US was for food consumed away from home.
Almost literally, that channel was largely closed overnight. As seen in the Census Bureau chart below, restaurants and other eateries sales dropped nearly in half, and although they have recovered somewhat, they remain at least 10% under the pre-Covid trendline. Also note this chart does not include schools, hospitality, and other institutions.
The food supply chain is often talked about as a singular thing, but in reality, there are at least three somewhat overlapping but separate supply chains and distribution channels in the US. These include: one for bulk commodities (grains etc.), one for home consumption and one for restaurant and institutional use. The home consumption channel requires more and specialized packaging to -accommodate smaller purchase quantities and convenience of use. The restaurant and institutional channel is designed toward larger package quantities with more diverse, often with higher quality fresh produce than is consumed at home.
The sudden collapse of demand in one channel and not fully offsetting expansion in the other was the primary reason for consumer perceived shortfalls. As an example, fresh eggs were difficult to find in grocery stores not because the chickens laid different eggs for restaurants and institutions, but because there was insufficient capacity in the consumer processing lines, as well as the retail packaging required, resulting in a struggle to shift supply from institutional and restaurant use to retail consumers. Thousands of acres of perishable fresh vegetables, requiring thousands of dollars per acre to establish and grow, that were originally intended for outside-the-home usages, had to be destroyed or plowed under for similar reasons.
The following chart is more than ten years old, but it gives perspective of how large this shift was for many products, as many items exceeding 30% or 40% were consumed away from home. We would expect the share of each item eaten from home to have increased over the last ten years as the proportion of all food eaten away from home increased.
Livestock, Labor, & Shelf Lives
Livestock & animal protein production suffered from different channel structural issues. The de-assembly line of animal protein processing (Henry Ford got his idea for car assembly from visiting a Chicago beef processing plant) is still labor intensive relative to the inverse process of product assembly. Robots are often a superior replacement for human labor in a repetitive assembly process in which precise movements are performed over and over. Disassembly of a side of beef or pork, however, requires small changes in angle, location, and depth of cuts, which vary slightly in measurement and have infinite combinations from one to the next. Mechanization, technology, and machine learning have not yet been able to fully equal the human mind, eye, and hand in discerning the variations required in those cuts. So, it requires labor. Lots of it.
Meat processors, no longer able to keep facilities fully staffed, were forced to reduce capacity or shut down entirely. For a livestock producer, in many cases there was no place to deliver animals at any price. The problem is that live hogs or other livestock have a short "shelf live" on the hoof after they have reached ideal market weight. You can continue to keep them, but they'll also continue to grow, incur expenses, and quality falls off fast. So, you are putting more money into an animal that's losing value by the day.
Additionally, it's a dynamic, continuously moving supply chain with new animals being born and finished animals going out every day. Vertical coordination means the contracted supply has been matched to processing throughput capacity; the livestock version of “Just-In-Time” delivery. The farmers in Iowa "finishing" or feeding out market hogs need to empty the buildings and clean and disinfect them to make room for the replacement piglets that are already in the supply chain. The length of time to shut down or adjust that supply chain is at minimum 3 months 3 weeks and 3 days, which is the gestation period of a sow (breed less to get less). The unfortunate, but only method, to respond to the processing disruption was to euthanize the surplus animals as they had nowhere else to go. As seen in the chart below, measured by changes in pork and beef supplies available for domestic consumption, the scale was massive at its peak.
A New Paradigm?
Those were the some of the immediate impacts of Covid – 19 in the agricultural markets. But what happens next?
Historically, every 10 or 20 years there have been farm market paradigm changing forces and/or events (external of basic supply and demand) which reshape the underlying market value drivers. These paradigm shifts impact crop production economics, logistics, cropping choices, farm profitability, and thus cash rents and land values.
Corn, as the dominant US row crop in both market size and acres and its ability to be grown virtually anywhere in the country, serves as a good proxy to visualize these paradigm shifts (see chart below). An obvious shift began in the 2006 to 2007 crop year with the combined impacts of $60 - $100+ crude oil (in gold below) and several rice exporters in SE Asia limiting or banning exports after a bad year. This led to grain being used for energy production (new demand), tight grain supplies, hoarding and export bans by nervous governments, all of which led to higher commodity prices. All ofAll these combined to make corn prices both very sensitive to tight stocks to use ratios (end of crop year remaining supplies divided by yearly demand) and highly correlated to the price of crude oil (in gold below). All of which drove a perception of permanent tight supplies or shortages of many crops as well as price highs which were previously unseen, and a follow-on increase in land prices.
Prior to that particular high crude price era (there have been others) was the 1996 “Freedom to Farm” bill (in green below) which ended government crop acreage mandates and allowed farmers to grow whatever and however much of any crop they liked. It also began phasing out market distorting federal subsidies and and transitioned them to a less market distorting insurance program. This was a time of abundant supplies and low but relatively stable commodity prices.
More recently, since 2014 with the return of cheap oil and higher corn yields, which have once again outrun demand, corn prices seemed to decouple from oil and fall back into near cost of production stagnation (in red below).
In 2020 it looks and feels as though we are now in the beginning of one of those paradigm shifts. Numerous forces are driving this. All will play a role, only some will be seminal, including but not limited to:
Cheap crude oil. Increased grain yields. Negative public perception of biofuels. Increasing consumer demand for “sustainably grown” and traceability by a public with little knowledge of food production. Food home delivery. Unattainable farm labor. Water shortages in the western states and particularly California. The return of government farm subsidies. Carbon consciousness. US foreign policy moving away from the post WWII structure of the US guaranteeing free access to US markets and security of the high seas.
Is this combination of new and shifting factors building pressure in a balloon that could burst and change our most overarching market drivers?
And now Covid.
Covid-19 and the world’s reaction to it is not a shaper of a new paradigm per se, but it may be the pin that bursts the balloon and accelerates the change. The caveat is that if restrictions we have placed on ourselves become part of the “new normal”, Covid could very much shape the new paradigm.
What does the new paradigm look like? Let’s start with a list of drivers, sub-drivers, knowns & un-knowns:
So, what does this boil down to? What are the common themes?
Beginning with the previously mentioned 1996 “Freedom to Farm” bill, nearly all agricultural markets began to move away from government mandated or heavily influenced farm crop mixes, acreages, and subsidies tied to production, (which set or heavily influenced planting decisions), to farmers making their own planting decisions (thus “Freedom to Farm”). The international movement toward free trade and globalization opened new export markets for US producers. Deregulation and constraints placed on regulatory growth lowered production costs or at least gave a level of certainty for investment. In other words, an era of (mostly) free markets. The corn supply & demand vs oil price chart discussed above is a demonstration of these market relationships and paradigm shifts.
What the drivers in the table, and as importantly their direction, have in common is a movement away from a more purely supply & demand driven market and towards one more influenced by social & environmental factors and policies. Even the first two drivers listed, technology and consumers, which may at first appear to be mostly market oriented (and of course are to some degree), are trending toward social & environmental considerations. Technology is racing to offset, in addition to demographic changes, immigration and labor policy impacts and food safety standards. Consumers are demanding producers demonstrate the “sustainability” of their practices, a physically intangible trait that is difficult to measure and could (will?) also limit the technology agriculture can implement regardless of demonstrated safety (GMO’s anyone?).
What could it mean to land values and investors? Here is what we can say for sure.
The best farmland with good water quality, quantity and security will always have value and will only become increasingly scarce. What are those geographies?
The world seems set to increase the demand for both more and better-quality food, even if the rate of that increase slows.
Increased social & environmental requirements can be either a cost or a value capture; do we pay for cover crops or get paid for carbon sequestration?
A widely adopted transparent and liquid carbon market will change land values. Where? What geographies will benefit most and by how much?
So, let’s tie this back to Covid – 19 as an agent of change. Very likely most people in agriculture could sense these changes beginning to happen to some degree, but the argument here is twofold:
First, Covid, or more specifically our reaction to it, has blown up supply chains, deepened public anxiety over where their food comes from and how it gets to them, and made those supply chains vulnerable to sudden change and those seeking to change them.
Second, the combined effect of the forces above will be to move US agricultural markets away from the more fundamental supply & demand and cost driven decision making era of the previous 24 years and towards one that answers first to social and environmental demands. Supply & demand will of course remain important, but it may become a secondary factor. And this all may now happen very quickly.