Monthly Archives: March 2007

Focus on United Kingdom

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Potential of grain-based biofuels production could change agricultural dynamics in the U.K.

The United Kingdom (U.K.) is extraordinarily productive when it comes to one grain crop — wheat. A gentle, moist, maritime climate allows yields of seven to eight tonnes per hectare (ha) for a crop of 15 million tonnes, accounting for roughly 75% of the UK’s total grain and oilseed production.

Stable feed and flour milling industries consume 12 million tonnes annually, but as much as 3 million tonnes of the U.K.’s high-starch soft wheat is usually exported to other European Union (E.U.) countries — primarily for feed use — with over half of that going to Spain. To limit the surplus, farmers have been paid to take 600,000 ha of land out of production under E.U. programs known as "set-aside."

The addition of a new variable — biofuels production — has the potential to change this equation radically. The U.K. government has recently mandated the inclusion of 2.5% biofuels by 2008 and 5% by 2010. Suddenly the country, which has been something of a laggard behind continental Europe in biofuels production and consumption, has the potential to take a leading role. So far, Brussels has only issued directives (i.e. suggested guidelines for its member countries regarding biofuels), but the U.K. is one of the first countries to make them mandatory.

Alastair Dickie, director of crop marketing for the Home Grown Cereals Authority (HGCA) predicts that if the U.K.’s first ethanol plants are built as planned within the next two years, much of the wheat that is currently exported could stay in the U.K. There is also the potential for up to two-thirds of the land now in set-aside to come back into production. The 3 million tonnes of wheat that could be grown on these 400,000 ha would become feedstock for ethanol production, and thereby not violate E.U. limitations on wheat production for food.

But Dickie also points out that "the U.K. government is trade-oriented," meaning it won’t likely subsidize or otherwise protect domestic biofuels production. Imported products will enter the market and be sold on an equal footing as domestic ethanol or biodiesel. However, he adds the caveat that imported biofuels "must be sustainable," making reference to the environmental consequences of expansion of palm plantations for biodiesel in Southeast Asia.

It is still too early to say when large-scale biofuels production will come on line in the U.K. Currently, only small amounts of recycled vegetable oil are turned into biofuel. At least five or six ethanol plant projects have been announced, a couple with financing from planned stock market flotations. However, none have broken ground, and investors have become wary as wheat prices have jumped to their highest levels in recent history at the same time that petroleum prices have fallen. But Dickie maintains that "at current price levels growers will expand production," implying that increased supply will bring down wheat prices and make the projects viable again.

The biofuels boom could slow the attrition in the number of U.K. farm operators. Today, there are nominally 70,000 farmers of whom 30,000 can be termed "serious" farmers. However, just 10,000 farmers are growing 80% of the crop, according to Dickie. Ten years ago, there were about 55,000 to 60,000 serious farmers, with 40,000 of them producing 80% of the crop. Today in the U.K., about 2,000 ha are needed for efficient farming. Dickie says there has been "an expansion of contractual farming by non-owners," which is "like share cropping."

FLOUR MILLING

To date, the companies that dominate oilseed crushing and flour and feed milling in the U.K. have resisted the temptation to enter the local biofuels business. Two companies with 12 large mills between them — RHM plc (formerly Rank Hovis MacDougall) and ADM Milling — control roughly half of all wheat flour output. An even larger U.K. food company, Premier Foods, has been attempting to take over RHM.

NABIM, the national milling association, reports that all together there are 59 mills operating in the U.K. owned by 31 companies, far fewer than the 250 mills that were operated by 200 companies in the 1950s.

Total wheat usage at these mills has remained stable over the last five years at just over 5.6 million tonnes.

Despite a national wheat surplus, U.K. millers grind only 83% local wheat. French wheat is imported to make flour for French breads, and up to 10% of the requirement for certain types of flour may be imported from the U.S. and Canada.

RHM got its start in 1875 when Joseph Rank, the founder, rented a small windmill. His milling business grew through technical innovations, including the introduction of steel rollers, and eventually through mergers with other milling companies. In recent decades, it has turned itself into a major food company again through acquisitions. Nowadays, the bulk of RHM’s flour production is used to make other company-branded consumer food products. For many of them, the cost of wheat is only a small part of the final price paid by consumers, helping to moot the food-for-fuel debate caused by rising grain prices.

Some British millers have attempted to respond to another environmentally driven consumer trend: the demand for bread made from organically grown wheat. It did not exist on the market five years ago, but observers estimate that 1% of all bread now sold is labeled organic, though there is no official data. There is not enough U.K. wheat that is certified organic to meet the demand, and so the handful of millers specializing in this niche partially use wheat imported from North America, the Ukraine and elsewhere.

There is a small but vigorous oats and barley milling industry, primarily made up of producers in Scotland. Overall though, there has been a reduction in oats and barley production, even for malting, while wheat production has benefited from investments in development of new varieties to increase yields.

OILSEEDS AND FEED

ADM operates just one oilseed crushing plant, at Erith outside of London, but it is the country’s largest. Cargill, which has several plants, controls the remainder of the country’s oilseed crushing. Its largest facilities are a rapeseed processing plant at Hull on the North Sea and a soybean crushing plant near Liverpool. Domestic oilseed crushing only partially meets the demands of the livestock sector for protein. The port of Seaforth, adjacent to Liverpool, serves as one of the main entry points for the millions of tonnes of soybean meal imported annually from the Western Hemisphere as well as soybeans. The South American share for both has been steadily increasing while U.S. totals have declined.

The feed industry has been subject to much turbulence since the BSE outbreaks in the 1990s, bringing wave upon wave of restructuring, mergers, acquisitions and divestitures. Today, there are two compound feed manufacturers that operate nationally. The largest, BOCM Pauls, produces about 2 million tonnes per year of both ruminant and monogastric (pigs and poultry) feed, giving it a market share of over 20% of compound feed production. The second national player is the feed-related businesses under Associated British Foods plc, which are mostly consolidated now into its subsidiary, ABNA. There are two other categories of feed milling companies in addition to the above national compounders. Country compounders are companies generally with just one mill selling regionally, and the third category is cooperative- and farmer-owned mills. The latter type of mill is declining in number.

AWB awaits its fate

The Australian wheat exporter, reeling from a recent scandal, will likely lose its single desk monopoly.

For more than 70 years, the Australian Wheat Board, more commonly known as AWB Limited, has, for the most part, been the sole exporter of Australian wheat. That’s significant since exports can be up to 14 million tonnes out of a crop of 24 million tonnes in a non-drought year. Australian wheat is milled in over 50 countries, according to the AWB.

But the organization’s single desk monopoly status may be coming to an end following the investigation completed at the end of last year into illegal kickbacks paid by AWB to the Saddam Hussein regime in Iraq. These payments had been exposed earlier by the Volcker Committee as the most significant abuse in the corrupt U.N. Oil-for-Food Program.

The future of the Australian single desk for wheat exports has been the subject of an intensifying public discussion that is likely to culminate in a major restructuring of the system by the middle of this year. A government-appointed task force called the Wheat Export Marketing Consultation Committee has formalized the debate by conducting a series of hearings with wheat growers and other industry players throughout the country in the past few months. This committee, made up of four leading corporate executives from inside and outside the grain industry, is scheduled to submit its recommendations by March 30. The government, in turn, is obliged to propose changes to the Wheat Marketing Act for a vote in the legislature in Canberra no later than June 30.

There is consensus, both in the industry and government, that some kind of change is needed. This view was stimulated by the findings of the year-long courtroom investigation, known as the Cole inquiry, into the approximately U.S.$220 million in kickbacks paid by AWB to the Saddam Hussein regime under the United Nations’ Oil-for-Food program. Commissioner Terence Cole tabled his report in November of last year. Not only did the report call for the criminal indictments of 11 AWB executives who took part in the illegal payment scheme during the years prior to the U.S.-led invasion in 2003, but it also called for the removal of the single desk monopoly from AWB.

Some interim measures have already been taken. Most important is the temporary lifting of AWB’s authority to veto bulk wheat shipments by other organizations, which is the legal basis for the single desk. This veto power has been transferred to the Ministry of Agriculture for six months until a reformed system can be put in place. Already, licenses for 500,000 tonnes of wheat exports have been granted to CBH Group, a major grain handling company with ownership of a number of flour mills in Southeast Asia.

Key industry organizations are lobbying hard for their visions of what the new wheat export system in Australia should be, ranging from a completely liberalized wheat export market to a continuation of the single desk, but with changes in its ownership.

The question is especially important to wheat farmers in Western Australia, who export 95% of their wheat through AWB International. The Western Australian crop is typically of good quality and less prone to drought than elsewhere in the country. By contrast, farmers in the more populated eastern states of New South Wales, South Australia and Victoria, where most of the remainder of production occurs, can sell their grain to local millers in a fully deregulated market and rely on the AWB solely as a receiver of last resort.

Even after the recent Iraq scandal, polls show that about 75% of wheat growers support preservation of a single desk in some form. This is understandable since a smoothly functioning single desk can make life easier for growers.

Under the single desk, the farmer commits his crop to the pool after harvest, receiving a minimum price after paying storage fees, and the AWB takes full responsibility for marketing the wheat in the pool and obtaining the best price possible on world markets. Wheat farmers are paid a premium at the end of the marketing season, which is the profit generated by AWB net of the pool management fee. All farmers receive the same price for their wheat, sorted according to certain quality parameters.

Other traditional arguments for a single desk are that it prevents competition among sellers of a commodity that could put downward pressure on prices while offering convenient one-stop shopping for buyers, who benefit from the significant discounts on freight.

All these may well apply to the Australian wheat exports, but Julian Breheny of the Western Australian Farmers Federation (WA Farmers) points to another justification for the single desk in the face of criticism from the World Trade Organization (WTO). Australian wheat competes on world markets against U.S. and European wheat produced by growers who depend on trade-distorting government payments for 30% to 40% of their income. Australian farmers receive no state assistance aside from subsidized diesel fuel. In the face of this competition, the price-averaging mechanism inherent in the pool is a needed protection for individual Australian growers, Breheny argues.

However, Breheney also recognizes that the single desk has not been effective in stopping the attrition in the number of Australian wheat farmers. He estimates that 10 years ago there were 10,000 wheat producers in Western Australia, but their number has steadily declined to 6,000 or 7,000 today, of which 4,000 are members of the WA Farmers Federation. The peak national growers’ body, the Grains Council of Australia, has 30,000 members.

WA Farmers wants to see the single desk preserved but changed into a completely grower-owned and grower-controlled entity that might be called the "New Single Wheat Desk." Breheny argues the AWB now has conflicting mandates to growers on the one hand and financial investors on the other. In 1999, AWB was converted from a government trading board to a growerowned company, AWB Limited. Two years later, it went public on the Australian stock exchange.

Management of the single desk was placed under a subsidiary, AWB International. Stock market investors want to see AWB maximize its profits, which is equivalent to increasing margins on wheat sales and maintaining generous pool management fees, while extract- ing payments from growers for goods and services. Conversely, the growers contributing to the wheat pool want to be paid the best possible price for their wheat by the single desk, while keeping costs down.

The proposal of WA Farmers would spin off AWB International from AWB Ltd. AWB International would be cooperatively owned by growers. The structure and much of the personnel would be retained from the existing organization, but it would be downsized as well to reduce overhead costs and increase the premiums paid to growers. One means of streamlining would be through sales of large blocks of wheat by tender to international traders like Louis Dreyfus Commodities, Cargill and Bunge, as well as to the major national players who export grain.

Interestingly, this proposal essentially mirrors one made by AWB at the end of 2006 to separate the ownership of AWB Limited and AWB International but preserve the latter as a growerowned body retaining the single desk.

The lobbying group that has been most outspoken in favor of liberalized wheat trade for more than six years is the Pastoralist and Graziers Association (PGA), also based in Western Australia. PGA spokesman Slade Brockman described the single desk as "an inefficient system that loads costs onto the pool. It has grossly exaggerated its ability to price wheat discriminately in the market." What the PGA seeks is "buying competition in the market," according to Brockman, who added that "all monopoly systems break down over time." While growers’ organizations still stand behind a single desk, "growers’ opinions have fragmented in the last six months. Many individual growers have voiced their opposition to the single desk."

The strong free market stance of the PGA is understandable. While wheat and wool traditionally compete for land, water and other resources in western Australian agriculture, government intervention, in the form of the single desk, favors wheat growers.

In this highly politicized environment, the final resolution of the wheat export dilemma is still open to question. The decision will ultimately be made by an Australian government that is heavily committed to the free trade policies that have delivered strong economic growth in the last 10 years. In 2010, a National Competition Policy Review is scheduled that could demand changes to the Wheat Marketing Act, which provides the authority for the single desk. The final deadline for change has been set by the WTO, which requires that all member countries eliminate statutory monopolies by 2013.

Grain trading companies, both international and domestic, favor deregulation of exports, though they are careful to voice this sentiment only through their lobbying organizations. The three largest national players that are primed to enter the wheat export fray are Cooperative Bulk Handlers (CBH), ABB and Graincorp. CBH operates a large silo network for collection of wheat, and many farmers dissatisfied with AWB pool prices have switched to CBH storage. Through its acquisition of Malaysian-based Interflour, CBH has a guaranteed export for its wheat to its mills in Indonesia, Vietnam and Malaysia. It has petitioned for a license to export 3 million tonnes but so far has only been granted 500,000 tonnes. Nevertheless, its first shipments under this license in February were historic as the first non-AWB bulk vessels shipments since 1930. Interestingly, milling companies in Southeast Asia without an ownership link to Australia have stated their support for the single desk since it prevents any miller from getting a price advantage on wheat purchases.

ABB still benefits from its ownership of the last remaining single desk for barley in the state of South Australia, but this monopoly is likely to end. Meanwhile, Graincorp’s latest annual report shows that it traded 1.7 million tonnes of wheat in 2007 inside and outside the country.

The major international grain companies all have some kind of presence in Australia, either in oilseeds, domestic feed and flour milling, coarse grains trade or other areas, and all are primed to step into wheat exports if the door is opened. Their trade group, the Australian Grain Exporters Association, is a strong proponent of elimination of the single desk.

Even if it is deprived of the single desk on which it was built, AWB should remain an important player. Since going private, the company has integrated forward and backward through acquisitions into a wide range of related spheres. AWB Limited stores grain, trades domestically and sells fertilizer, seed and other inputs and services to farmers through its subsidiary Landmark, which has more than 430 locations in the country, contributed just over one-third of total revenues, but it accounted for two-thirds of AWB’s gross operating profits in 2006. AWB has also diversified into livestock marketing and wool handling. To better secure its relationship with key overseas customers, AWB established a trading desk in Geneva a few years ago, giving it an ability to supply wheat from all origins to key customers. AWB Limited even has ownership in a major Egyptian milling company: Five Star Mill in Suez on the Red Sea.

By virtue of these activities, AWB is Australia’s largest agribusiness company. This is small consolation to investors, however, who saw the company’s share price fall by half in 2006 to below the issue price when the company went public in 2001. At one point, the 2006 loss in shareholder value totaled nearly U.S. $1 billion.

It is not just its soiled reputation and the potential loss of the single desk that have undermined investor confidence. Last year’s drought threatens to reduce the wheat crop by 60% to 10.5 million tonnes, and the long-term prognosis is for more frequent and longer droughts due to global warming.

AWB has responded with cost-cutting measures such as closure of its Beijing office and staff reductions. At the same time, 600 employees are undergoing "cultural training" to help eliminate the attitudes that led to the abuses described in the Cole inquiry report.

Will new euphemistically named policies enable AWB Limited to keep or get back the single desk? Probably not. Will AWB continue to be a player in the Australian and international grain markets? Yes, but probably no longer as a privileged monopolist.