Agri Commodities Outlook for 2018: Part 1 - Beverages and Dairy
This episode is part one of the IEG Vu Global Outlook 2018 series, where I speak with industry experts to review the past year in several agricultural commodities markets, and look ahead at what is to come in 2018. Be sure to download our comprehensive IEG Vu Global Outlook 2018 report where expert analysts cast their eyes back on the preceding 12 months and try to make some informed and accurate predictions for 2018 across multiple processed food commodity markets.
In this episode, I'm joined by IEG Vu analysts Neil Murray and Richard Dillon to look back at the past year in fruit juices (in particular, apple juice concentrate (AJC)), and dairy products.
Well, it’s been another eventful year in the apple juice and concentrates sector, with prices all over the place and increasing competition between the main producers, Poland and China. I’m joined now by IEG Vu’s principle beverages analyst, Neil Murray, to discuss the situation. Neil, let’s start with Poland, they went into the year with record apple stocks, high production, and yet still processers were running out of raw material by the end of the year. So, what’s happened there?
Well, basically there was, as you say, a very large production of apples, Poland had a very, very large harvest last season, and the Polish farmers and the apple brokers simply put all the foods into store. You’ve got to understand that the Polish farmers themselves are extremely militant and very fragmented, there’s a lot of very, very small farmers and there aren’t that many really big, dominant companies, growers. Anyway, they put the fruit into store, and they just sat on it, hoping and hoping and hoping that something unusual would happen, and it did.
There was a huge, very widespread and very sharp frost in Northern Europe in April and it’s struck, unfortunately, at the apple blossoming time, and it very severely damaged the fruit crops, the apple crops, and others, as well, in countries like Northern Italy, in Austria, in Germany and in Poland. So, the Polish harvest was then dramatically slashed, this meant that the fruit which the processors were hoping the farmers were finally going to release, so they could do some late season processing, actually went into the fresh market. The farmers are doing exactly the same thing this year, they’re holding onto their stocks, they’re all in cold store, hoping against hope perhaps there’s going to be another frost, so they can afford to wait, and we shall have to see what happens. In the meantime, there simply isn’t enough raw material being released to the processing industry, and what is being released is expensive.
So, moving onto China, China sounds like it’s undergone a bit of a minor revolution in the past few years when it comes to cold storage capacity. That’s gone hand in hand with reasonable fresh apple prices in the domestic market. That’s changed this year, with fresh prices tumbling, so, what are the reasons behind that situation?
Taking things first, the Chinese apple industry itself, their total apple production has been increasing and increasing and increasing, and this year is somewhere around about 44 million - 45 million tons. The network of cold stores was put in really about ten years ago, and that started changing everything because, prior to that, shifting fresh apples around a country the size of China was a difficult thing to do. You had to rely on distribution to areas that weren’t particularly far away, because there wasn’t a lot of cold storage and there wasn’t a lot of refrigerated transport, and so you had to rely on the fruit really being stored, in many places, ambient.
Well, cold store construction in China doubled between 2008 and 2012, and China now has the world’s third largest cold store capacity, it’s absolutely immense, it’s about 76 million cubic metres or something, it’s just colossal. It’s even been estimated that the total capacity may increase by a factor of twenty over the next decade. The growth in retail cold stores alone, that’s the supermarkets putting in their own ones, as opposed to independent cold stores, that's’ growing by up to 12% a year. At the same time as the cold stores were being put in place, they then had a huge growth in the motorway network. Once you’ve got the road freight system in place, you’ve got the roads, you’ve got the vehicles, you’ve got the cold stores and then, critically, you’ve got the computer links that tie it all together, you get an explosion. The sum is much, much greater than the individual parts. So, what’s happened now is that fresh fruit, which was not so very long ago only really available in the tier one cities, and then became available in the tier two, perhaps the tier three cities, is now actually available everywhere. You can get fresh fruit pretty much all over China.
So, that’s the first thing happened, that increased the huge demand-, or fed the huge demand for fresh fruit, which meant the processors were finding it hard to get hold of supplies. Then something else happened, and it’s really happened this year, the Chinese have grown immeasurably wealthier in the last few years, per capita incomes have increased and increased. So, now, with fresh fruit availability being colossal, the Chinese consumers are trading up, they’re buying better quality fruit, they’re prepared to pay the extra for really nice apples, and the apples are the big, big, big fruit in China.
So, what’s happened this year is that-, I’m not going to say poor quality fruit, because it isn’t, but fruit that otherwise would have gone to the retail market and perhaps cheaper has actually flooded onto the processing market. So, the Chinese have had a bonanza, the processing apple price is now-, they’re finishing processing now, but it fell below-, just below $100 a ton. It’s finishing the season at between $110 and $120 a ton, depending on which region you’re talking about. So, the apple juice processors have got access to huge stocks of raw material, at low prices, at prices that Poland simply can’t match. The Chinese raw material price is double the Polish price, so, they are producing apple juice like there’s no tomorrow.
So, with these mountains of lower quality fruit that are piling up, what impact is that going to have on China’s AJC processing volume?
It’s going to go up, the Chinese-, China Juice, in September this year, they were playing cautious, which is unusual, sometimes, for the Chinese, but the industry has been in dire straits for the last few years. They were thinking that they would be able to make 650,000, maybe 700,000 tons of apple juice concentrate this year. It has to be said that IEG Vu, we were present at the conference and we said, ‘We think you’re underestimating what’s going to happen, we think, and we hold to this, that China is going to make not less than 750,000 tons.’ The reason is they can make it and they can sell it reasonably cheaply, there’s 30% duty into the EU, that’s-, obviously this is not a factor for the United States, exports to the US, but even with the 30% duty added, Chinese product is cheaper than Polish, and it’s available. That’s the key thing, you can go out and buy it.
So, looking ahead, how is this increased processing capacity and volume in China-, how’s that going to affect their export figures and, at the same time, what’s going to happen with Poland?
Poland’s export figures are going to tumble, we think they could be as low as 150,000 tons - 160,000 tons, which is half what they were doing two or three years ago. China’s are going to go up, it’s hard to say how much, but we think China can price-, and this is related to exports, we think they can price higher than they’re currently pricing, and they won’t lose a customer, because Polish is so expensive, and even at $1,150 a ton FOV, with 30% duty added, they will still undercut Poland. So, we think Chinese exports could be in the region of 650,000 - 700,000 tons, in fact we’re pretty certain they will be. Poland, as we say, will be down to about 160,000, some pessimists in Poland are saying even less than that. This could change, the apple producers, the apple growers and the cold store managers in Poland could suddenly open the cold stores and flood the market with Polish apples, but we don’t think it’s going to happen.
There’s a second factor, which is overall, while people have been saying that the apple harvest is severely down in Europe this year, and it is, historically Poland’s crop is actually a large crop. There’s still 2.8 - 2.9 million tons. Well, only ten years ago, 2.5 million tons was considered a good crop in Poland, and 3 million tons was considered colossal. Because of all the new plantings, their production has been going up, and global production has been going up as well. So, actually, you’ve had an oversupply of apples, so all you’ve really got this year if you’ve got a correction. The supply and demand is more in balance, there isn’t actually a shortage of apples, what there is, for the apple juice industry, is a shortage of high acid, sour apples, which is what the European industry and European consumers prefer and what, by law, the Germans have to have. That’s a different matter.
Well, certainly a situation to keep an eye on in 2018.
Moving on very quickly to the orange juice market, I think it’s been one of the most eventful years on record in that particular sector. We’ve got falling demand in the major markets, the EU and the US, there’s disease outbreaks, problems with climate change, and then, to top it all off, Hurricane Irma sweeps through Florida at the end of the year. So, what’s the outlook for 2018?
We think consumption in major markets, which is, effectively, Europe and the United States-, we think consumption of drinking orange juice is still going to fall. There are various reasons for that, the first is that consumers simply have a wider choice of what drink they choose to pour down their throats. The second is the sugar and obesity scare, which is not going to go away, it really, really isn’t. This one is a major problem and its’ going to stay, because, fundamentally, there is sugar in fruit juices. If you are reasonable in your consumption, this isn’t a problem, but the consumers are being alerted by scare stories. So, you’re going to get orange juice consumption dropping. However, actual global imports and sales in the orange juice business, of orange juice, are not really falling that much. What’s happening is a lot of juice is going into other products, chiefly soft drinks, rather than 100% pure orange juice. People, bottlers, blenders, soft drinks companies are making beverages that might be, shall we say, 60% fruit juice, it doesn’t have to be orange, but let’s say 60% orange juice, and 40% carbonated water or something like that, to produce a refreshing drink that carries all the vitamins, but reduces the calorie count. This is what you’re going to see.
Florida is appallingly damaged, we think Florida is basically becoming an irrelevancy, with an orange harvest of 50 million - 60 million boxes, which is what we’re talking about for the coming season. Florida is producing a quarter of what it was producing a decade or so ago, it’s a real problem. Florida, the orange juice-, sorry, the orange farmers in Florida are just having a hell of a time. Can they recover? I don’t know, at a time when consumption is falling as well, there doesn’t seem to be much future in it. I wouldn’t be surprised to see farmers turning their land over to real estate, as they did in the past. Again, the issue that’s facing the orange juice industry is a bit like apple juice, it’s not necessarily that there is a huge shortage of orange juice, per se, because there are lots of other origins to buy the stuff from around the world. There’s the Europe, there’s the Middle East, there’s other countries in Latin America. What there is in orange juice is a shortage of sweet orange juice, which is actually exactly the opposite of-, although similar to what’s happening in apple juice. In apple juice we have a shortage of sour apples, in orange juice you’ve got a shortage of sweet oranges, which is needed to blend with the more sour, the more bitter, the more acid oranges that come from the main production areas. The blending is really, really important, so, the cost of sweet or high ratio orange juice is getting very, very expensive.
The processors and the bottlers and the blenders are having to source further afield, instead of simply placing a large bulk order with Brazil, who have so many thousands or tens of thousands or hundreds of thousands of tons of this quantity, of this grade, they’re having to buy piecemeal in small lots here, there, everywhere. They’re buying a lot from Mexico, they’re having to look at North Africa, they’re buying from Spain, a big Brazilian processor is actually setting up an orange juice production plant in Spain, which is interesting. This, of course, adds to all your overheads, all your costs, so, the price of orange juice is expensive, and we can’t see it coming down in the foreseeable future.
Finally, pineapple juice, previously the priciest of all the three big juices, but in recent years seen a bit of a horrifying slump. Is the worst now over?
We think it’s bottomed out. As you say, pineapple juice used to be the most expensive of the big three, and now it’s the cheapest. You can buy pineapple juice for as little as $1,000 a ton FOV Thailand, that’s concentrate. This has been fuelled by a number of things, they’ve had a lot of weather issues in Thailand in the past couple of years, heat, drought, things like that, and there was a really big miscalculation when it was decided to permit the raising of the nitrates limit in pineapple juice from 25 parts per billion, which is the normal European level, to 50 parts per billion. Which actually, coincidentally, is what the Americans have. It was thought that this would release stocks of pineapple juice, because there was a shortage of it, onto the market.
Well, what happened was everybody blended like mad to produce pineapple juice that was above 25 PPB, but below 50. The European big buyers and bottlers simply said, ‘We don’t want it, no, we want 25%.’ There were also some other quality issues.
Pineapple juice was basically taken off the shelves, you had a huge glut of stuff that the industry considered substandard and not enough quality stuff. Now, pineapple juice was taken off the shelves, taken out of blends, the price has basically halved, it’s tumbled, even fallen by more than half, it’s not as little as $1,000, for quality stuff $1,100 to $1,200. It’s going to go back up eventually, because the farmers have pulled out of pineapple, and this is what happens in Thailand on a regular basis, and gone back to growing things like sweetcorn or sugar cane. Because they’re not getting the returns on the fruit. The Thai government is guaranteeing a minimum fruit price, we hear, to the farmers, of 3.6 baht per kilo, which his still appallingly low, the farmers reckon they can’t make a profit with anything below 5 baht a kilo, other people reckon the farmers are exaggerating slightly and say, well, 4 - 4.5 baht is break even point. 3.6 baht is still low.
So, what’s happening now is there’s little raw material, there’s little production, demand is utterly dependent on the European supermarkets putting pineapple juice back on the shelves, and back into their blends. We hear this is starting to happen now, but unfortunately, it’s not something that can be done overnight. It takes a lot of time to readjust your recipes, to have them tested, have them signed off and then, of course, you have to change all the packaging, as well. So, that’s probably going to happen, I think a good example can be to look at what’s happened in Costa Rica, which mainly produces not from concentrate NFC pineapple juice, and it produces premium-quality stuff. Costa Rican NFC exports have continued to rise and rise. The price has crashed a lot in the last twelve months because of the knock-on effect from Thailand, but Costa Rica has proved that if you’ve got a really good, premium product, even if it’s priced high, there are enough consumers out there who’ll pay for it.
Well, plenty to chew over in the juice market then, thank you very much for your time, Neil.
I’m now joined by Richard Dillon, Senior Analyst for IEG Vu, to review the past twelve months in the dairy sector. An unusual thing occurred earlier this year when the European butter market made it onto the front pages of the national newspapers, prices of the commodity have soared to record levels and there was talk of a shortage in product. Richard, first of all, what was the catalyst for these rises?
Well, so, there were three driving factors, quite separate, but like chemicals in a lab they combined to create an explosive effect on the market. At one stage prices doubled in a year, hitting, simultaneously and coincidentally, €6,000 per ton, and $6,000 per ton, in one week. The global spurt was triggered in Europe, processors reacted to lower commodity prices and lower milk volumes in 2015-2016, by slashing the amount farmers are paid for their milk. Too much milk was seen as a problem, the EU brought in incentives for farmers to cut back. They did and, as a result, the spring flush earlier this year came and went with no appreciable spike in production, as was usually expected.
Only recently have milk volumes in Europe picked up, and then not by very much. The other factor is global demand, western food is becoming more popular in countries such as China and South-East Asia, pizza is a major driver of demand, the other is innovation as cheese manufacturers react to different domestic tastes around the world. It is the same for butter, which is in greater demand from bakers and food manufacturers. The third factor is that butter is now regarded as much healthier than, say, vegetable fats. It has wiped the floor with margarine over the past decade and is now no longer regarded as a villain by food writers and nutritionists. The message has been getting through to the public.
So, which of the countries that have lowered their production volumes in the past year or so, and why?
Well, France and Germany, basically, due to their size and history, are the continent’s two biggest milk producers. They’re traditionally slower to react to market signals. When commodity prices picked up t his year, nimbler operators in Ireland and Denmark, for example, were quicker to respond to extra demand. France is also exceptional in that milk prices are mostly subject to national negotiations. It is the same for dairy products, the country’s biggest butter buyer, for example, are the supermarkets, and they have traditionally set annual prices, and are unmoved by subsequent market changes. Dairy processors simply shrugged and took their custom abroad. Small and medium sized bakeries in France, that produce the iconic croissant-, croissants, by the way, are 25% butter, grimaced, and after much complaining, paid up. There are still plenty of croissants available in France, but the real pain, I imagine, is to company margins, a few extra cents on a croissant is unlikely to alarm the average French person.
So, in your opinion, are we going to be seeing shortages coming up in the next few months and, if that’s the case, which countries are likely to be hit the most?
I’m sceptical that there will be widespread shortages. I was in France the other day and saw no signs of empty shelves or any noticeable shortages of butter products. It has been flagged up in the UK by Arla, a leading manufacturer, as a potential problem ahead, in the next few weeks. Well, they must know what they’re talking about, all I will say, anecdotally, is that Arla is heavily promoting its Lurpak Spreadable range, with a cheery Christmas logo on the front of it. It’s only 40% butter, the rest made up of vegetable oils. A handy mix if you’re running a little short of the real thing. I think it is unlikely that there’ll be much of a problem in Ireland, for example, or in countries like Poland, where consumers have more access to small artisan on farm producers. Consumers will find a way to get the butter they need and there will-, and supermarkets will make sure that they are stocked up in the weeks leading up to Christmas.
So, do you think we’re in a bubble here? Or will those high prices be maintained going into the early part of 2018?
Butter prices have already fallen from their stratospheric height. The reason is that buyers were eventually forced to get back to the market, and they held off as long as they could. With more butter changing hands, competition has seen the market gradually deflate. Butter has now slipped to below €5,000 a ton in Europe. On the buy monthly global dairy trade online auction, regarded as a barometer of global prices, it was down 11% this week, from the last event, to $4,575 per ton.
Looking ahead, I don’t think such precipitous declines will continue, there is not enough butter being produced to satisfy what appears to be a growing world demand. So, prices are very unlikely, indeed, to fall back to where they were, what was seen in the past, by the trade, as broadly acceptable levels. They’ll still remain pretty high, but won’t get higher. The rises we’ve seen so far this year are going to have a big impact though, for years to come.
Okay, and finally, while prices for other dairy products, such as butter, have increased significantly, we’re still seeing skimmed milk powder, SMP prices, below the EU intervention price. There’s around 500,000 tons in public and private storage. You know, that’s a huge amount, do you see those stocks being depleted any time soon and what’s the likely impact of that volume of SMP re-entering the market?
Yes, I don’t want to be glib about this, this is very serious problem for the market, and for many years SMP was a commodity in demand and now we’re finding these huge stocks. Yes, EU stocks, around 370,000 tons or more will deplete, the first step is not adding so much to current stocks, and the EU has moved to accept zero volumes, when the intervention buying scheme opens next year, in March. This looks like being accepted by member states and, if so, will mean the EU will only be obliged to buy in volumes of its own choosing, it will probably mean paying considerably less than the current €1,698 per ton that is set in legislation. This is way above market prices anyway, food qualities around €1,450 a ton, feed at €1,330.
I think feed is likely to be the destination, for much of the current 21,000 tons of SMP, being offered under the EU tender system at the moment. It is over two years old, although, I’m sure, well kept, is becoming less attractive to food manufacturers. So, it is almost inevitable the EU will be forced to sell at lower priced fee prices. This could be a win-win for farmers at a time when processors are beginning to rein back a big on milk prices and even make small cuts. Cheaper feed would certainly help farmers who are still recovering from a squeeze on prices last year, but to get back to those stocks, yes, it’s going to be a big, major headache for the industry, for years to come, and no one really has an answer for it yet.
Well, we shall keep a close eye on developments there. Thank you very much, Richard.
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