China's Agricultural Sector
China's Agricultural Sector
While there has been much focus on China’s role in driving the prices of hard commodities, it has also had significant impact on the price of agricultural outputs, with many up multi-fold over the last decade or so.
With China only accounting for 10% of the world’s arable land yet needing to feed 20% of its population, there is much focus on the country’s insatiable appetite for agricultural products. Yet the Chinese agricultural sector has remained relatively opaque to outside observers, with foreign coverage on China’s agriculture sector being generally negative. Headlines focus on rampant conversion of prime agriculture land into giant residential housing complexes and industrial sites, pollution of vital waterways, depletion of important underground water resources, over application of fertiliser, and the mass migration of the rural population, deserting farms to pursue an easier lifestyle in the cities.
Indeed, though these are real issues there are positive developments taking place as well that allow one to be somewhat more optimistic about the sector’s outlook. On a recent trip to China I meet with farmers, local co-ops, agricultural machinery manufacturers and dealers, fertiliser producers and distributors, government officials and agriculture academics, in Jilan and Henan provinces, to improve our understanding of the changes taking place in rural China. Through the course of our meetings, a number of constant themes emerged.
Farm consolidation and collaboration (Co-ops) is a significant driver of change. Official Chinese numbers suggest rural land that has undergone some form of consolidation has increased from 12% in 2009 to 16% in 2011. We came across a number of such situations. One village visited formed a co-op in March 2009. It consolidated 160Ha out of its total 480Ha available and leased it to an outside party. From that 160Ha, the company has allocated 48Ha toward providing a secure supply chain of ‘organic’ (different to our western definition but still better than normal) sweet corn to McDonalds. To meet the specified standards of the customer, the company applies ‘green’ fertiliser and pesticide, lays down plastic sheeting for weed control and has installed drip irrigation (resulting in greater than 50% water usage reduction). For its troubles, the company experiences10% lower yields but achieves 20% higher prices. Negotiations are now under way to dedicate the full 160Ha to this method. The local village is happy because its land rent earns what it would have otherwise made but without shouldering the heavy labour or weather risk.
Increased mechanisation on farms goes hand-in-hand with consolidation. A visit to First Tractor (China’s leading tractor company and recent acquirer of a French tractor company for its gearbox technology) confirmed demand for larger tractors and farm machinery continues unabated. As farm sizes grow and labour availability falls it becomes far more economic for one man on a machine to plough, seed and harvest on behalf of many. This year tractor sales across the industry are actually down (due to changes in subsidies) but for tractors over 100HP, First Tractor is experiencing 50% annual growth. It has just completed a new plant that can now manufacture tractors with up to 400HP. There was one memorable meeting with the heads of a village (that soon swelled to half of the village population) about combine harvesters. In China, the latest combines from Deere harvest 3 or 4 corn rows at a time. It was pointed out that machines in the US are now harvesting 36 rows. Following a delay as English was translated into Mandarin, a wave of ‘awe’ rippled through the audience.
Interestingly, households in the region had only just received their official 'land use' certificates, a process that started over a decade ago. These certificates confirm land use entitlement from 1998–2028 and provide limited ownership rights to the land. As always, the actual ownership of land in China remains with the State. The issuance of these certificates should help simplify and accelerate similar consolidation programmes elsewhere and also enable access to finance. One of the recurring themes was the lack of finance that is available to farmers. A year’s supply of fertiliser and seed requires a substantial outlay before any crop earnings have been generated. It would be inconceivable for an individual farmer to purchase a tractor even with a generous state subsidy. However, with the land use certificate, the farmer now has collateral that will increasingly allow access to financing. Indeed, a co-op with 100,000 members has recently been granted financial backing by one of China’s largest banks and machinery manufacturers are now mulling over different finance models.
China has long been held as key driver of volume growth in global fertiliser markets, in particular potash where tight supply would drive higher prices. However, post just such a spike in prices in 2007, volume growth and prices have been subdued. Potash (potassium) is one of three key fertiliser inputs that make up NPK (Nitrogen, Phosphate and Potassium). Depending on soil conditions and the type of crop being planted, the ratio of these three inputs is tailored to optimise production. Not so in China, where farmers have typically applied less potash than seems optimal. Discussions with farmers indicated that they considered it to be too expensive and presumably unnecessary. It will be interesting to see whether this systematic under-application can hold-up through time. (For the potash bulls though, our mining work suggests an enthusiastic supply response is in the offing!).
Seed technology is another area that is lacking, with the Chinese government restricting the import of genetically modified (GM) seed. While China had planned to develop its own GM seeds there has been little to show for these efforts and as a result farmers are stuck with non-gm seed, both foreign and locally produced brands. Meanwhile, average yield rates for corn in China are about 80 bushels per acre versus 150 bushels in the US1, suggesting there are some gains to be made by adopting GM seed technology.
Another new development that was noted was the bundling of agricultural service that is already the norm in Western markets. Seed and fertiliser companies have begun to actively fund, promote and embed their products by providing a local dealership or contractor with the machinery to apply and harvest their products at no additional cost to the farmer.
The one conclusion that can be made is that further consolidation of farmland and with it, increased investment in mechanisation and technology. It would seem highly likely that these developments will result in higher yields and output, though it is hard to know to what extent these will allow supply to keep up with demand brought about by the country’s rising income levels.
1 Of course differences in yields will also relate to difference in the natural endowment of land as well as seed technology.
DISCLAIMER: The above information is commentary only (i.e. our general thoughts). It is not intended to be, nor should it be construed as, investment advice. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.