Harvester of Sorrow: Ukrainian supply disruptions are only a part of food inflation
Near the start of February, I discussed the implications of soaring natural gas prices on fertilizer production and, by extension, food prices. It is fair to say things have moved on significantly in the subsequent period, with the S&P GSCI Agriculture Spot index having since rapidly moved a further c. 17% higher to all-time highs. More startlingly, grains prices have moved far more sharply higher with wheat prices (at time of writing) up c. 50%.
Much as I would like to claim startling foresight in this regard, the true cause is, of course, the escalation of tensions between Russia and Ukraine into a full-blown invasion of Ukraine. This has clearly provided a supply shock to global food supplies. This in particular explains the additional upside experienced by wheat; Russia and the Ukraine are the world’s 1st and 5th biggest wheat exporters respectively, accounting for a combined total of c. 25% of global wheat exports (as well as c. 13% of corn).
The Ukrainian supply is obviously facing sharp challenges but Russian supply is facing logistical challenges to reach end markets too, with many major shipping companies refusing to transact out of the Black Sea (Russia’s sole warm water port) at present. These supply challenges saw wheat futures trade limit up on multiple consecutive days near the start of March.
Conversely, we have seen already that an expressed willingness of one or either side to pursue solutions which can bring about a cessation of hostilities have seen wheat prices move sharply lower as these disruptions are assumed to dissipate. Unfortunately, the Ukrainian planting season is, essentially, NOW; even if we saw peace tomorrow, logistical challenges in labour and equipment availability, or of other essential material inputs (back to fertilizer, again) means we are unlikely to see a successful harvest. Wheat markets were tight coming into 2022; a supply deficit seems certain now.
Against this backdrop, we are seeing governments move; the Iraqi government, already facing street protests over food price rises, has instituted an emergency $100m fund to purchase wheat. Egypt’s government has instituted bans on the export of multiple foodstuffs and urged changes to consumer habits amongst its citizens. Turkey’s government insists they can offset with domestic production, but given they imported roughly half of their wheat last year (85% of which was from Russian or Ukraine), this looks a fanciful assumption (and a dangerous one, when 51% of Turks have reported they were unable to afford food within the past 12 months).
Understandably, the Ukrainian government has also banned exports of food staples, joining a list which includes countries such as Hungary, Argentina, Indonesia, and Serbia. Globally, grains stockpiles have declined for the previous four years, and a fifth clearly seems on the cards.
Worse and worse, the Brazilian harvest has suffered under drought conditions (which have also made transportation by barge of the crops produced more challenging as river levels have fallen) and fertilizer shortages. Brazilian stocks have nonetheless continued to outperform in recent weeks, perhaps as domestic surpluses in energy and calories suddenly highlighting the Brazilian economy as a potentially less fragile EM economy.
Further pressures on supply seem likely later this year as fertilizer supplies constrict further. Russia and China have imposed export restrictions, whilst Belarussian suppliers have become unable to meet contracts for supply. Major producers of fertilizer such as Yara International, Nitrogenmuvek Zrt, and Borealis have been compelled to cut or halt output as a result of soaring natural gas prices.
For many other emerging countries, however, soaring food costs are likely to impact growth even if adequate supplies can be met. The marginal ability to consume will be impacted, and countries which remain dependent on food imports will see consumption slow. Once again, the ‘Chinese consumer’ thesis will be moved to the long-grass; despite heavy investment into domestic agricultural production a poor harvest has been forecast (not helped by topsoil degradation that some estimates say account for 40% of Chinese topsoil), the Chinese economy remains dependent on food imports.
These problems are existential for large portions of the world’s population. Whilst disruptions to food supplies may well become notable in the West, the relatively superior buying power of the Western consumer should ensure we can outbid emerging countries for scarce supplies. Yet the extra cost will surely be reflected in shopping baskets and fuel nascent wage inflation. Globally, the fragility of food and energy supply chains which has been thrown into sharp relief by the current crisis seems certain to see more strategic reshoring or near-shoring of a plethora of industries. Wage inflationary feedback loops seem imminent; in such a scenario, we can’t help but remember the observations of the managers of Diverse Income trust (DIVI), that exactly such an environment has historically led to UK market outperformance.