Global Industry Overview - Key Themes For Agribusiness In 2018 - JAN 2018

With 2017 coming to an end, we highlight our key global views for the agribusiness sector in 2018:

Key Agribusiness Themes For 2018
Themes Description Metrics Winners Losers
na = not applicable. Source: BMI
Agricultural Commodities To Outperform Other Commodities Sub-Indices We anticipate a tightening of global grain markets as yields will likely return towards trend-line averages after several years of exceptionally high yields. Quantitative: S&P GSCI Agricultural Index's performance Grains, cocoa palm oil
Broadly Improving Performance Of Agribusiness Companies The earnings rebound will continue, helped by accelerating EM economic growth, higher inflation in DM, and improving agricultural prices. Quantitative: modified Bloomberg Food Index performance vs other equities Global agricultural inputs, dairy, livestock companies Sugar, chocolate, palm oil companies.
Global Grain Market In Deficit For the first time in four seasons, the global grain market will see a deficit in 2017/18. This includes corn, wheat and soybean. Our global supply and demand balances. Upstream agribusiness companies, grain traders (if increased price volatility) Downstream companies (meatpackers, processed food companies)
Key Policy Debates To Impact Sector Regulation US Farm Bill, EU CAP, US marijuana legislation and environmental reform will also feature in 2018 legislative agendas. Qualitative environmentalists, marijuana producers Inputs companies
Trade: Expanding Globally But Pockets Of Disruption From US And Brexit Trade deals including TPP, EU-Japan, EU-Mercosur, are either being revived or continuing apace, but NAFTA and Brexit are key risks. Qualitative (deals agreed or ratified) and quantitative (volume of US trader relative to ROW). Farmers in the UK, Argentina, Brazil, Mexico US farmers, EU farmers (livestock in particular), Mexico and UK consumers

1. Agriculture Commodities To Outperform

We expect agricultural commodities to outperform over the next 12 months, after underperforming for the majority of 2017, led by grains and cocoa. [1] Grain prices have bottomed after a multi-year slump and we expect gradual gains in the coming months. As we move towards 2018 harvests, we anticipate a tightening of global grain markets as yields will likely return towards trend-line averages after several years of exceptionally high yields. For instance, we forecast the cumulative global grain market balance (using corn, wheat and soybean as a proxy) will shift from a surplus of 94.4mn tonnes in 2017 to a deficit of 2.9mn tonnes in 2018 (see below). Elevated carry-over stocks, which are the highest since 2001, will prevent a significant move higher, muting our bullish price outlook. Crop damage from a La Nina weather cycle in the coming months could reinforce agricultural price outperformance, particularly for grains, although this remains a risk rather than our core view. [2]

Agri Commodities To Outperform Industrials
Select Commodities - 2018 Average Price Forecast, % Difference From Spot Price
Note: Agricultural commodities highlighted in blue. Correct as of November 30 2017. Source: BMI, Bloomberg

2. Improving Performance Of Agribusiness Companies

Global agribusiness equities will maintain their uptrend in 2018, as bottoming commodities prices, and improved global economic prospects (especially in emerging markets) lead to superior profits. The upstream agricultural sector (including machinery, fertiliser and seed companies) will especially benefit as rising commodity prices will prevent fertiliser prices from falling further and encourage new tractor purchases. Indeed, input companies have already been among the best performing in the agribusiness sector over 2017 and we expect their strong performance to continue in 2018. Elsewhere, higher retail food prices will benefit livestock and food processing companies. Other sectors will fare relatively poorly, including sugar and palm oil companies and grain traders, which will suffer from low prices respectively. Snack food companies, which have been slow to respond to increasing healthification trends, will continue to struggle. [3]

Only In Line So Far
Select Indexes Rebased (November 28 2016 = 100)
Sources: BMI, Bloombrerg

3. Global Grain Market In Deficit

For the first time in four years, we are forecasting a global grain market deficit in 2017/18, the result of consistent global consumption growth and reduced supply growth as yields have declined slightly compared to previous years. In particular, for corn, we anticipate the market to register a deficit, mainly due to a 7% decline in US production stemming from weaker y-o-y yields. The deficit will be a moderate one, which underpins our view for only slightly higher average prices in 2018. [4] For soybean, we forecast a global market deficit in 2017/18 of 2.6mn tonnes, underpinning our view of slightly higher average prices in 2018. [5] For wheat, by contrast, although we forecast a balanced market following the 2018 harvests in the northern hemisphere, we believe that supply will largely outstrip demand over the rest of our forecast period to 2021 [6].

Despite reduced supply, we anticipate grain stocks to remain at elevated levels and thus, are slightly below Bloomberg price consensus on average across the grains complex for 2018. However, as mentioned above, we note a key upside risk in the form of La Nina, which could lead to increased volatility for agricultural commodity prices over the coming months. Currently, both option market volatility and speculative sentiment in the grains market are mired in multi-year lows, meaning only a small catalyst could result in a significant change in both of these indicators.

Grains Surpluses To Evaporate
Global Grain Production Balance, mn tonnes
Note: f = BMI forecast. Source: USDA, BMI

4. New Government Policies On The Horizon

Like most industries, government regulation is a key facet for the agriculture sector globally, especially in developed markets. However, we believe new policies will have a notable impact on the sector in three key ways in 2018: long-term regional policy, environmental regulation and Canada's decision to fully legalise marijuana starting in July 2018.

Regarding long-term regional policy, we specifically refer to a new US Farm Bill and EU Common Agricultural Policy (CAP) reform, both of which will see discussions begin in 2018. Both the Farm Bill and the CAP refer to the regulation and subsidy provisions for agriculture in the US and EU respectively. While the Farm Bill is traditionally renewed roughly every five years, the CAP has only undergone three major reform processes (1992, 2003, and 2013). As the US and EU are among the world's largest agricultural producers, changes to these two policies could have considerable impact in the global food supply chain. [7] Moreover, discussions around these policies, which will begin in mid-2018, will take place in the context of potentially very disruptive events in each market, renegotiations of NAFTA in the case of US and a potential Brexit hard-landing in the case of the EU.

Major Themes By Reform Cycle
Source: BMI

Regarding environmental policy, we believe that climate-related policy and regulation will target livestock and soil management as a priority, as these are 'high-impact' areas that could generate significant emissions reductions at low cost to governments. Rice cultivation, by contrast, will be spared immediate action; most rice is produced in low-income countries and plays a significant role in employment and food security, and governments will likely seek to avoid confrontation on this sensitive topic. We also expect government action on climate change to manifest itself in the form of more stringent land use regulations. [8]

Policy To Target Outsized Agricultural Contribution To Climate Change
Global - GHG Emissions By Economic Sector In 2010 (% of total anthropogenic emissions in Gt of CO2 equivalent per annum)
Note: Pie chart shows direct GHG emission shares (in % of total anthropogenic GHG emissions) of five economic sectors in 2010. Pull-out shows how indirect CO2 emission shares (in % of total anthropogenic GHG emissions) from electricity and heat production are attributed to sectors of final energy use. 'Other Energy' refers to all GHG emission sources in the energy sector other than electricity and heat production. Emissions are converted into CO2-equivalents based on GWP1006 from the IPCC Second Assessment Report. Source: IPCC, BMI

Finally, we will be watching developments in the marijuana space over 2018, especially in Canada. Much of our previous discussion on marijuana policy focussed on the US. [9] However, arguably the more significant policy developments in 2018 will come from Canada, as the Canadian House of Commons recently passed a bill effectively legalising the drug nationwide for the first time in almost a century. The policy (which will take effect in July 2018 and delegate all aspects of marketing, policing, tax collection and licensing to the provinces) will make Canada the first G-8 country to re-legalise marijuana. There is considerable uncertainty at this point as to how the regulatory frameworks will develop as existing laws will need to be changed and new laws created from scratch. These developments will likely be watched with interest by various international government and industry participants alike.

4. Trade: Generally Expanding But Pockets Of DM Disruption

In our 2017 Agribusiness key themes article, we noted that the degree of trade integration would depend on whether the country in question was an emerging or developed market. We see a similar trend happening in 2018, as emerging markets in many countries move towards liberalising trade, including agribusiness. For example, we believe that that the 11 remaining negotiating partners involved in the TPP negotiations following the US withdrawal will succeed in approving a modified version of the trade agreement (see 'TPP-11 Offers Substantial Benefits To Latin American Markets' 10 November 2017). Moreover, a new trade deal between Mercosur and the EU looks closer to completion than at any point over the last two decades. Finally, the EU is also expected to ratify a new trade deal with Vietnam, having already concluded a deal with Japan.

By contrast, the two biggest risks to agricultural trade at present pertain to the US and UK. For the US, while it remains our core view that the North American Free Trade Agreement (NAFTA) will remain largely intact following the conclusion of ongoing renegotiations between the US, Mexico and Canada, the hard-line stance taken by US negotiators at the fourth round of negotiations in October 2017 has significantly elevated the possibility of a US exit. [10] The agricultural sector is highly exposed to any change in the trading relationship between the US and Mexico, with the termination of NAFTA having substantial implications for agribusiness, with US farmers being key losers should the agreement be terminated. [11]

A Deal On The Brink
Scenarios For NAFTA Renegotiations
Source: BMI

Regarding the UK, while it is a scenario that both the British government and the European Commission are actively trying to avoid (we think that the two sides will be able to come to an arrangement that at least provides for a multi-year transition period to facilitate a 'smooth' exit from the single market), the risk of the United Kingdom leaving the European Union with no deal in place for the UK's subsequent relations with the bloc remains. [12] This could have profoundly negative consequences for agribusiness both in the UK [13] and the EU. [14]

Relevant Research:

1.Global Industry Overview - Key Themes For Commodity Prices In 2018, December 4 2017

2. La Nina Threats Return, October 18 2017

3.Year Ahead 2018: Food And Drink, December 8 2017

4.Corn: Moderate Market Deficits To Boost Prices Over Coming Years, December 5 2017

5.Soybean: Forecasts Maintained As Deficits Spur Moderate Prices Increases, September 27 2017

6. Wheat: Modest Price Gains In 2018, November 30 2017

7.Stricter Environmental Requirements Expected In Post-2020 CAP, November 21 2017

8.Environmental Regulation To Tackle Livestock & Fertilisers, Incentivise Biofuels, October 12 2017

9.'Marijuana: Headwinds And Tailwinds Following Legalisation' Special Report, March 9 2017

10.NAFTA: Scenarios For A Trade Deal In Crisis, November 14 2017

11.NAFTA Negotiations: Implications For Agriculture Trade In The Americas, February 28 2017

12.How Do We Get To A 'Cliff Edge' Brexit?, November 3 2017

13.'Cliff Edge' Brexit: Agribusiness, November 8 2017

14.Trade Disruption To Impact EU Meat Producers, December 12 2017