Against the grain: Agriculture grapples with price pressures

The gathering storm swirling around commodity markets augers of troubled times ahead. For agriculture, beset by the common concerns of currency fears, counterparty risk, an increased regulatory environment and once-bitten-twice-shy financial institutions, the climate is compounded by very real and entirely unique challenges.

Climate itself is amongst those challenges, but with growing population, increasing competition for land use, declining-to-stable crop yields and access to water, the question of how agriculture meets those challenges is occupying more and more thought.

The statistics are already eye-popping and, if true, the scale of the challenge ahead becomes more daunting. The UN’s Food and Agriculture Organization’s oft-quoted 70% increase in food production required by 2050 is a consistent headline grabber despite first appearing in 2009. In an article entitled "Barbarians at the farm gate(opens in a new tab)" last year, The Economist stated “humans will need to produce [in the next 40 years] more food than they did in the previous 10,000 put together.”

The magazine wasn’t alone — around the same time, UK newspaper The Independent picked up on a joint study involving Yale University, Michigan State University and Germany’s Helmholtz Centre for Environmental Research that floated the alarming concept of ‘peak food’.

Their research concluded that, for many staple crops, we’ve already topped out our maximum potential production.

That, physically, we cannot grow more. For cotton, dairy, eggs, corn, wheat, poultry, meat rice, soy, sugarcane, wheat — the list goes on, but you get the idea — we have passed the peak point.

Within a few months, Hollywood was at it too — the blockbuster "Interstellar" weaves a tale around humanity’s quest to survive after a mysterious blight kills off all crops except corn. The innate question of how to feed seven billion people has merged into the cultural mainstream in much the same way as harnessing electricity fired Frankenstein’s creature.

We’re living longer. We’re getting wealthier. There are more of us. And the climate is demonstrably changing.

If nothing else, the heady cocktail is likely to be reflected in volatility and increased risk to those looking to trade, and the era may prove to be a watershed for agriculture akin to the oil shocks of the 1970s.

Key to some of those changes was the adoption and development of new risk management tools, often powered by independent physical benchmark prices — assessed prices using a defined methodology and exposed to industry scrutiny which were able to represent values that the industry could use.

Established exchanges form a key element of the landscape and offer a number of robustly employed futures contracts, and will continue to form the spine of risk management strategies, but as some countries aggressively target expansion (largely through the old-fashioned way of bringing land into use — an option limited to a select few) growing production means the basis risks accrue further significance.

Agriculture isn’t oil though, and over years — despite leading the initial foray into trading, and lending key reference terms such as "exchange" to the physical institutions that are part of modern trading — has stood apart from the rapidly commoditizing international trading of metals, coal and energy.

However, with many of the core exchanges focused on key European or North American hubs, regions such as Australia, or the Russian and Ukrainian Black Sea incur a basis risk that may only grow increasingly onerous as volumes grow.

Market participants currently maintain hedging through a series of strategies including physical back-to-back sales or ill-fitting instruments that derive most price direction from other geographies.

Independent price reporting could facilitate a swap or other financial instrument that helps close that gap, trading as an outright price or as a differential to an established exchange.

It could also enable term contracts that cover long periods of time and maintain a link to the current market price.

And, with regulation and compliance playing an ever larger role in operations, the need to answer the question "where does this price come from?" looms ever greater in market participants’ minds.

Being able to cite the physical, market-tested indications that went into each day’s independent assessment enables those within the industry to keep track of their exposure, their mark-to-market values and auditing.

Russia’s current wheat production stands at some 60 million mt already — and is laying out ambitious plans to expand its non-GMO production and exports ever further.

And it’s not alone in that regard. As the volumes and the stakes grow higher, independent price reporting has a part to play in enabling market participants to at least better protect themselves from the uncertainties that lie ahead.