The guest commentary below was written by written by Daniel Lacalle. This piece does not necessarily reflect the opinions of Hedgeye.
Many have read that there is a food crisis looming and there are significant concerns about grain shortages. The main reason for this possible crisis is the Ukraine invasion. However, this is not the full picture.
Many countries around the world have a large deficit of cereal production, which is essential to feed livestock.
The main culprit is rising government intervention that has made costs soar even in periods of low energy prices, and an unsustainable level of restrictions that have made it impossible for farmers to continue planting and producing grain.
In 2020, Ukraine produced 4% of the world’s wheat production, and Russia 10%. Together, they produce almost as much wheat as the entire EU, but the reason is that the EU has made it impossible to produce wheat in an economical way.
According to the European Union website, the main costs (categories of expenditure) for cereal production are seeds, fertilizers, crop protection products and machinery/infrastructure.
According to the EU cereal farms report, the EU average total operating cost for cereals was €635 per hectare in 2020. In terms of crops, the EU admits that maize production has higher costs at all levels except for crop protection, which is higher for common wheat production.
Typically, cereal farms in economies with high levels of government intervention were already loss-making already in 2019, according to the Center for Commercial Agriculture.
“Average losses for the typical farms from Argentina, Australia, Indiana, and Kansas were $46, $1, $94 and $16 per acre, respectively during the five-year period ($114, $1, $231, and $39 per hectare, respectively).
German farms had the highest direct cost, operating cost, and overhead cost per hectare ($535, $573, and $506 per hectare, respectively)”. As such, German farms were also uneconomical.
While most average farms yielded a loss even in pre-pandemic periods, the highest economic profit earned was $68 per acre ($167 per hectare) for the typical Russia farm.
The rising cost of production came from increasing administrative burdens, environmental pressures, and rising taxes to farmers in the middle of challenging weather periods, as we have seen throughout Europe.
In Europe, farmers have seen rising minimum wages and increasing direct and indirect taxes on top of a soaring cost of energy driven by the cost of CO2 emissions multiplying even before oil and natural gas rose due to the war.
The average direct and indirect cost has increased even in the periods when inflation in the energy input was low. This has made the marginal producers react less rapidly to price changes and many farms simply to give up.
In any other circumstance, the partial collapse of supply from Ukraine and Russia would not have a significant impact, as analyst Aaron Smith points out. “How common are market shocks of this magnitude?
Russian and Ukrainian wheat exports were 7.3% of global production in 2020. Wheat production declined 6.3% in 2010, in part due to a drought that reduce Russian production by 20 million metric tons. Similarly large declines also occurred in 1991, 1994, 2003, and 2018”.
This may prevent a global food crisis, although countries like Egypt, Lebanon, Sudan and other Middle East and North Africa countries may have a very difficult time as Ukraine and Russia account for between 60 to 90% of their supply.
We cannot forget that the “Arab Spring” protests at the end of 2010 came after the unbearable rise in food prices. The risk of a similar situation now is not small.
Governments around the world should have learnt from these previous experiences and eased the administrative and tax burdens on farming to allow the market to provide flexibility in times of supply concerns from one or two nations. Instead, we have seen more rigidity, taxes and higher restrictions that have limited the possibility of easing supply chain issues.
This does not mean that farming does not need some regulation to grow and prosper. It means that excessive regulation and cost-driven government nudging has limited farmers’ ability to successfully face external challenges.
Raising the biofuel mandate that imposes a minimum 10% of all US gasoline to come from ethanol made from corn when millions may face food shortages is one of those illogical decisions.
The Ukraine war or tough weather changes would not cause a global food shortage in a normal environment of free trade and ease of doing business for farmers.
If there is a risk of food shortage it comes from years of limiting the possibilities for farmers and continuously making their production costs rise with unnecessary direct and hidden taxes.
This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap. This piece does not necessarily reflect the opinions of Hedgeye.