New Structure, New Strategies Down Under
September 01, 1999
by Teresa Acklin
Changes and challenges in the Australian wheat industry after privatization of the country's single-desk seller of wheat.
The Australian wheat industry has undergone major changes over the last decade, including the privatization of several bulk handling authorities and rail freight companies. On July 1, AWB Limited, a national and international wheat marketing organization owned by Australia's 45,000 wheat growers, took over the operations of the Australian Wheat Board, that country's single-desk seller of wheat.
AWB Limited was established June 1, 1998 to lay the groundwork for Australian wheat growers to take control of the grain marketing board when the federal government withdrew from active participation in the grain business.
“Restructure comes in response to changes in the focus of government policy, a rapidly changing global grains market with a trend to greater supply chain management and increasingly sophisticated customer demand,” said Trevor Flugge, chairman of AWB Limited and a wheat farmer in Australia, in a paper presented at the Grain World '99 conference earlier this year in Winnipeg, Manitoba, Canada.
The new AWB is in a “sound position,” he said, to meet the current global outlook for wheat and to meet the challenges in the next round of World Trade Organization negotiations. Excerpts of Mr. Flugge's speech, presented at the conference by fellow AWB board member Andrew Inglis, follow.
The current outlook for the wheat industry presents real challenges for farmers, marketers and governments.
World wheat consumption in 1999-00 continues to be greater than production by some 13 million tonnes and ending stocks of world wheat are expected to decline from 136 million tonnes to 123 million tonnes, according to the U.S. Department of Agriculture's World Agricultural Supply and Demand Estimates.
However, for the outlook to be translated into opportunity requires genuine commitment to trade reform and allowing the market to operate so appropriate price signals can be sent and resources can be allocated to their most productive uses.
AWB Limited, with a new structure and new marketing strategy in place, is in a unique position in the global grains industry. AWB markets and sells Australian wheat and other grains domestically and internationally, on behalf of about 45,000 growers. It is the country's third-largest exporter, with annual sales revenue in excess of A$4 billion (U.S.$2.6 billion).
At the time of privatization on July 1, AWB Limited had a capital base of almost A$600 million (U.S.$390 million), placing it in the top 100 companies in Australia.
About 85% of the wheat grown in Australia is exported and marketed by AWB Limited. Wheat production in Australia in 1997-98 totaled 19.4 million tonnes on 10.4 million hectares planted. Wheat production in 1998-99 is expected to be from 20 to 22 million tonnes, one of the largest years on record and putting Australia and Canada neck-and-neck as world's third-largest exporter of wheat, behind the United States and the European Union.
In marketing Australian wheat, AWB has developed a brand of wheat for virtually every wheat flour use. More than 50 different products are offered, each targeted to a specific end use.
Australian white wheat is the company's key platform in a customer-driven agricultural marketing system. There is an Australian white wheat suitable for producing Middle Eastern flat breads, European-style loaf breads and rolls and Asian-style noodles, as well as cakes, pastry, pasta, snack foods and confectionery products.
AWB operates in a largely deregulated domestic grain market. The company trades grains other than wheat, in competition with the likes of Cargill, Inc. and Louis Dreyfus Corp. Export sales through major international grain traders that act as intermediaries between AWB and its customers represent about 30% of the company's total export sales.
The level of domestic demand for wheat is relatively small, which leads to an intriguing statistic: Australia produces only about 3% of the world's wheat but is involved in about 18% of the world's wheat trade.
For largely historical reasons, the handling and transport of grain in Australia has been managed by state-owned monopolies. However, as with grain marketing, this has changed. A number of bulk handling companies have been privatized, and some have been listed on the Australian Stock Exchange. Many grain companies are diversifying. For example, the Queensland-based Grainco has invested in a joint venture to construct port-based storage facilities in Melbourne.
South Australia's rail freight system also has been privatized, and is now operated by a consortium that includes the American rail company, Gennessee Wyoming. A RailAmerica consortium also has been selected as the new owner of Victoria's rail freight company, V/Line Freight.
In light of these changes, it would have been to our peril if AWB had stood still.
RESTRUCTURING THE AWB.
The changes that transformed the Australian Wheat Board into AWB Limited began in the late 1980s when the Australian government removed the wheat board's monopoly on domestic grain marketing and deregulated the domestic wheat market. In 1992, the government ceased its guarantees on borrowings.
It was clear that an alternative structure was required to finance borrowings. Wheat growers, the industry and the Australian government, in a joint commitment to reform, recognized the need for change.
Change in the Australian wheat industry has its origins in: The policy direction of successive governments to remove themselves from the marketing of agricultural commodities.
A more competitive and shrinking global marketplace.
Improved transport, storage and handling, called “supply chain management.” Improved farm and gene technology, producing larger crops of better quality with greater reliability, better disease resistance and higher yields.
Increasing demands from customers for better and more consistent quality products.
Genetic engineering and biotechnology.
Decreasing on-farm returns.
Increasing pressures on food security because of the enormous world population growth.
AWB Limited evolved from a legislative arrangement established at the beginning of World War II, known as the Wheat Industry Stabilization Fund. This organization, called the Australian Wheat Board, was charged by the Commonwealth Government of Australia to be the national and international marketer of wheat on behalf of Australian wheat growers and to be the provider of finance to growers at harvest time. The wheat board was a statutory authority, underwritten by the government and responsible to the agriculture minister.
Over the years, the structure of that statutory authority has undergone a number of changes, but none more significant than that which occurred on June 1, 1998. On that date, AWB Limited was created under Australian corporations law, with two major subsidiaries AWB (International) Limited and AWB (Australia) Limited.
Since then, AWB Limited has been operated as a holding company, fulfilling the role previously performed by the Australian Wheat Board. By law, AWB Limited is subject to the same scrutiny, transparency, obligations and requirements as any corporation.
Beginning July 1, AWB became a grower-owned and controlled company, and its two major subsidiaries have distinct and separate roles.
AWB (International) Limited is the pools subsidiary, responsible for the wheat export pools and focused on maximizing pool returns. On July 1, with the exception of the single-desk export mechanism, all government involvement in wheat marketing ceased.
The Wheat Export Authority, made up of industry and government representatives, will provide additional oversight for the operation of the single-desk, which will remain until at least the year 2004. In the intervening period, its operation by AWB will be subject to review under the government's National Competition Policy to determine if the benefits outweigh the costs.
AWB (Australia) Limited is the trading subsidiary, responsible for domestic wheat and other grain trading and the export of any non-statutory grains. Its activities also extend to other commercial ventures.
One of the biggest changes that comes with privatization is that government underwriting of AWB's borrowings for harvest payments has ceased. AWB's shareholders now bear the costs and risks of underwriting borrowings, representing an additional risk for growers who previously faced only production risks. AWB (Finance) Ltd. offers price underwriting and financing on a competitive basis.
In structuring the new organization, a dual class share model was adopted. This model provides the best mix of grower control and commercial flexibility.
Growers were issued “A” class shares, which entitle them to elect the majority of members of AWB's board and change the company's constitution. In addition to “A” class shares, Wheat Industry Fund unit holders were issued “B” class shares on the basis of their equity stake in the company. “B” class shareholders are entitled to elect a minority of directors and, while unable to control the company, are eligible to receive dividends.
AWB's head office is in Melbourne, but it has three regional offices and 19 area offices thoughout Australia's wheat belt, as well as offices in Tokyo, Hong Kong, New York and Cairo.
Growers have been the force for change, and have recognized that marketing wheat globally requires the flexibility to respond to change. The restructuring of AWB is a clear recognition that a commercially driven marketing structure could be best achieved if controlled by the wheat growers in Australia, rather than the government. Australian wheat growers have managed and directed the process of this change.
The new company faces several challenges. The area planted to wheat in Australia in 1998-99 was a record 10.8 million hectares. Despite an almost ideal start to the crop year, some difficult weather conditions in Western Australia, Northern New South Wales, Victoria and Queensland have had an impact on the quality of the final crop.
Globally, there has been a significant downturn in market conditions from previous years. Futures prices have reached low levels not seen in 20 years, for the second time in just over a year. Ending stocks, which are at historically high levels, are expected to fall but prices should remain low. Export demand should decline as key importers increase production.
Beyond 1998-99, lower wheat production is likely to translate into tighter supply and firming prices. This is clearly evidenced in the United States and Canada, where winter wheat plantings are down and growers are shifting to oilseeds.
From an Australian perspective, the Asian currency crisis has undoubtedly had an impact on demand and growth forecasts. For example, commercial demand has declined in Indonesia. While some of this decline may be attributed to U.S. wheat donations, the entire decline in demand cannot be attributed to this alone.
It appears that Asian currencies have begun to stabilize and that some sense of economic normality is returning to the region. Further cause for optimism is seen in the underlying fundamentals of population growth, urbanization and changing dietary requirements in Asia all factors that promote a shift from traditional diets of rice toward more wheat and meat.
However, other external factors still influence the marketplace. Russia and South America also have experienced economic difficulties. How well the world copes with this extended financial crisis will have a significant bearing on the state of the global economy and prospects for the international wheat market.
This outlook is a reflection of the change in broader market fundamentals. As the taste of the world's population becomes more discerning, so does the choice of wheat.
In the past, selling wheat was a basic, straightforward business. The Australian farmer grew wheat and sold it to be marketed, without much thought. Today, because the market is so highly competitive, the wheat grower needs to know his product and his competitors.
AWB calls this integrated marketing, or “managing the crop from the paddock to the plate.” AWB is not alone in this approach. Probably the clearest example of how wheat marketers are moving toward greater supply chain management is the recent acquisition by the U.S.-based Cargill of the global grain operations of Continential Grain. At a congressional hearing on the merger, Frank Sims, president of Cargill's North American Grain Business, noted three major changes impacting the U.S. grains industry:
The growing importance of the U.S. domestic market.
The move from a few large buyers to many smaller buyers.
A move from transactional to relationship-based dealings with farmers.
It is interesting that there was a significant political groundswell against the acquisition in light of testimony that “consolidation does not necessarily mean concentration,” and that even if concentration does occur, adverse effects are not automatic.
The Australian wheat industry and AWB Limited has been at the cutting edge of integrating the value chain for many years, and has chosen to adapt to the market rather than try to force the market to adapt to the industry.
Last year, AWB Limited established a business called AWB Seeds, purchasing a seeds business in Victoria to offer a more comprehensive service to growers. AWB Seeds' aim is to develop a national presence in the Australian wheat industry and take a stake in the future of an industry that is undergoing rapid technological change.
Another division, Agrifood Technology, provides physical and chemical testing, quality assurance and applied research and development to the grain, food and feed industries. Agrifood has established the Asian Food Research Center, which provides market-driven research and development on a range of Asian food products, including many styles of noodles, pan breads, steamed breads and buns, flat breads, wonton skins and spring rolls.
Overseas, AWB has invested in a number of joint ventures designed to pursue compatible downstream activities, including a holding in the Five Star Flour Mill in Cairo, the only private flour mill in Egypt; a holding in a flour mill currently under construction in Ho Chi Minh City, Vietnam; a holding in the Shenzen Southseas Grains Industries in China; and a shareholding in a new grains trading joint venture with the Japanese agricultural cooperative Zennoh to import, export, buy and sell feedgrains, pulses and oilseeds in the Japanese domestic market.
These joint ventures, while representing a relatively minor investment, have significant strategic benefits in positioning AWB as a preferred supplier in each of these ventures.
AWB is actively pursuing a strategy of diversifying its operations to generate new areas of growth and profits. The company's approach is to be a value-added integrated marketer, an organization that proactively markets and delivers products and services up and down the agricultural value chain.
SEEKING TRADE REFORM.
The global grain industry is beginning to see a trend where companies no longer compete with other companies but where value chain competes against value chain.
In the United States, there have been significant attempts to bring participants in the value chain closer together in the maize and soybean industries. Driven by discerning, value-conscious consumers and rapid changes in technology, companies are moving faster and faster to lock-in advantages or lock-out competitors.
This is not surprising when one considers the importance of the commodity in which we are dealing. Wheat covers more of the earth's surface than any other grain and is the staple diet for a significant and growing proportion of the world's population. More importantly, it is a commodity that is strategically important for many countries, particularly in Asia and the Middle East, as it is instrumental in maintaining food, political and social security.
It is fortunate that the last three growing seasons have been characterized by an agricultural policy that has allowed the global wheat market to operate with a low level of government intervention. Notable has been the absence of the U.S. export subsidy program, the Export Enhancement Program, and some restraint in the use of export subsidies and restitutions by the European Union. However, the challenge lies in the future, not in the past.
The decline in the international grains market over the past year has brought with it enormous pressure in the U.S. and Europe for their governments to help the plight of farmers. How these major exporters react to the pressure will be critical to the health of the global wheat market as the new millenium approaches.
Sustained levels of production force down world prices and create a risk of generating a damaging cyclical process of further price decreases and more support.
Continuing calls for farm support in the United States come in spite of recent figures released by the U.S.D.A., which show that despite current low world prices, net farm income in 1998 was the third-highest in history. In 1999, prices are expected to decline further but incomes are expected to be only slightly below average. High levels of farm support exist despite the fact that “farm household income has averaged about the same as average U.S. household income during the past three decades,” the U.S.D.A. said.
U.S. agricultural provisions for fiscal year 1999 included U.S.$1.5 billion for international food aid under PL480, $550 million for the Export Enhancement Program and up to $5.5 billion for export credit guarantees. These payments exclude any “emergency relief” that may be provided. In the European Union, limits on the Common Agricultural Policy budget have been discussed, with suggestions of a maximum 40.5 billion euros.
It is easy to understand why many countries in the world cannot play the game of supporting the agricultural sector, even if they wished to. The E.U. and U.S. must recognize the significant responsibility that goes with their expenditure. Should support to the agriculture sector be considered, it must not force other countries to continually examine the bounds of credibility. Commitment must be real, not illusory or flexible.
Genuine benefits can be gained from trade reform. A quick analysis of some numbers should make this clear:
U.S. agricultural exports have increased nearly U.S.$20 billion since 1990.
Estimated benefits from the North American Free Trade Agreement between the U.S. and Mexico has been in the region of U.S.$1 billion over the past five years.
Imports by MERCOSUR countries in 1997 totaled A$133 billion (U.S.$86 billion), with Australia's trade to the region growing an average 5% a year over five years.
With continued liberalization in China, Australia's export trend growth over the past five years has been almost 12% and is valued at A$5 billion per year.
The Australian Bureau of Agricultural and Resource Economics has estimated that the Uruguay Round outcome on agriculture when fully implemented will result in an increase in the value of Australian exports at around A$1 billion per year.
To translate trade reform into long-term benefits requires genuine commitment. Globally, the signs are there, but are not yet strong enough to be buoyed with optimism. Domestic support measures have far greater populist appeal at the moment, but these measures can have the greatest impact on the industry. The level of political agitation to retain these measures is quite disturbing.
In Europe, 30,000 farmers protested in the streets of Brussels, even before negotiations began for compromise on Agenda 2000. The European Commission must be strong in the face of such pressure and push forward with reform. Any other outcome is simply not sustainable in the long term. The burden on European taypayers is just as serious as the impact on prospects for genuine trade reform.
Agenda 2000 and the U.S. FAIR Act do take us a long way from where we started in the Uruguay Round. The reforms are modest, but move in the right direction away from production-distorting price supports and toward direct income support. The challenge is to translate the recognition of the detrimental impact of agricultural supports on the global community into genuine market-oriented reform.
There needs to be genuine negotiation within the W.T.O. forum. There is concern that some E.U. member states view Agenda 2000 as their final position. If so, what scope is there for negotiation? Without negotiation and the possibility of trade-offs, the chance for success is limited.
The next round of W.T.O. negotiations is clearly a focus for AWB Limited and Australia's wheat growers. Its priorities include tighter restrictions and greater discipline on domestic supports, export credit, global market access and the elimination of agricultural export subsidies. But for the negotiations to succeed, there needs to be genuine commitment from all players. Production responses should not be distorted through domestic supports or export subsidies, and farmers should be free to respond to the market.
The United States and the European Union have a real obligation toward responsible action and policy. But they are not alone. All governments need to move forward on trade reform, to build on the genuine progress made in the Uruguay Round.
Trade reform is, quite simply, a global responsibility.