One of the world’s great grain belts extends along the Ukrainian and southern Russian steppes, into the black earth zones of central Russia, up and down the Volga River, across the low lying Ural Mountains, and far into western Siberia and northern Kazakhstan. This vast expanse of arable land — covering 4,000 kilometers from east to west and, in places, 1,000 km from north to south — never had the chance to approach its potential during 70 years of centralized socialist agriculture.
Now, a foundation is being laid for the two largest former Soviet republics, Russia and Ukraine, to emerge as grain exporting powerhouses. Astonishingly, if trends continue, before the end of the decade the two countries taken together could challenge the United States’ long-held position as the world’s top wheat exporter.
In just a few years, they have transformed themselves from being large net importers into large net exporters of grain. Both Russia and Ukraine experienced bumper harvests in 2001 — the best in over a decade. The Russian crop was 85 million tonnes, consisting of wheat, barley, rye, oats and oilseeds, principally sunflowers. The Ukrainian crop came in at about 46.5 million tonnes, up from an average of only 25 million tonnes during much of the 1990s. The 2002 crop is expected to be somewhat smaller in both countries due to a severe drought this May, but the long-term trend is clearly upward.
Much needs to be done before the enormous breadbasket potential of Russia and Ukraine can be realized. While free market reforms are finally starting to create a productive agricultural sector, a great deal of export infrastructure, principally grain terminals and even new or expanded ports, still needs to be built.
Both countries will have to work hard to offer the quality and varieties demanded by world markets. Much of the wheat exported now from the two countries is feed wheat, but in the future there will be emphasis on milling wheat.
The two Slavic nations will also have to overcome the protectionist instincts of potentially their largest market, the EU, which absorbed a large amount of the recent surpluses before the flow was abruptly halted by the EU’s imposition of higher import duties on Russian and Ukrainian grain in the spring of this year.
There is a clear sense of urgency in the Russian grain industry. Alexander Ivlev, vice-president of the Russian Grain Union, an industry association based in Moscow, estimates the carryover from last year’s Russian crop at 15 million tonnes. Total grain export capacity of Russian ports is currently only 5.5 million tonnes, he said. Another 2 to 3 million tonnes of Russian grain could be exported through Baltic and Ukrainian ports except that Russian rail freight rates for international shipments are much higher than the already steep Russian domestic rates. Even if industry lobbying gets this issue resolved, the additional port capacity provided by the Ukraine and Baltics will not be nearly enough.
In recent months, several projects to build new grain export terminals at Russia’s Black Sea, Baltic Sea and even Pacific ports in the Russian Far East have been announced. The owners and operators of the facilities are intended to be private Russian grain enterprises. However, in some cases, the announcements were made jointly by private companies, the port authorities and the Russian Ministry of Agriculture, showing the importance that grain export development carries at a national level.
It is only a matter of time before Russia’s newly dynamic market economy solves the grain export bottlenecks, and it can be said that optimism reigns today in the Russian and Ukrainian grain industry. This scenario is in stark contrast to this region’s previous history while under central planning.
Stalin’s brutal collectivization of agriculture in the 1930s exterminated the kulaks, the class of highly skilled and wealthy farmers, bringing declines in agricultural production, and even a couple of years of artificial famine. Steady underperformance was the rule after that. Throughout the 1980s, the Soviet Union was the world’s largest grain importer taking 10 to 20 million tonnes annually.
The collapse of the Soviet system brought new dislocations and decline once again as the former collectives were cut off from the central budget. No money was available for inputs or equipment. Andriy Yarmak, director of the Kiev branch of APK-Inform, points out that fertilizer was not spread in Ukrainian fields for most of the 1990s. Average wheat yields dropped from 3.5 tonnes to 1.9 tonnes per hectare. Ukrainian grain production hit a low of 24 millon tonnes in 1999, when the country even applied to receive milling wheat from the U.S. under USDA aid programs.
Grain trading was liberalized early on in the reform process. It became the domain of a huge network of small private traders which sprung up. Major companies, such as Cargill and Louis Dreyfus, who previously had only exported grain to Russia, became active players in the domestic grain trade as well.
The proliferation of the grain traders and fierce competition among them was partly due to a milling and baking industry that had been privatized and liberalized early on in Russia, though with much delay in the Ukraine. Suppliers competed on the basis of price, quality, service and financing. There has since been much consolidation among the private traders. Trading company Razguliay Ukrros now employs over 500 people at its Moscow headquarters, the same building where it started with just a handful of employees 10 years ago.
While privatization of the food processing industry happened fairly quickly, agricultural reforms took much longer. The former socialist collectives – the sovkhozes and kolkhozes – have now all been converted into joint stock companies with each member receiving shares. Also, a new class of private farmers has emerged in each country. The Russian Grain Union estimates their number has now stabilized at 260,000 farmers, though there is still a big turnover as some give up and others try their hand.
Increased investment and corporate farms
The key reason for anticipated bigger harvests is the increased level of investment in agriculture. Suddenly, private business groups spawned by the ‘Wild West’ capitalism of the FSU have discovered that there is money to be made not just in the city, but also on the farm. Many of these companies are based in the financial and industrial sector.
By buying up majority packets of shares in the former agricultural collectives, they gain long-term control over large tracts of land. They hire well-trained and motivated farm managers, make formal business plans to win credits from their banks, and buy equipment and inputs from major international companies.
In fact, the Russian grain sector has been attracting investment from some of the country’s best-known corporate names. Interros, with nickel mining and airplane engines in its portfolio of companies, is one of these Russian business groups. At the end of 2001, the company formed a subsidiary, Agros Holdings, which in the second quarter of 2002 acquired a majority share in the former state company Roskhleboprodukt. The latter had formerly acted as the grain products monopoly in the Ministry of Procurement.
The company’s grain elevators have room for 2 million tonnes; annual flour milling and feed milling capacities are 800,000 and 1.8 million tonnes, respectively. Following the trend among competing enterprises, Interros Agros has recently announced plans to acquire farmland. It will concentrate on the fertile region around Stavropol, Russia’s southernmost grain producing area, where very high protein wheat can be grown.
Bart Swankhuizen of Cargill’s Krasnodar trading office in the southern Russian grain zone, guesses there are 10 to 15 private Russian business groups with holdings between 50,000 ha and 150,000 ha. The trend is toward greater and greater accumulations. One company based in the metals industry has set up an agribusiness enterprise called Stoilenskaya Niva. According to Russian press reports, it has already gained control of one million ha in a single Russian oblast (state or province). The company purchased 150 combines in 2001 from Russia’s leading manufacturer.
Domestic and foreign grain companies now own all of the Soviet era grain elevators. The grain zone is punctuated with hundreds of these concrete behemoths, mostly silo structures, dating to the 1960s and 1970s, which — on paper at least — offer sufficient storage capacity for much larger crops. However logistical considerations, outdated handling systems, poor energy efficiency and maintaining grain quality in these crumbling structures are the questions that face all who own and operate them in the new competitive environment.
Nevertheless, asset values have been very low for these structures, often just a few dollars per tonne of storage capacity, and buying and upgrading them has usually been the most economical option. In fact only a handful of new modern grain storage facilities have been built in Russia and Ukraine since market reforms began.
Grain production influences
Grain growing must be profitable to attract big business groups, and indeed a well-managed corporate farm has every possibility to keep its production costs low in Russia and Ukraine.
Yarmak of APK-Inform, said Ukraine now ranks as one of the world’s lowest cost grain producers. He performed a study that showed quality Ukrainian wheat loaded on a vessel at a Black Sea port can cost US$70 to $75 per tonne, even with a generous profit for the trader included. He estimated the average farm cost at $45 per tonne.
Cargill’s Swankhuizen said there are certain areas in southern Russia where wheat farms are yielding 5 tonnes per ha with production costs of only $180 per ha, including transport to the port.
Low production costs have mainly to do with exceedingly fertile land leased or bought inexpensively. Other factors are low labor costs — a Ukrainian farmhand earns less than $100 per month — and cheap energy supplied from Russia’s vast petroleum and gas resources.
Even farm machinery can be a bargain. Thanks to the large devaluation of the ruble in 1998, combine harvesters produced in Rostov in southern Russia and basic tractors manufactured in neighboring Belarus are only a small fraction of the price of deluxe machines made by the major international companies.
In Russia, sown area is rapidly increasing after contracting for much of the 1990s. Expansion began less than two years ago, but already there has been an increase of 1.5 million to 2.0 million ha, according to Swankhuizen. In 2002, about 60 million ha were planted. Swankhuizen estimates that there are 15 million to 30 million ha of untilled land that could still be planted with grain.
There is also an underlying demographic factor adding to these grain surpluses. With negative population growth and lower living standards, Russia and Ukraine are consuming less grain than ten years ago. Current consumption is estimated by Russian Grain Union officials at around 70 million tonnes.
A 50% to 60% decline in livestock herds in Russia since 1991 has also reduced feed consumption. As of January, cattle numbers stood at 26.9 million compared to 57 million in 1991, and contraction has been even greater for pigs, sheep and goats.
Predictions for the level of future grain crops vary widely. Swankhuizen predicts Russian grain crops will range from a low of 80 million to a high of 130 million tonnes, depending on weather and market conditions. The median of this range is nearly 25 million tonnes larger than Russia’s bumper harvest last year, and 30 to 35 million tonnes above Russia’s annual consumption. Yarmak of APK-Inform is even more enthusiastic about Ukraine’s prospects. He believes that in several years, a low target for Ukrainian grain production will be 65 to 70 million tonnes, one and a half times as big as the 2001 bumper harvest.
Where will it all go?
What will be the outlet for this deluge of Ukrainian and Russian grain?
The traditional channels are for barley and feed wheat to be shipped to Saudia Arabia and other Gulf Countries, while milling wheat goes to the burgeoning North African market. There is even a steady market for Ukrainian feed wheat in South Korea. According to Yarmak, the Ukraine exports grain to about 30 countries. Ivlev of the Russian Grain Union said there are 25 members of the RGU doing some exporting, 10 of which are very active.
The key for now is not who exports or where the grain is sold, but simply how the increase in exports will be handled. In Ukraine, there was just enough Black Sea port capacity to handle the 9 million tonnes of grain shipped abroad from the 2001 crop. Two to three million tonnes additional capacity could be added in the next few years. The country benefits from having several deepwater ports.
Russia does not. Of the several new port projects that have been announced, none have even secured their sites, and it could be years before the new export terminals are operating. Russia’s only deepwater port on the Black Sea, Novorossiysk, has just a single berth for Panamex vessels. On the Baltic Sea, the St. Petersburg port of Ust-Luk could accommodate. New export grain terminals have also been announced for the Pacific Ocean port of Vladivostok, but some industry insiders are skeptical. Rail transport costs are high in Russia, and it is 4,000 km from the grain growing areas of western Siberia to Russia’s only ice-free Pacific ports.
It is easy to surmise that wheat prices to the producers in Russia and Ukraine will decline below world levels as long as both countries produce surpluses without the transportation capacity to move that extra grain to world markets. In fact, July 2002 farm prices for Russian wheat are running 15% to 20% below the level of a year ago at this stage of the harvest. Falling prices could dampen the general enthusiasm prevailing now, and slow the rapid pace of new investment in grain production in the short term.
David McKee is a consultant that assists companies seeking to initiate business with the agricultural, food processing and beverage industries in the former Soviet Union and other countries. He can be reached by E-mail at firstname.lastname@example.org.