Investing in Russian agriculture

by David McKee
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Russia’s wheat industry has made an exceptional comeback in global trade since the lifting on July 1 of the export ban that had choked off the outward flow and sent international prices suddenly upward less than one year before.

In late September, Russia’s Deputy Prime Minister Viktor Zubkov predicted that total grain exports could reach 23 million tonnes in the 2011-12 marketing year, at least three quarters of which will be wheat. This would surpass the record levels exceeding 20 million tonnes achieved in 2009-10 and 2008-09.

Since July, the Russian authorities have been steadily increasing their estimates for this year’s total grain harvest which is now expected to be at least 90 million tonnes, compared to just 60 million tonnes in the previous drought-afflicted year.

This normalization just reconfirms the long-term prognosis for Russia’s wheat production and exports to continue increasing to respond to the steadily rising demand in many developing countries, particularly in sub-Saharan Africa and the Middle East.

Traditional suppliers to global markets like the U.S., Canada and Australia simply do not have the land, cost structure and often the rainfall to increase production at the margin like Russia and its neighbors, Kazakhstan and Ukraine.

Much has already been done to modernize Russian agriculture and improve yields and efficiency since the dissolution of the Soviet Union and the end of collective farming. However, more is needed to enhance Russia’s competitive advantage and bring it technologically to the level of other countries. This will require, above all, continued investment from both international and domestic sources in the entire chain of value for wheat and other grains.

Capital

The amount of money now pouring into modernization of Russian farming by homegrown industrial tycoons is an encouraging development for the diversification of Russia’s economy away from its energy and mineral export intensive base.

A major industrial group leading this trend is Basic Element, a Russian diversified investment group, whose main shareholder, Oleg Deripaska, has pieced together a major farming enterprise in his birthplace in southern Russia. Kuban Agro-Holding is named for the bountiful Kuban region, situated around the city of Krasnodar between the Black and Caspian Seas.

This region, with its relatively mild climate, offers the highest yields for Russian cereals production. It was mostly unaffected by the drought, heat and wildfires that destroyed most of the wheat and barley crops in Russia in the summer of 2010. Deripaska’s agricultural division, like other farming and trading enterprises in southern Russia, had been forced to hold the biggest share of the estimated 10 million tonnes of wheat carryover stocks resulting from the ban. Since July, these stocks have been released on world markets in combination with the new crop, thus explaining the unprecedented level of exports.

Since its founding in 2002 through the acquisition of a former collective farm, Kuban Agro-Holding has bought over 30 enterprises, including 19 large farms, three grain elevators with combined capacity 240,000 tonnes, three seed farming complexes, milling and baking complexes and others. The holding bought the Svoboda sugar refinery in Ust-Labinsk in 2006. All told there are more than 5,000 employees.

Kuban Agro-Holding’s collection of agribusiness operations is vertically structured into separate divisions for farming, seed production, grain storage and processing, sugar and construction.

Basic Element has injected capital and new management into these operations. The company’s specialists have visited the leading agribusinesses in Brazil, Austria, Denmark, Germany, the U.S., Australia, Hungary, Canada, Israel and the Netherlands in the last three years in order to seek out the best technology and practices.

In a recent World Grain interview, Andrey Oleynik, the managing director of Basic Element’s agricultural division, reported that Kuban Agro Holding produces 205,000 tonnes of cereals of which 160,000 tonnes are wheat and 45,000 tonnes are barley. There are 75,000 hectares of sown land, 45% sown with wheat.

Despite the sudden fall in world wheat prices since Russia resumed its exports, Oleynik said the firm plans to double its planted area in the next couple of years. “However, the percentage of wheat will remain the same,” he said.

In addition to sowing more land, Kuban Agro-Holding will focus on increasing yields. “The potential to increase grain production efficiency is quite high. At the moment we only operate at 65% from what is called ‘ideal farming,’ so there is plenty of room to grow,” he asserted.

“Agro-Holding implements the latest achievements of global agricultural science. Of course, these technologies must be adapted to local conditions, so we pay a lot of attention to the development of our own know-how.”

Oleynik believes that his own firm’s activity will be in line with a general rise in Russia grain production and exports. “Russia has the quality, price and active distribution to continue expanding grain production,” he said. “The planted area of wheat is set to rise regardless of the price, which is just another factor stimulating production.”

Russia’s grain production will surpass 100 million tonnes in the next few years Oleynik believes, even after falling back to 60 million tonnes in the disastrous 2010 harvest. However, more must be done to accommodate greater exportation of wheat and barley. “We need to further develop transport infrastructure with particular investment in railways, port facilities and storage capacity,” he said.

If this happens, Oleynik believes “in the nearest future Russia will be one of the biggest exporters and a major player in the world grain market, and one of the most attractive markets for investment.”

Kuban Agro-Holding is particularly keen to enter specialized niches that are not met by local production. Earlier this year Deripaska’s company inked a $6 million agreement with an Israeli company to obtain soy processing technology that will enable it to produce soy concentrates for a range of food, cosmetic and pharmaceutical uses. Krasnodar Territory is Russia’s main soy producing area and the crop is expanding thanks to demand from Russia’s booming feed and
poultry industries.

Corporate social responsibility

The founder of Basic Element, Oleg Deripaska, who is one of Russia’s wealthiest men with a fortune of over $10 billion, according to Forbes magazine, was raised on his grandparents’ farm in the region where he has now invested so heavily. This may help explain the level of social consciousness reflected in Kuban Agro-Holding’s activities.

“Agro-Holding is one of the biggest agricultural businesses in the Krasnodar region and the largest in the Ust-Labinsk area,” Oleynik said. “As one of the largest regional employers and taxpayers, we see our mission more broadly and therefore participate in the social and philanthropic life of the region. This is very much in line with the philosophy of our owner, Oleg Deripaska, that socially responsible business creates the positive social foundations critical for our business to grow.

“We invest a part our profits in social infrastructure, support schools and kindergartens, create new housing opportunities for young professionals, participate in village programs and support small business development and much more.”

Thanks to a doubling of profits in the last two years, the enterprise has also become one of the leading taxpayers in the Krasnodar Territory, contributing a total of about 300 million rubles to district and regional government coffers in 2010.

Risks and Rewards

Kuban Agro-Holding’s annual revenues of $207 million, though growing, represent just a small part of the billions in dollars of sales generated by Basic Element’s multinational empire centered on areas such as mining and metals, energy, construction and manufacturing. Average profit margins are about 7%, according to Oleynik, but he adds, “The risks of investing in agriculture are similar, perhaps even lower, than other business areas. Most of the risks are related to the weather. Last year, for instance, when there was a severe drought around the world, we had quite favorable weather conditions here which allowed us to get a good harvest.”

Russia now has sophisticated financial markets and a dynamic stock exchange. The tremendous potential for agricultural growth means that going public is a possibility. “We are actively considering listing,” Oleynik said.

That would open up ownership in Kuban Agro-Holding to any Russian stock market investor with an appetite for agriculture-related risk.

The global financial crisis in 2008 hit Russia particularly hard and halted much of agribusiness lending for a time. Deripaska’s empire had to retrench in agriculture just as it did in metals and other areas. But rather than sell his agricultural assets to provide funds to the core business, Deripaska raised Kuban Agro-Holding’s position in Basic Element’s organizational structure, which encompasses 250,000 employees in order to more directly oversee the expansion in agribusiness.

The drought and export ban was a second blow after the financial crisis. Many analysts have argued that the ban was more a political move to keep wheat-dependent feed prices low for Russia’s expanding meat industry. In this case, Kuban Agro-Holding would have benefited since livestock production enterprises are a part of its portfolio of enterprises.

The upside potential for agriculture in Russia is still enormous. Not long after removal of the export ban, the country’s agriculture minister, Yelena Skrynnik, gave voice again to the prediction, kept moot during the year-long ban, that Russia’s grain exports would reach 40 million tonnes by 2020. Now with the grain export tap opened all the way, confidence has returned to the sector.

However, if the ambitious grain production and exports goal publicly proclaimed by Russian bureaucrats and politicians are to be realized, it will take much more bold investment from Deripaska’s Kuban Agro-Holding and many others operating on a similar scale as well.

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