U.S. soy crushers face challenges

by Arvin Donley
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The United States is the world’s leading producer and exporter of soybeans and ranks second to China in soybean crush volume.

But as a recent report from Rabobank, “Structural Challenges in U.S. Soy Crushing,” points out, U.S. soybean crushers, who last year processed nearly 45 million tonnes, are facing major challenges, including a slowdown in demand growth, margin contractions and falling capacity utilization. These challenges are coming from home and abroad.

“China’s high soybean demand is reshaping the global playing field,” the report said. “While both China and Argentina support their crushing industries through differential tax systems, the U.S. currently limits direct intervention to farmer payments, which may change in 2012.

“Indirectly, the U.S. is damaging its soybean industry through tax credits to ethanol producers — the ethanol byproduct DDG is a formidable competitor for soybean meal in animal feed,” Rabobank said.

China’s Influence

China’s strong import demand for soybeans, but not soymeal or soy oil, has dramatically reshaped the global soybean trading and processing playing fields, Rabobank said.

Driven by the growing wealth of its huge population and the associated improvements in consumer diets, China has become the world’s largest consumer of soybeans. It now accounts for a 60% share of world soybean imports, effectively pulling soybeans away from U.S. crushers.

The report notes that despite this robust demand increase, China’s domestic production has remained relatively stable at around 15 million tonnes, as soybeans are not considered to be a strategic crop, unlike corn, wheat and rice. China’s soybean imports have risen from negligible levels in the late 1990s to an expected 56.5 million in 2012.

Eager to support its domestic crushing industry, China introduced a differential import tax structure in 1998 to encourage imports of whole soybeans rather than soymeal and soy oil.

The tax structure includes:

• a 3% import tariff plus 13% value-added tax on soybeans;
• a 5% import tariff plus 13% value-added tax on soybeal; and
• a 9% import tariff plus 13% value-added tax on soy oil.

“The tax structure has been extremely effective,” Rabobank said. “China, under this tax policy, has been the key factor influencing global soybean exports in the last 10 years. China’s surge in soybean imports means that U.S. processors must pay higher prices for soybeans relative to the domestic price for soymeal, which has contributed to processor margin contraction.”

Despite this supportive tax policy, overcapacity in the crushing industry remains a serious problem in China. Rabobank estimates that in 2010 China had a total soybean crushing capacity of approximately 100 million tonnes and crushed 55.8 million. To address its overcapacity problem, China’s National Development and Reform Commission published a directive in 2008 that suggests decreasing capacity to 75 million tonnes by 2010 and to 65 million by 2012. The guideline also stipulates that a single company may not expand once it accounts for 15% of national production volume.

Rabobank said that approval for expansion tends to favor state-owned crushers under this policy.

“To date, the guideline has been unsuccessful at shrinking capacity,” Rabobank said. “However, it has prevented foreign companies from green field or merger and acquisition expansion, instead forcing them into lease agreements with local crushers.”

Argentina’s tax system

Argentina’s domestic crushing industry has grown dramatically in the past 20 years, nurtured by growth in soybean production and the country’s differential export tax system.

The system supports Argentina’s domestic crushing industry by taxing soybean exports at a decreasing rate as the soybeans move down the processing chain. Exports of soybeans are taxed at a rate 3% higher than that for soy meal or soy oil, creating a disincentive to export soybeans.

Rabobank said the policy has worked to stimulate soy crushing in Argentina, and the country’s share of world soy meal exports has risen from 20% to nearly 50% over the last 20 years.

As part of the export tax system, soybeans are taxed at 35%, soy meal and soy oil exports are taxed at 32%, and soy biodiesel exports are taxed at 20% and given a 2.5% tax credit.

“The policy has also worked to encourage investment in some of the world’s largest and most efficient crushing operations,” Rabobank said. “At 20,000 tonnes per day, Argentina’s largest crushing facility (Molino Rio de la Plata plant in San Lorenzo, Santa Fe) dwarfs even the largest facilities in Brazil or the U.S. at 6,700 and 7,000 tonnes per day, respectively.

“By incentivizing domestic crushing, Argentina’s differential tax also helps these huge plants maintain high rates of capacity utilization. The consequence is that Argentina exports an extremely high volume of soy meal and soy oil instead of exporting whole soybeans.”

Another South American soybean power, Brazil, features a tax system that is administered by each individual state in Brazil and is one of the country’s primary tools for generating state tax revenues.

“As such, the tax has many entrenched supporters among state governments, even though it is complicated and does not serve the strategic interests of the industry or the country as a whole,” Rabobank said.

Brazil’s soybean tax system works as follows:

• soybeans are taxed at 12% each time they cross a state border;
• soymeal and soy oil are not taxed for crossing state borders; and
• exports are not taxed.

The report said that, in principle, Brazil’s intention is to tax soybeans at a total rate of 12%. The complication arises because there is little integration between taxing authorities in the different states. As a result, the 12% tax is cumulative unless a transporter is sophisticated enough to use legal means to collect overpayment credits.

“This can be an expensive and time consuming exercise,” Rabobank said.

The report noted that biodiesel production has grown dramatically in Brazil since 2005. This takes the oil fraction off the market, which could help U.S. crushers. However, to the extent it creates excess soy meal, it could be detrimental.

“Currently, Brazil’s biodiesel program is seen as a net negative for U.S. crushers, though only a moderate one,” Rabobank said.

Pressure from Canada

The report also focused on Canada, where canola oil and meal compete directly with U.S. soy oil and soymeal. Canadian canola production has increased from 5 million tonnes in 2001-02 to 12.4 million in 2009-10. Crushing capacity has increased from 3.7 million tonnes in 2006 to its current level of 7.5 million tonnes, effectively adding about 6% to North American oilseed crushing capacity at a time when demand for meal from the livestock and poultry sectors is softening.

“The primary driver of growth in Canadian canola production has been demand for healthier cooking oil in the U.S.,” Rabobank said. “While some of this demand growth has come from consumer pull, some of it has come from regulatory push. Wealthy retail consumers in the U.S. increasingly prefer canola oil or soy oil because it has lower saturated fat and higher unsaturated fat levels than soy oil.”

The report said that on the supply side, favorable crushing economics have been a factor in the growth of Canada’s canola production. Rabobank estimates that in 2010 North American canola crushing margins averaged $129 per tonne versus only $28 per tonne for soybean crushing.

Ethanol’s impact

Policy intervention in U.S. soybean markets differs greatly from the tax structures used in Brazil and Argentina. U.S. soybeans, soymeal and soy oil are all transported between states and exported out of the country tax free.

While there is no import/export distorting tax structure in the U.S., the report said the soybean industry ha paid significant costs because of tax policy supporting the U.S. ethanol industry.

“Ethanol policy has indirectly hurt U.S. soybean processors via increased production of ethanol’s byproduct, DDGS, which competes with soymeal production.

In recent years, a 45-cent-per-gallon tax credit for U.S. ethanol producers and a 54-cent-per-gallon tariff on ethanol imports, combined with high gas prices, caused an explosion in the amount of ethanol production in the U.S., thereby leading to an increase in the amount of DDGS produced. However, the ethanol tax credit is set to expire at the end of 2011 and the import tariff will more than likely cease at that time.

“This is likely to make ethanol production and blending less attractive at the margin level, but will probably not cause a decrease in production as long as the mandated levels remain in place,” Rabobank said.

Mandated legislation in the U.S. requiring increasing minimum production levels for corn-based ethanol means that growth will slow in the coming years and peak at 15 billion gallons in 2015.

Rabobank said that despite high corn costs, ethanol blending has been profitable this year and ethanol production is anticipated to reach 13.5 million gallons, far above the mandated minimum of 12.6 million gallons. Still, the report said the production pace will slow sharply over the next three years compared to the last five years, suggesting dissipating competition from DDGS.

The change in ethanol policy may also help reverse another trend that was hurting U.S. soybean crushers.

The report noted that per capita consumption of meat in the U.S. appears to be peaking, and with it domestic demand for soymeal. Some of the contraction in demand growth is due to market saturation, some is due to the aging demographic and some is related to changing lifestyles.

However, U.S. ethanol policy has likely played a role as ethanol subsidies provide a relative cost advantage for corn to be used for fuel rather than for livestock or poultry feed, which are the primary markets for soymeal.

“This gradually makes U.S. animal protein production more expensive and therefore less affordable domestically and less competitive globally.

Potential positive developments

In addition to the change in ethanol policy, the reported highlighted some potential developments that could benefit U.S. soybean crushers.

• Animal protein production is growing rapidly in the Black Sea region due to cheap and plentiful grain supplies. However, both Russia and Ukraine are importers of soymeal, as there is a mismatch between grain and oilseed meal production. Rabobank said it is possible that Russia could become a more significant importer of soymeal, which could help U.S. crushers. But both countries product sunflower, and Ukraine is a big exporter of rapeseed which could eventually reduce the region’s soymeal import needs.

• Rabobank believes that China may be importing over 20 million tonnes of corn within five years’ time to meet its growing demand of poultry and livestock feed. However, it is also possible, and quite economical, for China to import meat as a complement to corn imports. China is by far the world’s largest pork producer, and if it outsourced 2% of its pork production to the U.S., it would require an increase in U.S. output of 10%. Assuming hog production accounts for 25% of meal demand, U.S. soybean processing utilization would improve by 2.5%, a meaningful sum, Rabobank said.

• Another possible driver for improve soybean crushing margins in the U.S. is growth in biodiesel production. But without the $1-per-galllon biodiesel tax credit, which expires at the end of this year, the odds of significantly increased production in this industry are virtually nil.