Can Brazil fill the export void?

by Arvin Donley
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Many analysts believe that in the years to come corn exports from the United States, currently the top producer and exporter of that grain commodity, will steadily diminish while demand for corn in China will continue to increase.

In this scenario, Brazil has been singled out as a strong candidate to fill the gap by providing increasing amounts of corn to the international market. But a recent report by Rabobank International notes that the fast-paced growth of Brazil’s meat industry may hinder such prospects.

Despite Brazil’s reputation as an agricultural powerhouse with large land area availability and vast farmer know-how, Rabobank projects that by 2015 Brazil’s corn supply surplus could drop to as low as 2 million tonnes.

“Strong incentives must be in place for Brazilian farmers to boost corn production to levels capable of enabling growth in exports,” Rabobank said. “Such incentives, which are expected to come forth as increased prices, must be sufficient to compensate for land reallocation, higher logistical costs and investments. Our estimation points to an acreage price of $6.45 per bushel in Paranagua to spur corn production in Brazil at rates above the historical average.”

Accounting for 6.7% of global corn production with an annual output of 57.5 million tonnes in 2010-11, Brazil is the third largest corn producer in the world. Despite the enormous tonnage, the country lags behind the U.S. and China, which account for 38.8% and 20.6% of global production, respectively. Nevertheless, the Brazilian output has traditionally been more than enough to provide for its own meat industry, which accounts for nearly 70% of the country’s total corn demand.

Rabobank said the ties between the Brazilian domestic corn and meat markets have traditionally been very strong amidst a constant lack of incentives for exportation of the product. Therefore, Rabobank said it is reasonable to expect that if the international community aspires for Brazil to increase its international corn supply, the formation of incentives (price levels), beyond those traditionally provided by domestic demand, would be required to promote a shift toward an export-oriented mode while compensating for land reallocation costs (shifting production closer to the ports), higher logistical costs (freight and storage facilities), and the investments required for expansion in planted area and increased yields.

In the report, Rabobank projected corn demand from the Brazilian meat industry over the next five years.

Poultry

Boosted by rapidly growing domestic consumption and soaring exports, the Brazilian poultry sector achieved a 6% compound annual growth rate (CAGR) between 2005 and 2011. However, Rabobank believes that the domestic demand growth will decelerate over the next few years due to the current high per capita consumption rate and low income-elasticity for this type of meat. Therefore, Rabobank projects a 3% CAGR over the next five years.

On the international side, given the growing competition with North America, and to a lesser extent, Argentina, as well as a strong likelihood of slow international economic recovery, Rabobank assumes Brazilian poultry exports will ease over the next five years, presenting an average annual growth rate close to 4%.

Rabobank projects the incremental demand for corn coming from the poultry sector at 3.3 million tonnes by 2015.

Pork

With an average annual growth rate of 3.2% over the past five years, the Brazilian pork sector has also been displaying strong growth that outpaces most other major pork-producing countries.

Rabobank projects domestic pork demand will grow at an annual rate of 2% in the medium term as income growth of the middle class in Brazil should continue to rise. On the export side, Rabobank projects an annual export growth rate of 3% through 2015.

“Thus, the expectations for domestic consumption and exports lead us to project a growth of the Brazilian pork supply of 2% per year for the next few years,” Rabobank said, adding that the incremental consumption increase for corn will be 1.6 million tonnes through 2015.

Beef

For the coming years, Rabobank’s expectation is that the number of cattle finished through the semi-confinement system will increase, stimulated by the stricter environmental regulations on land utilization and fiercer competition for land from other agricultural commodities. With additional investments being made by packing companies to secure supply, the number of cattle being finished in feedlots should increase as well.

Rabobank assumes a basic composition of feed in which animals in self-confinement receive 3.4 kilograms per of corn per day during 100 days of the year and that animals in feedlots will get 4.5 kilograms of corn per day throughout the same period. Rabobank forecasts an average growth rate over the next five years for animals in semi-confinement and feedlots of 6% and 5%, respectively.

The additional demand for corn from this group will increase 770,000 tonnes over the next five years, Rabobank projects.

Dairy

Feed demand from the Brazilian dairy sector has been increasing at an annual rate of 6% over the past seven years.

Rabobank said the bright prospects for dairy consumption — stimulated by growing incomes of consumers — combined with the search for higher efficiency to remain profitable, suggests that demand for feed in the dairy segment will keep its fast pace of growth for the foreseeable future.

Considering that demand for feed from the dairy sector will continue increasing at an annual rate of 6%, and assuming that corn makes up 27% of total dairy feed composition, the incremental demand for corn form this sector would be 190,000 tonnes over the next five years.

Layer hens

Projections from the Brazil Egg Institute point to a likely increase in Brazilian per capita egg consumption to 208 eggs per year by 2016, which when combined with the projected population growth implies an overall rise to 42 billion eggs, or a CAGR of 7% for the next five years.

“Being a bit more conservative and assuming a CAGR of 3% for the coming years and taking into account that each layer hen produces 300 eggs per year, we could expect that the average number of layer hens will have to grow 16.5 million heads,” Rabobank said. “If we also consider that each hen receives 100 grams of feed per day on average, and corn accounts for 60% of total feed contents, the additional corn demand for this sector over the next five years will total about 360,000 tonnes.”

Forecasting production

Given the pressures on the Brazilian corn commodity market, additional corn demand coming exclusively from feed production growth is projected at 6.3 million tonnes by 2015, totaling an annual corn for feed usage of 47 million tonnes — a huge 15.5% increase from the 40.7 million tonnes destined for such use in 2010-11.

Considering the average Brazilian corn yield of 3,950 kilograms per hectare over the past five years, this increase implies an additional 1.6 million hectares of planted corn area, an 11.7% increase from the 13.7 million hectares of corn planted in 2010-11, adding up to 15.3 million hectares (or 61 million tonnes) in 2015-16, if demand for all other uses is kept unaltered at current levels.

Moreover, Rabobank said if it is assumed that other domestic corn uses, such as industrial and human consumption, sustain the growth rate of the last five years, an additional
1 million tonnes or 250,000 hectares of planted corn area will be needed by 2015.

“All things considered, our projected demand for corn in Brazil for 2015 nears the 54-million-tonne mark or a corn production area of 15.6 million hectares, representing a 14% increase from the 2010-11 total planted area or a 2.7% CAGR,” Rabobank said. “If we consider that corn planted area will keep growing at a CAGR of 2.3% — the same rate as over the past five years — the supply surplus would slightly decrease over the coming years, averaging 7 million tonnes. This means the competition between the domestic and export market is set to become fiercer in the near future.”

Rabobank said Brazil’s ability to match this conservative projected growth in corn demand becomes much more difficult if a longer time period is used to calculate the average CAGR in planted corn area. Over the last decade, the CAGR averaged 0.9%. Such an assumption could imply a reduction of the Brazilian corn supply surplus to 2 million tonnes.

According to Organization of Economic Co-operation and Development projections, even if an increase in productivity is factored in, Brazil will still face strong difficulties in keeping up with demand as yields are only expected to grow 1.6% annually over the next 10 years. In this sense, Brazil will have to present corn production growth above the historical average in order to satisfy all of the market’s needs. However, Rabobank said part of the rise in domestic corn use is likely to be for meat production, a fraction of which will be exported, which in turn would decrease the need for Brazilian corn exports as countries would import meat instead.

“Our estimate indicates that 1.5 million tonnes out of the total growth in corn use will be driven by meat exports,” Rabobank said.

Defining the appropriate incentives

The report noted that unless strong incentives for corn farmers occur, Brazil is unlikely to sustain large exportable surpluses. Estimating price levels for the commodity is a difficult task as corn prices are affected by a wide range of elements and variables. Nonetheless, there are some key elements that must be taken into consideration, according to Rabobank.

Because of its tropical climates, Brazil is one of the few countries where more than one corn harvest per year is a realistic possibility. The country’s corn production has been characterized by its division into two planting seasons: 1) the first harvest or summer crop, which starts by the end of August in the South, extends from mid-October to late-November in other regions, and takes place during the rainy season; 2) the second harvest or winter crop, which is planted mostly in the Centre/West and South during the dry winter season from February to March, usually following the soybean harvest.

While the winter corn crop is becoming an increasingly successful production mode in Brazil, Rabobank said its viability is arguably the most decisive factor underlying a conciliatory expansion of the corn crop in terms of land allocation with other commodities in the country. Regions where the practice is unattainable are only able to realize an increase in production through yield increases or area expansion.

Since the winter corn crop is grown during the dry season, it is frequently subject to adverse weather such as inadequate rainfall and high temperatures, which can be extremely damaging to yields. Therefore, inappropriate climate drastically reduces the areas in Brazil where double-cropping is possible. Still, Mato Grosso and Parana, traditionally the two most important corn-producing states in Brazil, accounting for roughly one-third of the total corn production in the country, are very suitable for the practice.

As these two states have historically been the most responsive to incentives for increased corn production, understanding the factors that direct their farmland allocation is crucial for projecting the minimum levels of incentives that would accelerate the expansion of the corn crop in Brazil in the short to mid-term, Rabobank said.

In the Brazilian Centre/West, as represented by the state of Mato Grosso, the summer corn acreage has slowly increased throughout the past decade. The reason, Rabobank said, is made evident by the lower historical margins for corn in comparison with soybean production, a key component behind farmers’ decisions about land allocation, which led farmers to adopt the corn crop only as a rotational summer crop cultivated with the use of very low technology and frequently left on the field because harvesting is not profitable.

“The region still has vast potential for double-cropping, as it lacks alternatives for other winter crops,” Rabobank said. “However, prices have to be right for farmers, not just above marginal costs but also high enough to make the activity financially interesting (profits higher than capital cost).”

The report noted that the southern region of Brazil also features strong second crop adoption rates. In fact, the 2011-12 winter corn production may be almost equal to the summer corn production in the region. The southern region is much closer to the ports, greatly reducing logistical costs in comparison to the Centre/West region. However, the winter crop in the South faces competition from wheat and other coarse winter grains. Thus, corn production margins must be higher to boost growth.

“Regarding the summer crop in the South, as in the case of the Centre/West, corn has to compete almost exclusively with soybeans,” Rabobank said. “In this sense, further incremental increases in corn production would have to be driven by higher margins obtained from corn production than from soybean production.”

In terms of prices, using producers’ historical average EBITDA margins for soybean production over the last 10 years, Rabobank estimates that, given the current costs for corn production, prices would have to run around 27 Brazilian reals (BRL) per 60 kilogram bag (or $6.35 per bushel, taking into account an average exchange rate of 1.80 per U.S. dollar) at the Port of Paranagua for corn to be competitive against soybeans as a summer crop and spur significant corn area expansion.

Final Analysis

Rabobank concludes that reaching the necessary increases in corn production to become a more prominent player in the international market over the next few years will be a difficult task for Brazilian farmers, the main reasons being the quickly increasing domestic demand for meat production and ever higher competition for land area by many alternative crops.

“It can be concluded that the price levels that would accelerate the expansion of the corn crop in Brazil must be well above the marginal cost of production and must reflect the particular circumstances of each producing region,” Rabobank said. “Still, it seems clear that incentives are necessary to stimulate the above average growth rates and higher investments in technology which would be required to increase exportable surpluses.

“It must be restated that this is a very simplistic estimation of the price incentives needed to promote faster corn expansion in Brazil, and is based on the assumption of growth in production in only the traditional production regions. It also ignores other sources of growth, such as pasture conversion into corn area, as it was deemed to be only of significant impact on a longer time horizon. However, the expansion of the corn crop is unquestionably highly dependent upon price incentives in the regions where its production is viable. The world needs to understand that incremental corn production from Brazil is only likely to come to fruition if the incentives exist.”

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