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Out-competed by Ukraine

Massive Ukrainian farms are producing grain and getting it into export position for $100/t less than in Canada

In the last issue of Country Guide, I wrote of my travels in China, and of how that trip made me question the true competitiveness of Canadian agriculture. Unfortunately, a new Australian study validates many of my concerns.

“Ukraine: An emerging challenge for Australian wheat exports” is the third study from the Australian Export Grains Innovation Centre (AEGIC), a not-for-profit public company created by the state of Western Australia and the Australian Grains Research and Development Corporation. Its goal is increase the value and competitiveness of Australian grains internationally.

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AEGIC started with a study of the Australian grain value chain and is now undertaking similar studies of its competitors.

In 2015 AEGIC released its study of Western Canada’s grain export system. Even despite Western Australia’s lower farm productivity and lower infrastructure efficiency, the study found, farmers there had a competitive advantage over us in delivering grains into the critical Asia market.

On top of that, the report identified strategies Australia could use to actually increase its competitive advantage over Canada (its major competitor in the world grain markets) by simply copying Canadian systems and processes that are working well.

That’s why AEGIC didn’t see Canada as a major threat. But Ukraine is a different matter altogether.

One troubling paragraph summarizes the AEGIC view: “Ukrainian wheat exports are currently a modest threat to Australia’s wheat export industry in its key markets. BUT… the potential threat is large, albeit uncertain for many reasons.”

By extension, Ukraine could pose an even greater threat to Canada’s farms.

Ukraine’s advantages

AEGIC identifies a number of factors which give Ukraine a competitive advantage. Probably the biggest is soil quality.

Ukraine has 32 million hectares of arable land, much of it humus-rich chernozem soil. In fact, one-third of the world’s top-quality chernozem soil is in Ukraine. Their inherent productivity has enabled Ukraine to already become the world’s third-largest exporter of corn and barley and sixth-largest exporter of wheat as of 2014. Ukraine is also the world’s leading producer of sunflower seeds and No. 1 exporter of sunflower oil.

Figure3_agricultural-competitive-advantage

Ukraine has a relatively moderate and favourable climate for grain production. Furthermore, climate change projections suggest future conditions will be conducive to even greater production.

In addition to these natural advantages, there are societal and business factors which also make Ukrainian agriculture more competitive.

Agriculture is an extremely important industry to the Ukrainian economy. Agriculture was responsible for 9.3 per cent of the GDP, 17 per cent of employment and 26 per cent of exports in 2012, which means agriculture is more important socially and economically in Ukraine than in either Australia or Canada. As a result, the Ukrainian government is more responsive to agricultural needs and concerns.

Among the big changes Ukrainian governments have made to increase agricultural production, they now allow private ownership of farmland, something that was not permitted when Ukraine was part of the Soviet Union. Today 74 per cent of farmland has been allocated to private ownership.

However, land ownership reform is still a work in progress. The distribution of land to the rural population resulted in most people owning only one to four hectares of farmland, which they are still restricted from selling. They are not restricted from leasing the land, however, and the government mandates that owners receive a rent of US$50-US$70/ha. While low by North American land rental rates, this income is significant for Ukrainians when you consider the per capita GDP in Ukraine is only US$3,100. Meanwhile, of course, these relatively low lease rates lessen grain production costs for Ukrainian farmers.

The privatization of land ownership coupled with the adoption of free market economics has resulted in a phenomenon called the corporatization of farming. One-third of the farmland in Ukraine is now farmed by large corporate enterprises known as agroholdings — a rate that far exceeds the corporatization of Canada or Australia.

Table13_export-grain-supply-chain-costs

Big, bigger, biggest

Do its huge corporate farms make Ukraine more competitive?

Much of the AEGIC report details the impressive competitive advantages these massive farming enterprises offer:

“They (agroholdings) enjoy the combination of relatively unconstrained access to modern machinery, economies of scale, a devalued local currency, a low-cost production base and the ability to bide their time selling without the pressure of cash-flow constraints,” the report says.

Table5_average-annual-rates-of-growth

As well, it says, “Larger entities, such as agroholdings, are better able to tap into foreign sources of credit, acquire USD-priced inputs and obtain political patronage, if needed.”

The report states that agroholdings also have easy access to abundant cheap labour and foreign capital.

Many of the agroholdings not only farm, but now control entire supply chains, including production or importation of crop inputs and the value-adding of the farm production, either through exporting the crops they have grown via their own facilities or by milling them at their own processing facilities.

Most alarming, however, is that while these Goliaths have economy-of-scale advantages in terms of production costs, the real drivers of their success are their access to credit and their ability to add value through vertical integration.

Nor should we overlook the competitive advantage that its farmers get from Ukraine’s devalued currency. While Canadian farmers know the positive impact on grain sales of the fall of our dollar from near par to the low 70s cent mark against the U.S. dollar, the value of the Ukrainian hryvnia has decreased from 14 per cent of the U.S. dollar to three per cent in the last year alone, cutting its value by three-quarters.

Table3_producer-support-estimates

Ukraine’s disadvantages

Fortunately for Australian and Canadian farmers, there are some major hurdles preventing Ukraine from capitalizing on these advantages. They include:

  • Geopolitical risks. The continuing conflict with Russia and general unrest in eastern Europe continues to impact agriculture.
  • Endemic corruption. Bribery is common.
  • The comparatively weak rule of law.
  • Lack of infrastructure and poor road and rail system. Delivery lineups at terminals at harvest time can stretch 20 kms.
  • Arcane landownership rules. Large agroholdings may be leasing from more than 1,000 land owners.
  • Economic instability, including high interest rates, high inflation.
  • Difficulties repatriating capital.
  • Lack of investment in agriculture.
  • Low-quality wheat.

A major disadvantage identified in the report was the low share of the world price that Ukrainian farmers receive: “From 2009 to 2012, the average farm gate price for wheat in Ukraine averaged only 68 per cent of the FOB price. By comparison, farmers in the U.S. and Canada received 90 per cent and 79 per cent of their respective FOB prices over the same period, with Australian growers receiving between 80 and 90 per cent of FOB values.” Unfortunately, as the numbers show, while getting a bigger share of the value of grain than Ukrainian farmers, Canadian farmers were receiving a significantly lower share of FOB prices compared to the U.S. and Australia.

What we need to do

While there are real problems in Ukraine, Aegic they are fixable with funding, a supportive government, and time.

In the meantime, the bottom line is that Ukrainian wheat is already very competitive. Growing a tonne of grain and getting it into shipping position costs C$100 less per tonne in Ukraine than in Australia.

Based on AEGIC’s study of Canada’s grain system, which puts our costs at $20 higher above Australia’s, Ukraine’s potential advantages over Canada are staggering.

The threat is enhanced by the fact that buyers are increasingly willing to accept Ukrainian grains. Before 2000, buyers required a US$30 discount before purchasing similar quality Ukrainian wheat. Today that discount has dropped under US$15.

The report’s key recommendations are below. A full copy of the report can be downloaded here as a PDF from the AEGIC website.


Verbatim from AEGIC: key recommendations and Ukraine summary

1. Collate, monitor and analyze developments in Ukraine (and surrounding nations) and inform the Australian grains industry of the implications. Forewarned is forearmed. Accurate and timely information about emerging competitors increases the opportunity for Australia’s grains industry to make strategic decisions based on sound analysis.

2. Investigate why (or whether) Australian wheat is preferred in our major markets and why Ukrainian wheat is or isn’t preferred in those same markets. If we know what customers value we can better serve their needs.

3. Convey market and competitor information to those Australian stakeholders whose responses can increase returns for Australian wheat growers. Australian grain growers need to benefit from better serving their customers and reacting to competition.

4. Use our ‘window of opportunity’ carefully. It’s a tide (not a tidal wave) of Black Sea wheat entering some of our major markets. The Australian grains industry has time to plan and co-ordinate an effective response.

Our aim is to bring much-needed nuance to discussions regarding the impacts of Black Sea grain production on Australian wheat exports. Currently the discussion includes views ranging from those who see the loss of wheat export markets being a fait accompli, to those who feel that ‘business as usual’ will suffice and the supposed threats are grossly overstated. Not unexpectedly, reality lies somewhere between.

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Gerald Pilger

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