Is the Black Sea a dark cloud over Australia’s grains industry?

Prof Ross Kingwell
Australian Export Grains innovation Centre (AEGIC)

Recent research reports from AEGIC examine the grains industry in Ukraine and Russia; main players in what is known as the Black Sea region. The findings of the reports are sobering reading for Australia’s grains industry. The reports highlight that the Black Sea region is:

  • blessed with fertile soils, cheap labour and far greater currency depreciation than has occurred in Australia
  • increasingly accessing modern machinery and better crop genetics
  • achieving higher rates of yield growth than occurs in Australia
  • benefiting from significant investment and upgrade of its grain supply chain infrastructure, unlike the situation in some grain-growing regions in Australia
  • greatly increasing its grain production and grain exports, taking market share away from Australia in several markets
  • generating healthy profits in most parts of its supply chain, farm to ship, even at current low prices for many grains
  • extending the export reach of its grain due to its low cost of production and current low cost of international sea freight
  • unlikely to be unduly disadvantaged by projected climate change, unlike some grain-growing regions in Australia.

Against such a set of competitive strengths, what can the Australian grains industry do? Is carrying on as usual, good enough? Is the strength of the Black Sea a temporary phenomenon that will quickly pass? Is a Hanrahan call that ‘We’ll all be rooned!’ – in this case by the Black Sea – only a simple and unhelpful exaggeration?

Some of these questions can be answered with confidence. Others have answers in our own hands and thus have less certain outcomes, if only because the Australian grains industry is not renowned for acting quickly with unity of purpose.

We can be confident, for example, that Russia’s rise in 2015/16 to become the world’s greatest exporter of wheat (25.2 mmt) is unlikely to be a one-off. Consultation with Russian grain analysts indicates that it is highly likely that by the early 2020s Russian grain production will exceed 115 mmt and Russia will remain a principal global exporter of wheat.

The increase in Russian grain production is unlikely to come from increased plantings of grain in new areas, despite Russia having access to potentially large areas of arable land. Its increased production to-date has mostly come from higher yields. In the future, increased production will continue to come from higher yields but greater intensification of cropping in traditional grain-growing regions is also likely. These regions are well-served by transport and port terminal infrastructure and have supply chain costs less than those in Australia (Table 1). By contrast, Australia’s growth in grain production since the early 1990s has come from a combination of yield increases and greater areas of cropping, as farming systems altered to favour crops. However, future increases in grain areas in Australia are unlikely as are marked increases in grain yields. Hence the Black Sea region and Australia face different likely production trajectories over the next few decades.

Australian farmers already are well practised in using modern technologies, new varieties and professional advice for crop management, so highly inefficient methods of grain production are rare. By contrast in the Black Sea region many farmers, but not large commercial agroholdings, are yet to embrace leading technologies, superior varieties or best practice crop management; so they have untapped improvements in yields and farm profitability. Solely by improving the efficiency of their farm operations and embracing new technologies, greater volumes and higher profits are likely to be achieved by many small and moderately-sized Black Sea grain producers.

As Black Sea farmers, including the large agroholdings, further improve their grain production, and as their export grain volumes increase then utilisation of supply chain infrastructure will increase, further underpinning the returns to those assets. In turn, this will encourage additional investments by governments, grain logistic businesses and grain marketers in grain supply chain infrastructure: on-farm and upcountry grain storage, better roads and railways and more port terminals.

Black Sea countries, relative to Australia, have experienced substantial depreciations of their currencies against the United States (US) dollar resulting in those countries enjoying large cost advantages as shown in Table 1.

Table 1: Export wheat supply chain costs in 2015/16 (Australian dollars).

  Russia Australia Ukraine Canada
Cost (A$/t) % supply chain cost Cost (A$/t) % supply chain cost Cost (A$/t) % supply chain cost Cost (A$/t) % supply chain cost
Cartage to bin
$3.46  6% $7.80 9% $4 8% $11.4 13%
Storage $5.13 9% $9.00 11% $3  5%  $17.7 21%
Upcountry handling $9.21 17% $18.40 22% $8  14%  $16.2 19%
Transport to port  $15.52 28% $26.70 32% $13 23% $49.8 59%
Handling at port
$22.18 40% $13.10 15% $23 40% $10.7 13%
Ship at port
$0.18 0% $6.80 8% $1 2%
$4.0 5%
Levies $0.10  0% $2.80 3% $5 9% $3.2 4%
Supply chain cost $55.79 32% $84.60 28% $57 30% $113.0  37%
Production cost
$119.96 
68% 
$216.15 72% $133 70%
$191.0 63%
Total cost ($/t)  $175.74   $300.75    $190   $304.0    
Russia and Ukraine, relative to Australia, have substantially lower farm costs of grain production, and have less costly supply chains. Hence, these Black Sea countries have twin advantages; lower farm costs and cheaper costs of moving grain from farm down and onto ships. Overall, Russia and Ukraine have a A$125 and A$110 respectively price advantage over Australian wheat in 2015/16. Although these estimates are averages and best viewed as indicators of relative advantage, nonetheless they reveal the current large advantage available to Black Sea grain. Hence, a likely scenario is that Black Sea grain exports will increase and although Australian grain production will also increase, there will almost certainly be an erosion of Australia’s export market share and Australia will slip down the grain export rankings, especially for wheat.

Should we be concerned? Is the business of grain export like gold medals at the Olympics where our position on the league table of grain exporters affects national pride? To be sure, export earnings are affected – but national pride? Probably not, if only because grain export does not feature high in the consciousness of most Australians. Of more comfort to grain producers in Australia is that Australia already possesses some key advantages that allow it to more easily accommodate the competition emanating from the Black Sea.

Firstly, Australia possesses an enviable research and development (R&D) and crop breeding funding system that ensures Australian grain producers invest in and receive a steady stream of productivity and profitability-enhancing innovations and crop varieties. By contrast, wheat variety improvement and grains R&D in the Black Sea is less well-funded, less organised and less focused on efficient outcomes. Governments in the Black Sea and in Australia are struggling with the state of their finances which limits their investment in agricultural R&D and support services. However, the grains industry in Australia has a system of funding its agricultural R&D and provision of plant varieties which is a source of competitive strategic advantage for Australian grain producers. If state and federal governments in Australia ever recover their financial rectitude then some socially profitable investments in agricultural R&D and supply chain infrastructure are possible which will only add to Australia’s competitive strengths in grain production.

Secondly, unlike many grain producers in the Black sea region, most Australian grain growers are not forced sellers of their grain at harvest. Unlike their Black Sea counterparts, Australian grain farmers have access to effective grain storage, complemented by a range of price risk management options so they can be more strategic about how they sell their grain. The quality and availability of grain storage and grain selling options in Australia is a further competitive advantage.

Thirdly, due to the magnitude of grain demand in Asia, Australia remains geographically well-placed to benefit from this demand growth. Such is the size of this demand growth that Australian and Black Sea grain can simultaneously enter Asian markets. Admittedly, Australia’s market share in price-conscious market segments will diminish, but as long as Australian grain maintains its quality, consistency and relative affordability then Australian grain will retain a role in other less price-sensitive market segments. Hence, Australian grain will rarely be the cheapest origin of grain, in spite of its proximity to Asia; but provided it remains responsive to the quality preferences of consumers in higher-paying market segments then there will be continuing sales opportunities in Asia.

Fortunately for Australia there is currently minimal overlap among Australia’s and Russia’s top-20 wheat customers. However, Russia is gradually exporting more wheat into Australia’s key South East Asian (SEA) markets. Russia has identified Morocco, Indonesia, the Philippines, South Korea, China and Algeria as important sources of future demand. Aside from Morocco, all of these markets would be considered as key Australian markets of ongoing or future importance. At the lower price end of the market, Russian wheat has been slowly gaining acceptance as filler wheat in various SEA products. Russian wheat’s baking properties make it acceptable for inclusion in bread flours, although Russian wheat typically lacks the extensibility needed for high-quality noodles.

Freight differentials, along with undemanding quality requirements, make Black Sea wheat a dominant force in Middle East and North Africa (MENA) markets. However, with its need for more extensible wheat and balanced dough properties, the SEA market supports a premium for Australian wheat. However, this advantage is losing traction, resulting in Australian wheat facing price and inclusion rate pressure.

The Asian baked goods sector is expected to grow as some Asian diets Westernise, but traditional rice and noodle-centric diets will still often dominate. Nonetheless, because wheat cannot be easily grown in some Asian countries, the Westernisation of their diets, combined with their growing populations, will mean that some countries will increasingly rely on wheat imports. Australia is likely to share in the supply of wheat to some of these Asian countries. Australia offers geographical proximity, reliable grain storage, ease of execution of grain contracts, and a useful range of wheat qualities.

Against the rising tide of Black Sea wheat flowing in the direction of Australia’s export markets, differentiation can act as a defensive and offensive investment. To support this strategy of differentiation wheat breeding in Australia can develop wheat types attractive to end-users and Australian wheat-growers. This requires identifying the traits of value that can feature in Australian wheat varieties. Other activities, such as classification changes, new segregations, more efficient supply chains and industry-good marketing functions, however, are essential competitive complementary activities. To deliver these complementary changes requires organisational coordination and innovation in the Australian grains industry.

Australia needs to maintain its current efforts to undertake R&D that drives down the unit cost of grain production in Australia. Also, the upgrade and rationalisation of its grain supply chains needs to continue to further reduce their overall unit costs, but Australia also needs to address value chain failure in its grains industry. Other competitors (Canada and the US) have for decades used organisational coordination and innovation as a tool for lessening value chain failure. This failure occurs where industry participants underinvest in end-user training, market promotion, information-sharing and product innovation. Fears of free-riding, inability to fully recoup an appropriate share of generated benefits and blinkered self-interest contribute to chain failure that weakens and lessens the potential value of Australia’s grain exports. Yet Canada and the US have many examples of organisational and policy innovation that serve to protect and enhance the international competitiveness of their grains industries.

Australia may not be able to match the price competition from the Black Sea region but it certainly could, if willing, partly match the organisational innovation, coordination and competiveness that characterises North American grains. A status quo response from Australia’s grains industry to the competitive challenge of the Black Sea region is insufficient. Australia needs to maintain its currently useful activity but also needs to embrace further beneficial change.

For hard copies of the AEGIC reports please email admin@aegic.org.au

Image:  AEGIC