The food chain
Food prices are bound to explode. Not only do we face a rise in population but we also are confronted by the need to improve our biofuel and ethanol feedstock (Unecsco – Institute for Water Education, ‘Water footprint of bio-energy and other primary energy carriers‘, 2008). No doubt the correlation between soft commodity indices, equity markets and major currencies has increased. The drivers are somewhat clear: increased speculation in the various futures markets. It is commonly known that agriculture consumes the most water across the globe. Technology and irrigation management have played vital roles for decades aiming to maximize yield. Horticultural projects such as maximizing yield of strawberry output in the UK are common practice for example.
In a nutshell it is possible to enhance agricultural output by enhancing yields, increase the acreage used, or by fastening the velocity of the harvesting cycle. Both Standard Chartered and Deutsche Bank have published investment reports that center on the implications of the food chain. “If the world population reaches 9.1bn by 2050, this will require a 70% increase in food production from 2005-2007 levels, including a 900m tonne (43%) increase in cereal production and a 200m (74%) increase in meat production” (Standard Chartered, ‘Special Report – Food’). The population growth implies that we add a country the size of the UK to the global population every year. The challenges continue along the food chain: “1 tonne of grain typically requires about 1’000 tonnes of water” (Standard Chartered, ‘Special Report – Food).
We observe that the need for water will rise dramatically with wealth. China and India are likely to demand higher levels of protein away from rice to chicken, pork and other meat products. To ramp up production, water will be a crucial element to satisfy the hunger of the emerging new middle class. McKinsey warns “[b]y 2030, under an average economic growth scenario and if no efficiency gains are assumed, global water requirements would grow from 4,500 billion m3 today (or 4.5 thousand cubic kilometers) to 6,900 billion m3.” The consultants continue saying that the shortfall is dramatic (see graphic).
The modern Silk Route
The Ukraine is perceived to be able to support the agricultural supply chain. It harbors significant amount of black soil, some 40% of the worlds total. However, the countries infrastructure is in desperate need for upgrading. Nonetheless, as an investment play participating in the Ukrainian agriculture may yield significant returns. Accessing the market will be difficult as will be the due diligence. We would expect that land title is difficult to secure and the rule of law needs to be assessed carefully.
While the weather appears to become an ever larger factor we can safely assume that parts of Africa, Asia and the Middle-East will be significantly affected should earth temperature rise as predicted by a number of scientists. What are the implications for these regions then? To maintain a constant agricultural yield, higher capex is likely to be an issue. To increase areable land significant upfront investment in sophisticated agriculture systems will be required.
The Food and Agricultural Organization (FAO) has recently published a new model to forecast yield and crop production. The Washington Post claimed that India is investing $4.2bn to lease land in Ethiopia supports Standard Chartered’s special report on Food which highlights (investment) opportunities for Africa. Land utilization across Africa is relatively low thus any increase in yield will be significant on a percentage and per capita basis since we are starting from a low base. Deutsche Bank takes a more holistic approach as it investigates both the demand and supply side in more detail. An interesting observation is that the “current available commodity inventories for corn is just 47 days” (adopted from USDA-NASS 2009). The report further notes that “[c]hanging precipation patterns and the shifts of regional weather to be hotter and drier in some regions while other regions become more moist will cause severe challenges to existing agricultural systems.”
We believe that investments in water and the food chain are closely related. Agriculture projects or funds that participate in the food value chain are intrinsically linked. Further, as the soft commodity future markets are well developed we expect to see a rising correlation between water markets and the food sector.
So how to play it? Fundamentally, Venture Capital investments in bio-fuels can give an indication where the opportunity is going. Since bio-fuel does compete for arable land this space should be watched carefully. Consequently, as the competition for alternative energy increases, we expect demand for biomass and ethanol to increase which will impact water and food related investments. We recently saw a few specialist funds that aim to capture the very niche opportunity that may exist in exploiting the food (and water) value chain, in particular with respect to Africa. A further opportunity that is worth highlighting here, is the potential for desalination projects (desal). Investments in the space have moved significantly and we expect further investment dollars being deployed in this area. The Global Water Intelligence group has published an overview on the state of Desal projects that is worth having a look at. A number of funds (mutual, hedge and vc) invest in ‘Blue Gold’ or water.
Ernst & Young conducted a few interviews with people who have a vested interested in the water space including water and technology company executives, venture capitalists and investors. Worth a read to get an idea what current thought leaders are up to.