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Trade War Disruption Threatens Already Vulnerable Soybean Producers & Supply Chain

Last week, China announced that it would slap 25% tariffs on 106 American products including soybeans, deemed by some to be the “crop of the century”. The tariffs, if carried out, could disrupt global soybean trade flows and change planting decisions at farms across North & South America.

Celebrated for its versatility, the soybean plant can be transformed into many products, be that tofu & cooking oil for the kitchen or biodiesel for agribusiness. It can also be crushed into soya meal and fed to chickens, pigs and fish which will quickly fatten up thanks to the plant’s superlative protein content. As incomes have risen in emerging Asia, so too has the consumption of animal protein, which has driven up demand for feedstock – especially in the form of soya meal – across global farms. While world demand for staples such as wheat has been rising by 1% a year, in line with population growth, soybean demand has been rising by 5% a year.

Accordingly, from the rural United States to the Brazilian interior and Argentine pampas, farmers have been racing to grow enough soybeans to meet this demand. Land used to harvest soybeans around the world has been expanding faster than for any other field crops and will reach 1bn hectares (10 million square kilometers) in a decade. Last year, soybean became the most widely sown crop in the United States, surpassing corn.

As with many commodities, China is the main driver of demand growth, which is why news of a 25% Chinese tariff on American soybeans sent tremors through the market last week. China imports two-thirds of all soybeans traded globally, and accounts for nearly 60% of American soybean exports. In 2017, that amounted to 32 million metric tons of U.S. soybeans sent to China and $12.4 billion in revenues. China purchases eight times more from the U.S. than Mexico, the second biggest buyer. This is what’s at stake for U.S. producers and exporters who are concerned that the tariffs will give Latin American soybeans a competitive advantage over U.S. ones.

As it stands, the U.S. soybean market is quite vulnerable. Bumper harvests have resulted in several years of low crop prices. Now, tariffs could lead to some market share loss if Chinese buyers turn to other suppliers. Under such conditions, U.S. stockpiles could surge, putting further downward pressure on prices. This new risk factor already has some growers thinking they should scale back whatever planting activity and investment in equipment they had planned for the next harvest season. With this ripple effect, the tariffs would also have a negative impact on suppliers of agricultural equipment and fertilizers.

While several industry trade groups are warning that the escalating trade battle will have a “devastating effect” on American soybean farmers, processors and exporters, some analysts question whether China can really afford to impose the duties. The U.S. is the second largest exporter in the world, after Brazil, and China sources 40% of its soybean imports from America. Without U.S. supplies, there may not be enough soybeans in the world to meet Chinese demand. Moreover, import tariffs will raise input prices for China’s livestock industry and soy processing companies, ultimately leading to higher prices for Chinese consumers.

Paradoxically, the recent trade tensions have triggered some large purchases of U.S. soybeans by European buyers, one of the first indications that the tariffs could disrupt global commodity trade flows in unexpected ways. Last week, 458 thousand tons of U.S. soybeans were allegedly sold to processors in the European Union. That would be the largest one-off sale to the bloc in more than 15 years. Traders attribute this activity to the fact that, accelerated buying of Brazilian beans by Chinese importers who want to avoid U.S. tariffs has pushed Brazilian soybean prices to historic highs, making U.S. exports cheaper by comparison for non-Chinese buyers. Until that reverses, we could see the U.S. selling to destinations (and in volumes) not ordinarily seen.

MRP will continue to follow developments relating to the soybean tariffs. China has stated that it would impose the planned tariffs only when the US imposes its own set, which means there is still room for negotiation and the tariffs may not materialize. If there is no resolution, however, a trade war could have very negative consequences for the U.S. agricultural sector, just as the Smoot-Hawley Tariff Act did almost a century ago. Particularly because China’s trade retaliation would arrive at a time when US farm incomes are already shrinking, and forecast to decline 7% to $60 billion in 2018. That would bring net farm income to the lowest point since 2006 just as borrowing costs are rising.

Investors who want to gain some long or short exposure to the unfolding disruption can do so via ETFs such as the Soybean ETF (SOYB), the DB Agriculture ETF (DBA), the Agribusiness ETF (MOO), or the Fertilizers & Potash ETF (SOIL).

Soybeans (SOYB) vs Basket of Agricultural Commodities (DBA) vs Agribusiness (MOO) Fertilizers (SOIL) vs S&P 500 (SPY) : 2-YEAR CHART & YTD CHART

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