Canadian Agriculture and Agri-Food Outlook for 2014

Canadian Agriculture and Agri-Food Outlook for 2014 Kevin Grier, Senior Market Analyst, George Morris Centre R. Allan Mussell, Ph.D., Senior Research Associate, George Morris Centre December 2013 Introduction We may look back on 2013 as being a very different year compared with 2012. US crop production appears to have rebounded impressively from the drought of 2012, and western Canada has experienced a record harvest. These factors have driven grain prices down from 2012 s lofty levels, and partly as a result, livestock profitability has recovered. Thus we look to 2014 with a different view compared with last year s outlook at this time of year. Highlights Western Canada saw very large grain/oilseed crops, Eastern Canada had a similar crop to 2012; in both cases, prices significantly down in 2013. 2014 pricing outlook similar to 2013 new crop prices Pork and beef segments look to 2014 with tight supplies, strong demand and a higher price outlook. Reduced feed costs support an improved profitability outlook, with challenges in competition for feeder cattle Renewed stability seen in supply managed segments in 2014, bracketed by ongoing domestic and trade policy challenges Consolidation in input supply markets to serve larger customers and reduce operating costs. The outlook for feed and fertilizer is for stable pricing in 2014 Grains and Oilseeds Western Grains and Oilseeds Western Canadian grains and oilseeds will see an exceptionally large crop in 2013, combined with somewhat different acreage trends than have been seen in recent years. This year s wheat acreage was up strongly, with western Canadian wheat acreage at its highest level since 2001 at about 24 million acres. At the same time canola acreage was down to just under 19 million acres, counter to its long-run expansionary trend. According to the Statistics Canada Field Crop update released in early October, wheat yields in western Canada are estimated at a record 48 bushels per acre. Projected canola yields are almost 37 bushels per acre. Barley and oat yields are expected to set yield records at 68 bushels per acre, and 83 bushels per acre, respectively. The large western Canadian crops, in combination with strong recovery in US corn production from last year s drought, have dampened grain prices. This was expected with a large crop following the drought-influenced 2012 US harvest and short stocks. However, OECD forecasts for wheat, oilseeds, and coarse grain foresee prices stabilizing at levels that are high compared with history. New crop 2014 Minneapolis wheat futures are consistent with this, currently ranging over $US 7.60/bushel, compared with new current crop 2013 futures at about $US 7.40/bushel.

OECD Crop Price Outlook USD/ t 700 600 500 400 300 200 100 0 2002 2007 2012 2017 2022 Wheat Oilseeds Rice Coarse Raw Sugar Grains Source: OECD-FAO Agricultural Outlook 2013-2022 Eastern Grains and Oilseeds The 2013 crop year sees a rebound of the US corn and soybean crops in the wake of the short 2012 crop, with a corresponding decrease in prices. According the USDA, 2013 US corn acreage and soybean acreage were at essentially the same levels they were in 2012. However there was a big difference in yield, especially for corn. The 2013 US average corn yield is estimated at 155 bushels per acre compared to 123 bushels per acre last year; 2013 US average soybean yields are estimated nearly 2 bushels per acre over the 2012 average yield. Canadian corn yields were stable in the 2012 droughtplagued crop, and this is projected to occur again with the 2013 crop. Statistics Canada projects a 2013 Ontario average corn yield of about 154 bushels/acre, compared with an average yield of 153 bushels/acre in 2012, while 2013 Ontario soybean yields are projected at 43 bushels/ acre compared to 48 bushels/acre last year. Corn and soybean prices are well off the 2012 peaks. New crop 2013 futures prices range just over $US 4.30/ bushel for corn and $US 12.60/bushel for soybeans. Consistent with the OECD outlook for stability at relatively strong price levels, new crop 2014 corn futures currently range above $US 4.75/bushel. In the immediate term, US exports and US corn utilization will influence corn pricing. New crop 2014 soybean futures prices range around $US 11.60, reflecting a reduced tightness of supply of soybeans compared with corn. Livestock and Poultry Last year the drought, which severely impacted the US corn and soybean crop, was the overriding factor in the US and Canadian livestock and poultry industries. Feed, particularly corn as the most important feed ingredient, amounts to 50-75% of livestock production costs. The impact of the 2012 drought therefore, was exceptionally damaging to livestock and poultry margins in the latter half of the year. In 2013, the margin prospects due to feed costs were almost the mirror opposite of 2012. The 2013 year started with very high feed costs due to the 2012 drought. As summer progressed into early fall it became apparent that the US crop would be near record volumes. From that point, corn and feed prices dropped dramatically, significantly boosting livestock producers bottom lines. The main take-away here is that feed costs are of course always important, but in light of 2012, the reversal of 2013 sets a positive tone for at least the first half of 2014. Hogs and Pork Canadian hog producers entered 2013 on a severely negative note given the impact of the drought on feed costs. After about four years of losses from 2006 to mid-2010, producer balance sheets were in the process of recovery and producers entered 2012 with positive prospects. The 2012 drought more than wiped out any equity recoveries of 2011, and once again resulted in producers leaving the industry. High profile financial failures at Big Sky and Puratone on the Prairies were the most visible examples. As 2013 progressed, however, hog producers began to see margin recovery despite ongoing high feed costs. Strong domestic and export demand for pork resulted in second and third quarter hog price recovery. Furthermore, declining grain costs in the third quarter ensured very positive margins going into the fourth quarter of 2013. In fact, producer margins remain positive in the 2013 fourth quarter which is unusual given typical seasonal performance. The interesting point of the past two years is that from Ontario Producer Net Margins C$/Head 50 40 30 20 10 0-10 -20-30 -40-50 -60 JN FE MR AP MA JU JL AU SE OC NV DE 2012 2013 Source: George Morris Centre Calculations 2

a margin perspective, 2013 has been a mirror opposite of 2012. The bottom line is that in light of much lower grain costs, strong demand and relatively tight supplies, the Canadian hog production sector enters 2014 on a positive note. The lower grain prices will ensure stability in that crucial feed cost area for at least the first six months of 2014. Cattle and Beef The Canadian cattle and beef industry entered 2013 with higher than normal levels of uncertainty and hope as a result of the E.coli crisis at the XL Foods plant in Brooks, Alberta in the fall of 2012. The crisis shut the Brooks plant for weeks in the fall of 2012. Given that it is a huge volume plant and only one of two on the Prairies, the market disruption was exceptional and costly to cattle feeders. That crisis resulted in the loss of one major packer, XL Foods, and the takeover of the plant by largest meat company in the world, Brazilianbased JBS SA. On the surface it may appear that the industry simply swapped one plant owner for another. That however, is misleading given that JBS was already an active participant in Alberta through its Hyrum, Utah cattle slaughter plant. In other words the Canadian cattle industry did lose a key buying presence with the loss of XL. With that context the Canadian cattle industry was also struggling with the impact of the US drought. Canadian cattle feeders saw their feed costs soar, while cow-calf producers saw feeder cattle prices pressured lower, both as a result of the drought. As with the hog margin situation, cattle feeder margins in 2012 and 2013 are mirror opposites in terms of first and second half performances. The differences however, are that cattle feeders are still largely in a loss position, at least on cash market sales. Yearling Steer Monthly Profit/Loss Margin Dollars per head C$/Head 100.00 50.00 0.00-50.00-100.00-150.00-200.00-250.00-300.00 Source: Canfax Jan Mar May Jul Sep Nov 2012 2013 As has been the case for at least five years, a dominant issue in the industry is cattle supplies. Herd liquidation has been occurring in North American for a variety of reasons, including drought, for the past decade. The net result is over capacity at the packer and cattle feeder level. This has resulted in plant closures (Cargill Texas) and feedyard consolidation. Going into 2014, the issue of supply will be even more dominant as it is likely that cow-calf operators will decide to retain heifers for breeding. In other words, profits at the ranching level will finally result in an attempt at herd rebuilding. This in turn will result in record beef, fed cattle and feeder cattle prices in 2013. The net result is that the cattle feeding sector will continue to face exceptional working capital demands in a much higher priced and higher risk environment. Chicken and Turkey The chicken and turkey sectors determine the price of birds on a formula basis. This formula is tied largely to feed costs. Included in the formula are margin guarantees that are essentially unaffected by variable input costs. This formula pricing feature of the supply management programs insulates producers from the impact of the soaring 2012 and 2013 first half grain costs, as noted above. That is, despite the sharp increase in production costs, turkey and chicken producer margins in these industries are largely unaffected. As a result of the formula pricing, live turkey and chicken prices rose dramatically in the latter half of 2012 and the first half of 2013. During the latter part of 2013, live prices began to fall given the declining feed costs. This pricing volatility of course put pressure on chicken processors but at the same time, consumer demand for chicken and high prices in the US resulted in processor margin relief. Generally speaking, both producers and processors enter 2014 on a positive note. Given lower grain prices the stability of margins at both the producer and processor level should continue. Eggs As with chicken and turkey described above, the egg production sector is protected by a supply management pricing formula. The formula shields producers from the varieties of downward price fluctuation and in the case of 2012 and early 2013, from high feed costs. With that noted, the industry has been enjoying the benefits of more robust Canadian egg consumption. Per capita egg consumption has grown by over 12% in the five years between 2007 and 2012. As a result, egg production has been increasing at a steady and predictable 2% growth rate. In other words, the image of the egg industry in the 1990 s and early 2000 s of a mature industry is not 3

Canadian Egg Production Million Dozen really applicable, as the industry has been re-invigorated due to improved demand. As a general observation, the industry has responded well to health concerns raised during the 1990 s and has successfully promoted the health and nutrition benefits of eggs. The egg industry has been modestly transformed from a low demand, mature industry into a more growth oriented profile. Into 2014, given that the industry is supply managed, it can be expected that income stability and strong returns will continue. The main trials facing the industry relate to interprovincial disputes involving production and allocation. As with chicken these types of disputes are intrinsic to the system and are not threatening to the overall structure. Dairy 680 660 640 620 600 580 560 540 520 500 Source: Statistics Canada 2004 2006 2008 2010 2012 Dairy markets in Canada exhibit tremendous stability in both price and volume. The fluid milk market is stable, with aggregate volume essentially keeping pace with population growth. Industrial milk used in dairy manufacturing ebbs and flows along a path of slow growth in aggregate. In 2013, industrial milk quota in Canada has been stable at about 190 million kg, and pricing on industrial milk is up about 1%. The challenges facing the dairy industry remain in the background, for now, and the immediate term outlook is for continued market stability with small milk price increases and small changes in market volume. The dairy industry will continue to face ongoing issues related to market growth, which relates to milk pricing. Some evidence of this exists in the creation of milk class 3(d) for cheese used in foodservice in 2013. The recent Canada-EU trade agreement with its expansion of Canadian market access to the EU for cheese stands to create pressures on the system, as some combination of price competition for domestic cheese market share and reduction in quota is likely to result. Assuming the agreement is ratified by both Canada and the EU, adjustments to it will be deferred to a future date. Farm Services and Supply Feed The feed industry tends to be a cost pass-through business, in which the dominant factor pricing a complete feed is the cost of grain to manufacture it. The combination of lower priced grain and improved operating margins in livestock feeding industries are supportive to feed industry returns and management of receivables. Feed continues to face consolidation pressure due to declining swine, beef, and dairy cow herds. As such, the feed industry is likely to continue its consolidation into a small number of national-scale firms, with significant regional players. This will occur in a more positive profitability environment for its customers. Fertilizer The retail fertilizer/crop products segment is similar in nature to feed, being based upon cost pass through pricing to customers, and on the financial health of its customer base and competition among firms. Historically, nitrogen fertilizer pricing has been closely linked to natural gas prices. Natural gas prices have increased in 2013, but remain low relative to history. The crop farming customers for fertilizer are coming off historically profitable years. At the same time, like feed, retail and manufacturing consolidation is ongoing, with Agrium acquiring Viterra fertilizer operations in western Canada, The Andersons acquiring Thompsons Ltd. in Ontario, Mosaic recently acquiring CF Industries phosphate operations in Florida, new anhydrous ammonia plant projects announced in Louisiana, Iowa, and Quebec in 2013, and with fractured elements within the international potash cartel. The implication would seem to be that renewed competition and favorable ingredient prices will keep retail fertilizer prices in check. Going forward, according to CIBC World Markets, nitrogen and phosphate sources are seen as relatively stable in pricing, and potash prices have been in decline. This is expected to keep fertilizer prices in line with the crop revenue outlook; the urea/ corn price ratio remains at the low end of the historic range. Farm Machinery Past and anticipated farm profitability has driven farm machinery sales. This continued through 2013. According to the Association of Equipment Manufacturers in its October report, 2013 year to date sales of two wheel drive tractors is up over 9% vs. 2012, four wheel drive tractor sales are up 1.5%, and sales of combines are 4

down 1.4%. Thus, a growing sales base is in place for profitability in the farm machinery segment. Policy Developments Trade policy developments will occupy significant attention in 2014. The prospective implications of the recently-signed Canada-EU Comprehensive Economic and Trade Agreement (CETA) trade agreement will continue in 2014. Focus can be expected on increased market access given to the EU for cheese under CETA, what adjustments may occur in the Canadian dairy industry, and how compensation would or could occur. Conversely, CETA provides for duty-free exports of 81,000 tonnes of Canadian pork, duty-free exports of 65,000 tonnes of Canadian beef and veal, duty-free exports of 3,000 tonnes of Canadian bison meat, unlimited dutyfree exports of Canadian horsemeat, and unlimited duty-free exports of Canadian prepared meats. The EU will retain duty-free access to the Canadian market for pork, obtain duty-free access for beef, and receive reciprocal unlimited duty-free access for prepared meats. The agreement also includes a commitment to resolve technical barriers to trade. The Canadian Meat Council asserts that, Compared to an average value of only $54 million of meat exports to the EU during the past three years, the results of the CETA negotiations will offer export opportunities with a potential annual sales value of up to $1 billion for Canadian beef, pork, horsemeat, bison and prepared meats processors. The Trans-Pacific Partnership negotiations are expected to advance further in 2014, perhaps to conclusion, with similar tradeoffs in agri-food expected as with CETA in terms of increased market access for meats as well as grains/oilseeds, and increased domestic market access for supply-managed products. Finally, if a new US Farm Bill is not completed by 2013, there will be intense pressure to develop and sign a Farm Bill in 2014- with particular Canadian interest in US crop insurance and dairy policies under a new Farm Bill. Summary The outlook for 2014 envisions a return to a more stable or normal economic environment for the major segments of Canadian agriculture. Crop prices are expected to be much lower than 2012 but still strong compared with history. Profitability in red meat will be supported by short supplies, good demand and lower feed prices. Supply management will remain stable even as it engages new and ongoing policy issues out in the future. Farm supply segments are expected to continue the evolution toward more consolidated businesses, offering stable pricing to customers in 2014. These are bracketed by major agri-food policy developments anticipated in 2014. This publication is for general information purposes only. Nothing in this publication constitutes investment, legal, agriculture, accounting or tax advice, and recipients should independently evaluate the financial, market, commodities, agriculture, legal, regulatory, credit, tax and accounting risks and consequences involved, and specific to the recipient s situation, before entering into a transaction. The information, opinions and statistical data contained herein has been obtained from sources (internal and/or external) that CIBC believes to be reliable (without having conducted any independent investigation). CIBC assumes no obligation to update any information, opinions, statistical data or forward-looking statements contained herein for any reason, including if CIBC subsequently learns that such information is inaccurate, incomplete or otherwise in error or to notify any person in respect of thereof. CIBC does not represent or warrant the completeness, accuracy or currency of this publication or any information, opinions and statistical data contained herein. This report may provide addresses of, or contain hyperlinks to, Internet web sites. CIBC has not reviewed the linked Internet web site of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for the recipient s convenience and information, and the content of linked third party web sites is not in any way incorporated into this document. Recipients who choose to access such third-party web sites or follow such hyperlinks do so at their own risk. 5