INFOCUS MARCH 2018 FUTURE OF FRESH

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1 INFOCUS MARCH 218 FUTURE OF FRESH

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3 AUSTRALIAN HORTICULTURE Australian agriculture continues to capture the attention of investors, government and business as the country looks for its next industry boom. Surging demand in Asia, the adoption of new technologies, and favourable outlooks for commodities established and emerging have materialised. Australian horticulture is also experiencing enviable momentum, driven by productivity gains and unprecedented domestic and global demand. New capital is also entering the sector and investment must continue as the industry seeks to satisfy global demand, which requires significant production increases and supply chain improvements. Today, horticulture makes up 19 per cent of Australian agricultural production and is the largest employer within Australian agriculture. However, Australia s exports constitute only 1.2 per cent of global fruit exports and.3 per cent of global vegetable exports, so considerable prospects remain as long as producers can align production with demand from our nearest neighbours. Already, fruit exports to China have increased more than 5 per cent in the past four years, helping Australian horticulture to become the fourth largest export group for Australian agriculture (after meat, cereals and wool) and worth almost $3 billion in 216. Following improved market access to China, further growth is being seen for Australian citrus, table grapes, Tasmanian apples and stone fruit. Locally, fresh fruit and vegetable prices remain more volatile than most food items, due almost exclusively to a reliance on local supply. However, while vegetable prices are less volatile than fruit, prices for vegetables are growing at a higher rate than fresh fruit retail prices. At the farmgate, the dynamic shifts with the price of fruit increasing at around the same rate as the retail prices, while the farmgate price for vegetables is actually in decline. This disparity, in some part, can be attributed to the growing global demand for Australian fresh fruit which has seen Australia become a net exporter of fresh fruit while remaining a net importer of fresh vegetables. But what impact will an increase in exports of fresh fruit and vegetables have on Australian consumers and retail prices? Analysis of current trends show a significant impact from increased exports of domestic fresh produce on both retail prices and the prices received by Australian producers such that on current trends retail fruit prices would increase by 3 per cent, and farmgate prices would almost double, while retail vegetable prices would increase by over 3 per cent but farmgate prices would increase only 2 per cent by 23. Questions also remain for growers around the viability of capital intensive undercover production systems. Similarly, for farmers with access to irrigated land, horticulture typically returns more per hectare and per megalitre than any other agriculture, but experience on the Murray-Darling shows that on a return on capital basis, horticulture has been far lower than cotton, rice or even dairy farming. Although opportunities for Australia s horticulture industry are becoming clearer, growers need to grapple with unique challenges: a highly volatile environment, production and income lags in new development, and careful management of resources required to produce the food that our local consumers and, increasingly, global consumers have come to appreciate and expect. However, Australian agribusiness has traditionally responded to challenge and opportunity with adaptation and innovation, and we see this playing out already. Ongoing investment remains critical, as does careful consideration of both domestic and international demand. On balance, it feels like an exciting time in Australian fresh produce. Mark Bennett Head of Agribusiness and Emerging Corporate Regional Business PAGE 1

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5 THE AUSTRALIAN HORTICULTURE INDUSTRY Horticulture covers the production of a range of commodities including fruits, nuts, vegetables, table grapes, flowers and turf. Whilst horticulture is a significant contributor to Australian agriculture, the vast number and range of commodities that sit within the sector often lead to it not being considered one of Australia s major agricultural industries. The numbers, however, tell a different story; in horticulture produced $1.4 billion worth of produce, or 19 per cent of Australia s total gross agricultural production across 14,3 horticulture businesses nation-wide. While highly seasonal in production, horticulture is the largest employer in Australian agriculture, employing 75, people, predominantly through seasonal or part-time employment. In , the major commodities produced by the sector were almonds, apples, potatoes, bananas, oranges and avocados. Production areas for the industry are also widespread, ranging from tropical fruit, fresh tomato, capsicum, and zucchini production in Queensland; stonefruit, oranges and grapes in New South Wales, Victoria and South Australia; potatoes, cherries, apples and onions in Tasmania; and almonds, grapes, canning fruit and processing tomatoes in Victoria. GROSS VALUE OF PRODUCTION IN AUSTRALIAN HORTICULTURE 12 1 ($AU Million) /11 211/12 212/13 213/14 214/15 215/16 Nurseries, cut flowers or cultivated turf Fruits and nuts (excluding grapes) Grapes Vegetables Source: ABS PAGE 3

6 CHANGES IN HORTICULTURAL PRODUCTION Production in Australian horticulture has shifted in recent years with significant increases in the production of almonds, avocados, macadamias, oranges and cherries, and a reduction in pears, peaches, tomatoes, onions and nectarines % change Berry and Tropical Fruit (ha) 14,685 16,631 25, % Citrus, Stone and Pome Fruits ('s trees) 21,747 32,217 43, % Grapes (ha) 98, , , % Nuts ('s trees) 3,378 4,316 14, % Vegetables (ha) 13,61 111, ,5-9.3% Source: ABS According to Horticulture Innovation Australia (HIA), Australians consume 68kg of fresh fruit and vegetables each year. Over 95 per cent of that supply is sourced from Australian fruit and vegetable producers. Of Australia s production, approximately 12 per cent goes to the fresh export market, under 3 per cent goes into the processing market and over 6 per cent goes into the fresh supply market. Australia s supermarkets continue to take the vast majority of fresh fruit and vegetables, and according to the Federal Department of Health, around half of all fresh product sales (such as meat, fruit and vegetables) are sold through Australia s two largest supermarket chains, Coles and Woolworths, with 72 per cent of consumers buying through a supermarket. 1 Fresh food (including fruit, vegetables, meat and dairy) also make up a very significant part of supermarkets sales accounting for not only up to 4 per cent of grocery chains revenues, but also acting as drivers of customer patronage. 2 Whilst the domestic fresh food market is vital to the majority of horticultural producers, predictions from the United Nations Food and Agriculture Organisation are that annual domestic growth in fresh fruit and vegetable consumption will fall from.9 per cent per annum to.3 per cent per annum, and, as such, many producers are looking to the increasingly lucrative export markets. Despite the dominance of retailers in sales of fresh fruit and vegetables to consumers, wholesalers dominate buying from producers, taking around 45 per cent of farmers produce before onselling to a range of retail outlets, including supermarkets. Retailers will commonly buy through direct sourcing arrangements, however a broker is often appointed to coordinate the sourcing and supply requirements of the retailer. This may include coordinating individual grower supply volumes to meet expected retail demand, and managing quality and packaging requirements. 3 1 Roy Morgan, 2 McKinsey & Company (213) A fresh take on food retailing [online] 3 ABARES, Foodmap PAGE 4

7 FRUIT AND VEGETABLE SUPPLY CHAIN IN AUSTRALIA (215 16) 27% PROCESSING 679,356t 94% PRODUCTION 2,516,572t $4,352m 12% FRESH EXPORT 299,143t $628m FRESH IMPORT 114,719t $368m 61% FRESH SUPPLY 1,645,557t $4,543m 6% Source: HIA PAGE 5

8 FRESH FRUIT AND VEGETABLE PRODUCT CHANNELS TO CONSUMER PRODUCTION IMPORT FRESH FOOD WHOLESALER FRESH CUT PROCESSOR BROKER FRESH PRODUCE DISTRIBUTOR QSR CATERERS SPECIALTY RETAILER EVENT/ LEISURE DINING OUT INSTITUTIONAL INDEPENDENT RETAILER TAKEAWAY FSS RETAILER Source: ABARES, Foodmap: An Analysis of the Australian Food Supply Chain PAGE 6

9 DOMESTIC DEMAND Fresh fruit and vegetable consumption in Australia makes up approximately 13 per cent 4 of total food expenditure. And while there is a general trend that expenditure on food consumption declines as a percentage of total household expenditure as incomes increase, the most recent ABS Household Expenditure Survey shows that food expenditure increased 16.1 per cent between 29 1 and , compared to total household expenditure on goods and services which increased 15.3 per cent. Growth in food expenditure was, however, vastly outweighed by growth expenditure on education and mortgage repayments (43.5 per cent each), medical and healthcare (25.6 per cent) and fuel and electricity expenses (25.8 per cent). Domestic demand and prices are also heavily impacted by the large amount of processed fruit and vegetables that Australia imports, and which has maintained downward pressure on fresh fruit and vegetables as an alternative. In the shorter-term, Consumer Price Index (CPI) figures released at the end of 217 showed a 4.4 per cent fall in fruit prices due to warmer conditions in Queensland, resulting in a production glut, and more recently, a hot summer that has increased vegetable prices. A longer-term look shows that the retail prices of fruit and vegetables have behaved very differently. Fruit has been showing higher volatility and price spikes associated with tropical weather events, but overall underperforming the CPI, while vegetables show less volatility, but are performing relatively stronger at the consumer end. The story at the farmgate level, however, is very different. A weighted-index of farmgate, wholesale, retail and export prices for fruit and vegetables shows that while retail prices for vegetables have increased, on average, more strongly than retail fruit prices, the farmgate returns to vegetable farmers actually declined between 21 and 215. While vegetable export prices increased at a greater rate than retail prices and in turn, wholesale prices. CONSUMER PRICE INDEX ($) CONSUMER PRICE INDEX - FOOD ($) Sep 89 Sep 96 Sep 3 Sep 1 Sep Mar Jun 17 Source: ABS, ANZ CPI all groups excluding food Food and non-alcoholic beverages Fruit and Vegetables Source: ABS, ANZ CPI all groups excluding food Meat Dairy Cereals Fruit Vegetables 4 ABARES, Food demand in Australia: Trends and food security issues PAGE 7

10 It is also of interest that data from the United States Department of Agriculture demonstrates that this pricing trend is also occurring in the United States, with the farmgate share of the retail price of vegetables falling slightly since the late 199s, while the farm value and the farm share of the retail price of fruit has increased strongly, particularly since 28. The growing farm to retail margin for fruit in comparison to vegetables, both in Australia and the United States, is most likely due to the relatively low level of international trade in vegetables compared to fruit. This means that alternative, high-value markets have not been developed as a competing demand to domestic retail sales. Transport industry sources have also suggested that marked advances in cold chain storage and logistics have been more beneficial to fruit producers than vegetable products. This is because vegetables generally have a longer shelf-life than fruit and increasing that shelf-life through better storage and transport options has had limited advantage, as opposed to the fresh fruit supply chain which has gained significant value in both market access and continuity of supply outside of traditional growing seasons. AUSTRALIA FARM TO RETAIL PRICES INDEX (VEGETABLES) 5 AUSTRALIA FARM TO RETAIL PRICES INDEX (FRUIT) Mar 1 Jan Mar 1 Jan 17 Retail vegetables Wholesale vegetables Retail fruit Wholesale fruit Farm-gate vegetables Export vegetables Farm-gate fruit Export fruit Source: ABS, Comtrade, ANZ Source: ABS, Comtrade, ANZ UNITED STATES FARM TO RETAIL PRICE SPREAD (VEGETABLES) UNITED STATES FARM TO RETAIL PRICE SPREAD (FRUIT) Index Percentage points Index Percentage points Retail costs Farm value Farm to retail spread Farm value share per cent (RHS) Retail costs Farm value Farm to retail spread Farm value share per cent (RHS) Source: USDA Source: USDA 5 The index graphs depict changes in value only, and do not indicate relative value PAGE 8

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12 AUSTRALIA S TRADE IN HORTICULTURE Export of Australian fresh fruit and vegetables has been growing strongly in recent years and combined, now sits as the fourth largest export group for Australian agriculture, after meat, cereals and wool. In 216, fruit and vegetable exports reached almost $3 billion, 6 having grown 4 per cent and 3 per cent per annum respectively since 212. Australia s fruit exports now constitute 1.2 per cent of global fruit exports, however only constitute.3 per cent of global vegetable exports (excluding dried legumes) and 2.4 per cent of global exports including dried legumes. Fresh fruit and nuts made up the majority of Australia s horticulture exports in 216 with almonds the largest export commodity ($USD 575 million) followed by grapes ($USD 29 million) and citrus ($USD 245 million). Vegetable export commodities, again after excluding dried legumes, were a small portion of that, with carrots the largest single vegetable export commodity ($USD 64 million) followed by asparagus ($USD 23 million) and potatoes ($USD 21.5 million). Australia remains a net importer of processed fruit and vegetables and fresh vegetables, however, in recent years, it has become a net exporter of fresh fruit and nuts. By destination, the greatest growth in exports in both fruit and vegetables has been to Asia with fruit exports to China increasing over 5 per cent in four years. Other growth markets have included Hong Kong, Japan and India. Vegetable exports, while more subdued than fruit exports, have also increased strongly in recent years particularly to Singapore, Malaysia and the United Arab Emirates (UAE). While Japan remains our third most important vegetable export market, export quantities have remained relatively stable in recent years. Lucrative export markets differ from commodity to commodity however typical markets such as South Korea, Japan, China and the Middle East remain some of the highest paying markets for Australian fresh fruit and vegetables. MONTHLY AUSTRALIAN EXPORTS AUSTRALIAN HORTICULTURE EXPORTS ($AU Million).8.6 ($US ') Nov 1 Nov Meat and meat preparations Meat and meat preparations (Linear) Cereals and cereal preparations Cereals and cereal preparations (linear) Vegetables and fruit Vegetables and fruit (linear) Fresh fruit Nuts Fresh vegetables Processed fruit Processed vegetables Plants and bulbs Source: ABS Source: Comtrade, ANZ 6 This figure includes dried chickpea exports which would fall under the standard classification for vegetables for trade purposes. By themselves, chickpeas, lentils and other dried legume exports were almost $1.5 billion in 216. PAGE 1

13 TRADE BALANCE ($US ') Source: Comtrade, ANZ Fresh fruit Nuts Fresh vegetables Processed fruit Processed vegetables Plants and bulbs FRUIT EXPORTS BY DESTINATION ($US ') ($US ') Source: Comtrade, ANZ China Hong Kong Japan India Indonesia World VEGETABLE EXPORTS (EXCL. DRIED CHICKPEAS AND LEGUMES) BY DESTINATION ($US ') ($US ') Source: Comtrade, ANZ Singapore United Arab Emirates Japan Malaysia S Korea Hong Kong World PAGE 11

14 GROWING CONSUMER DEMAND IN ASIA The rise of the Asian middle class and associated increase in demand for meat and protein is well documented. The impact on demand for fresh fruit and vegetables is equally as exciting an opportunity for Australian exporters. GROWTH IN ASIA S MIDDLE CLASS LARGER THAN PREVIOUSLY ESTIMATED A 217 study by the Brookings Institute 7 found that previous estimates of middle class growth in Asia, and their purchasing power, have been significantly understated. The study found that there were 5 million more people in the global middle class than previously estimated at the end of 216 some 3.2 billion, and that was increasing by a rate of 14 million people each year. Around 88 per cent of those new entrants into the middle class are likely to be in Asia meaning that by 23, it is estimated that there will be just under 3.5 billion in Asia s middle class. The study also found that the spending power of the middle class was larger than previous estimates. In 215, middle class spending was about $35 trillion, roughly 12 per cent higher than previously thought. It now accounts for one-third of the global economy. DEMAND FOR FRESH FRUIT AND VEGETABLES IS GROWING Aside from growing global demand for meat and animal products, the lesser-told story is the increase in global consumption of fresh fruit and vegetables. Since the early 199s, the global per capita consumption of vegetables and fruit (excluding root vegetables) has increased by 3.6 per cent and 12.4 per cent per annum respectively. These are substantial figures in the context of milk consumption increasing.8 per cent and meat consumption increasing 1.5 per cent per annum. ASIA FOOD CONSUMPTION kcal/capita/day kcal/capita/day Starchy roots Vegetables Fruits excluding wine Milk excluding butter Meat Cereals excluding beer Source: FAO, ANZ 7 Kharas, N (217), The Unprecedented expansion of the global middle class: an update, The Brookings Institute PAGE 12

15 CHANGES IN CONSUMER HABITS FOR FRUIT AND VEGETABLES VARY BY REGION The pattern of overall increasing consumption is mirrored in Asia although unlike global food consumption, the widely publicised increase in demand for meat in Asia has dwarfed any other food category, with meat consumption per capita growing 14.3 per cent per annum since 199 compared to 9.4 per cent for vegetables and 6.6 per cent for fruit. Demand for milk in that same period has grown 5.9 per cent, seafood consumption has grown 1.8 per cent and consumption of pulses has grown only.6 per cent. Of interest is the pattern of consumption changes between regions and groupings of countries. Vegetable consumption, which does not include root vegetables, has fallen per capita in the European Union and risen slowly in the least developed nations and low income, food importing regions. Global fruit consumption growth, however, while lagging growth in vegetable consumption as a whole, continues to grow in the European Union (EU), particularly since the mid 199s. CONSUMPTION OF VEGETABLES BY COUNTRY/REGION kcal/capita/day Source: FAO, ANZ Asia World EU Low income food deficit countries Least developed nations GLOBAL CONSUMPTION AND EXPORTS kcal/capita/day ( ) Source: FAO, ANZ Vegetable consumption Fruit consumption GLOBAL TRADE NOT KEEPING UP WITH CONSUMPTION With demand for vegetables increasing across Asia, the global trade in fruit and vegetables shows greater strength in fruit exports than vegetable exports. Global vegetable exports now constitute 8 per cent of global consumption, compared to fruit exports which account for 24 per cent of consumption. As both sectors continue to grow, the consistent trend remains that growth in trade in fresh fruit is outpacing consumption growth, as opposed to growth in trade in vegetables which lags growth in consumption. This disparate growth in trade can often be put down to the persistent trade barriers such as tariffs, however analysis shows that, on average, tariffs for vegetables remain lower than tariffs on fruit exports for many of Australia s most important trade partners. The recent execution of Free Trade Agreements with many of these nations will fortunately see these tariff rates reduce over the implementation period of the Agreements kcal/capita/day ( ) Vegetable export (RHS) Fruit export (RHS) CONSUMPTION OF FRUIT BY COUNTRY/REGION AVERAGE TARIFF RATES ON AUSTRALIAN EXPORTS (216) kcal/capita/day Trading Partner Vegetables (incl. legumes) Fruit China 4.6% 6.2% Korea 72.5% 38.2% India 3.7% 32.4% United Kingdom 14.2% 9.7% Thailand 7.5%.% Japan 6.4% 7.7% Asia World EU Low income food deficit countries Least developed nations United Arab Emirates 2.4% 1.4% Indonesia 5.4% 6.7% Source: FAO, ANZ Source: UN Trade Map PAGE 13

16 AUSTRALIAN MARKET SHARE OF ASIAN FRUIT IMPORT MARKET Change (27 16) Change in Australia s exports to Asia Asian Market Size: 216 (USD$') Almonds and other nuts 3.1% 4.8% 1.7% 475.5% 6,851,556 (excl. coconuts, brazil nuts) Fresh strawberries, raspberries, blackberries, 1.7%.8% -.9% 14.7% 4,691,835 black, white or red currants, gooseberries Citrus fruit, fresh or dried 5.% 7.3% 2.4% 251.2% 3,619,791 Apples, pears and quinces, fresh.4%.5%.1% 246.4% 3,479,393 Coconuts, Brazil nuts and cashew nuts,.%.%.% 38.3% 3,25,254 fresh or dried, whether or not shelled or peeled Grapes, fresh or dried 8.1% 12.8% 4.7% 529.3% 2,961,952 Bananas, incl. plantains, fresh or dried.%.%.% 734.8% 2,82,777 Dates, figs, pineapples, avocados, guavas, 1.4% 1.8%.4% 249.1% 2,383,222 mangoes and mangosteens, fresh or dried Apricots, cherries, peaches incl. nectarines, 6.5% 3.7% -2.8% 243.5% 2,37,371 plums and sloes, fresh Melons, incl. watermelons, and pawpaws (papayas), fresh 5.9% 6.9% 1.% 123.8% 391,65 AUSTRALIAN MARKET SHARE OF ASIAN VEGETABLE IMPORT MARKET (EX CHICKPEAS) Change (27 16) Change in Australia s exports to Asia Asian Market Size: 216 (USD$') Onions, shallots, garlic, leeks and other.2%.3%.1% 5.2% 3,43,199 alliaceous vegetables, fresh or chilled Roots and tubers of manioc, arrowroot, salep,.2%.1% -.1% 6.6% 2,15,34 Jerusalem artichokes, sweet potatoes and similar Other vegetables, fresh or chilled including asparagus,.%.1%.1% 79.5% 1,56,362 celery, mushrooms and capsicum Cabbages, cauliflowers, kohlrabi, kale and.2%.2%.1% 15.5% 871,672 similar edible brassicas, fresh or chilled Potatoes, fresh or chilled 5.2% 2.9% -2.3% 134.9% 783,3 Tomatoes, fresh or chilled.5%.5%.% 4.6% 668,11 Carrots, turnips, salad beetroot, salsify, celeriac, 2.2% 2.9%.7% 156.8% 578,843 radishes and similar edible roots, fresh or chilled Lettuce "Lactuca sativa" and chicory 3.1% 3.6%.5% 242.7% 29,259 "Cichorium spp.", fresh or chilled Leguminous vegetables, shelled or unshelled, fresh or chilled 14.9% 15.%.1% 36.% 19,822 Cucumbers and gherkins, fresh or chilled 8.3% 15.7% 7.5% 142.% 61,212 Source: UN TradeMap PAGE 14

17 IS AUSTRALIA WELL PLACED TO TAKE ADVANTAGE OF THE ASIAN OPPORTUNITY? The opportunity for Australian exporters to fill the growing demand in Asia for fresh fruit and vegetables is clear and while fresh fruit and nut exports have begun to take advantage of this opportunity, Australian vegetable exporters have less penetration and growth into the Asian market. There are numerous reasons for this, but the largest is quarantine access to Asia s largest market, China. Currently Australia has a quarantine protocol signed with China for the importation of almonds, citrus, table grapes, cherries, Tasmanian apples, lettuce and asparagus and, more recently, stone fruit. WHERE ARE THE OPPORTUNITIES FOR FUTURE GAINS? Once Australia s export of fresh fruit and vegetables is broken into different commodities, it becomes clear that while Asia s fruit import market is much larger than the demand for imported vegetables, Australia s vegetable production where potatoes and tomatoes are the two largest vegetable harvests does not align strongly with growth in demand for vegetables in Asia. For Asia s three largest fruit imports (almonds, berries and citrus), Australia s market share has grown for almonds and citrus to 4.8 per cent and 7.3 per cent respectively. However of Asia s three largest vegetable import commodities Australia s market share is.3 per cent (onions),.1 per cent (cassava) and.1 per cent (asparagus and celery). Our larger market share lies in the smaller vegetable imports of lettuce, carrots and turnips. Indeed, while China imports very little in the way of fresh vegetables, the one major import product of cassava is not highly produced in Australia. So while Australia s fruit exports to Asia are kicking off, there is still considerable potential for vegetable growers to either align their production more closely with demand in Asia, or to continue to build a value-added brand for growing middle class demand across Asia. WHAT ARE THE BARRIERS TO TAKING ADVANTAGE OF THOSE OPPORTUNITIES? Despite recent success in negotiating Free Trade Agreements with China, Japan and South Korea, the greatest barrier to exports remains market access through quarantine protocols. While those fresh fruits and vegetables with access to China have performed very strongly, a large number of Australia s major vegetable products and, to a lesser extent, fruit, have not gained market access. Californian strawberries have recently gained access to the Chinese market, providing evidence that there is scope for continuing expansion of trade to Asia. Other issues facing trade in fresh fruit and vegetables remain the timeliness and safety of cold chain logistics, which is continuing to improve in leaps and bounds particularly as Australian chilled beef has gained access to the Chinese markets. On the local production end of the supply chain, producers are faced with increasing energy costs impacting their ability to irrigate, or maintain appropriate conditions if producing undercover. Access to reliable seasonal farm labour also remains an ongoing problem for those producers who require seasonal workers. FOR ASIA S THREE LARGEST FRUIT IMPORTS (ALMONDS, BERRIES AND CITRUS), AUSTRALIA S MARKET SHARE HAS GROWN FOR ALMONDS AND CITRUS TO 4.8 PER CENT AND 7.3 PER CENT RESPECTIVELY PAGE 15

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19 SELLING INTO CHINA Selling fresh produce into China is a complicated task, with many hurdles to jump before export can take place. Firstly, gaining technical market access by having the product and country of origin included on the list of permitted imported fresh fruit and vegetables into China is essential to exporting. Achieving that status is often difficult and time-consuming work, which is completed through the local Department of Agriculture. To date, Australia has technical market access for almonds, citrus, table grapes, cherries, Tasmanian apples, lettuce and asparagus. Technical market access can often be influenced by political factors such as reciprocal access for Chinese exports to Australia or the amount of local production of a certain product. While the China-Australia Free Trade Agreement delivered the progressive removal of tariffs on Australian horticulture exports, achieving market access remains a barrier for many producers seeking to enter the Chinese market. Once technical market access is achieved, the key concerns for producers or wholesalers include deciding who to partner with to help export and distribute their produce, and which in-country structure to adopt. While trading through the grey market channel, (a partially legal/illegal channel used to avoid taxes and duties via Hong Kong) has been a long-standing access point to China, it is becoming riskier as Chinese authorities have cracked down on this behaviour. Alternatively, legal trading directly to China will require a number of partners to import, distribute and sell produce. The exception to this is the emerging channel of e-commerce sales, where producers sell directly to online customers through an online platform. The growth in the e-commerce channel has the potential to greatly increase the ease of import for those products, and small producers, seeking to enter the Chinese market. CHINA S IMPORTED FRESH PRODUCE DISTRIBUTION CHANNELS FOREIGN EXPORTER HONG KONG IMPORT PORT MAINLAND CHINA IMPORT PORT (SHANGHAI, GUANGZHOU) Grey channel CHINESE IMPORTER GENERAL DISTRIBUTOR WHOLESALE MARKETS LOCAL DISTRIBUTOR WET MARKETS SUPERMARKETS AND CONVENIENCE STORES HYPERMARKETS FRESH FRUIT CHAIN STORES E-COMMERCE CONSUMER Source: EU SME Centre Sector Report: The Food & Beverage Market in China 215; USDA 214 Retail Report PAGE 17

20 IMPACT OF INCREASING TRADE ON DOMESTIC FOOD PRICES When discussing the opportunity for Australian fruit and vegetable producers to access growing export markets in Asia, it is also worth considering the impact of increasing exports on domestic retail prices paid by Australian customers. Figures compiled by ANZ show the potential impact on retail and farmgate prices on an increased percentage of Australian fresh fruit and vegetables export, and an increased reliance on imported fresh produce. The scenarios presented are not intended to represent forecasts or likely outcomes rather they are intended to show the impact of a range of movements in Australia s fresh produce trade and trends. Indeed, current trends in fruit export growth have the potential to be overstated due to the boom in exports seen in recent years from gaining market access to China, while growth in vegetable exports are likely to be understated due to the current lack of market access. Current price trends in fruit production and trade have seen fresh fruit exports increase an average of 12 per cent per year over the past five years, while imports have increased 5.4 per cent and production has increased an average of 3 per cent per year. At the same time, relatively low growth in vegetable production and trade has seen a greater volatility in prices, but lower farmgate returns for vegetable producers. If these trends were to continue, by 23 retail fruit prices would increase by 3 per cent and farmgate prices would almost double, while retail vegetable prices would increase by more than 3 per cent but farmgate prices would increase by only 2 per cent. But what will be the impact on domestic retail and farmgate prices if export growth continues? An increase in fruit exports growth to 14 per cent per year, would mean that exports would increase to more than 9 per cent of Australian fruit production, and imports would constitute more than 89 per cent of Australian consumption (assuming that per capita consumption remains steady). This would see a retail price increase of 76 per cent and a farmgate price increase three-fold. In contrast, an increase in vegetable exports of 7.5 per cent each year would see a retail price increase of 78 per cent and farmgate price increase of 42 per cent. While these figures do not represent forecasts, it does clearly show the choices that face Australian consumers as fresh produce trade to Asia continues to grow. And as producers continue to receive better prices from export markets than domestic markets, Australian consumers will increasingly have to consider the trade-off between price and buying local. ASSUMPTIONS (UNDER HIGH, CURRENT AND LOW GROWTH TRENDS) OUTCOMES (BY 23) AU production (annual growth) Export growth (per annum) AU production exports as % AU consumption imports as % Retail price increases 8 Farmgate price increases 8 2.% 16.% 4.% 14.% 91.3% 89.4% 75.9% 36.% FRUIT 3.1% 12.2% 68.1% 48.6% 29.6% 99.8% 2.% 5.% 54.1% 7.1% 12.7% 11.% 7.% 9.% 2.% 7.5% 14.4% 12.5% 78.5% 42.1% VEG 1.4% 5.4% 11.1% 12.6% 32.5% 1.9% 1.% 3.5% 9.7% 19.7% 5.% 119.% High growth Current trend Low growth Current levels 8 Outcomes reflect current trends only and are not forecasts. PAGE 18

21 CAPITAL-INTENSIVE HORTICULTURE The trend in Australian horticulture is increasing towards capital intensive forms of horticulture such as indoor or hothouse production. Despite this, outdoor vegetable growing continues to dominate the industry; the value of the outdoor vegetable industry has grown 31 per cent since 21, compared with the undercover vegetable growing industry which has grown 22 per cent in the same time. One key difference between the industries is the attractiveness to larger investors with the undercover vegetable growing industry dominated by larger players including Costa Group, Perfection Fresh Australia Pty Ltd and Flavorite Hydroponic Tomatoes Pty Limited. The outdoor growing sector is highly dispersed with more than 5, outdoor vegetable producers compared with less than 9 undercover vegetable producers. The growth in undercover production is being dominated by existing players and while revenue for undercover producers has increased almost 4 per cent since 28 9, the number of establishments operating has very slightly decreased in the same time. The trend for outdoor producers, as with the rest of Australian agriculture, has been towards a fewer number of larger farms with the total area planted to vegetable growing increasing 32 per cent since 28 9, while the number of enterprises has decreased by more than 6 per cent in that same time. Interestingly, growth in revenue received by outdoor vegetable producers has matched growth in undercover production revenue for that time period. Many larger investors are now looking at expanding their undercover production systems for one key reason: reduced exposure to seasonal conditions and income volatility. Indeed, on other key metrics, including cost, income and return on equity, the two systems are highly comparable. According to figures by IBISWorld, the profit margin of outdoor production systems was around 9 per cent of revenue and undercover was around 7 per cent. Rent, utilities and wage costs were higher for undercover producers while contracting costs, fertiliser use and land costs are higher in outdoor production systems. As expected, volatility in revenue growth is much lower for undercover production which has ranged from -5 per cent to 12 per cent since 28 9, while outdoor production revenue has ranged from per cent to 26 per cent. One other key difference between production systems one which is primarily due to the strong concentration of a few undercover producers is the next stage purchaser of produce. While both undercover and outdoor producers sell most produce (around 45 per cent) to wholesalers, the second greatest market for undercover vegetable producers are retailers (25 per cent) while outdoor producers sell far more produce to the processing market (around 3 per cent), with only 6 per cent going direct to retailers. Another key difference is that undercover producers do not export their produce with almost all production destined for the local market, compared with outdoor production which exports more than 6 per cent of production. MANY LARGER INVESTORS ARE NOW LOOKING AT EXPANDING THEIR UNDERCOVER PRODUCTION SYSTEMS FOR ONE KEY REASON REDUCED EXPOSURE TO SEASONAL CONDITIONS AND INCOME VOLATILITY Data from the Australian Bureau of Agricultural and Resource Economics ad Sciences (ABARES) also highlights the fact that, whether undercover or outdoor, those producers with higher capital levels either in land, equipment or fixtures, consistently have greater returns on capital than those with smaller capital investments. As an example, for those farms with capital invested of $2.3 million, the rate of return is.5 per cent, compared with farms with capital value of more than $9 million where the rate of return is 4.9 per cent. While this trend towards undercover production is significantly more prevalent in vegetable production particularly tomatoes it is a growing trend in fruit production, with high-value exports such as cherries a good example. It is also clear that as agricultural land becomes expensive, particularly in peri-urban areas which are close to retailers, capital-intensive, undercover production systems will become more attractive. PAGE 19

22 IRRIGATED INDUSTRIES AND WATER EFFICIENCY Australian fresh fruit and vegetable production is heavily reliant on irrigated production, with 78 per cent of vegetable production, 9 per cent of fruit and nuts and 94 per cent of grape production occurring under irrigation. This is more than any other Australian commodity except rice. With increasing demand for water resources between agricultural commodities, between agriculture and urban use, and between agriculture and the environment, the question must be asked, what s the best and highest value use of limited water resources? Under National Water Reform, this question has been left to the market and individual farmers and licence holders to decide. But what has ten years of National Water Reform shown us about changes in the allocation of water between commodities? AUSTRALIAN WATER USE In , Australia used 16,132 GL (gigalitres) of water, down 7 per cent from Of this, 59 per cent was used by Agriculture, Forestry and Fishing. The decrease in consumption is mainly attributed to the reduced water consumption in agriculture in New South Wales/Victoria due to large decreases in rice, wheat, canola and sorghum plantings and a reduction in dairy water consumption in Victoria. The limited availability of water and the subsequent high costs of water led to fewer farmers watering crops and pastures in these areas. Nationwide, there was a 9.4 per cent decline in water consumption for Agriculture in , down to 9,435 GL, even though Queensland experienced increases of 9.1 per cent and Tasmania 34.3 per cent. Agriculture was the predominant consumer of water for most states and territories, excluding Western Australia (dominated by mining), Northern Territory, and the Australian Capital Territory (dominated by households). The total area of irrigated land in Australia makes up just.6 per cent (2.1 million hectares) of all agricultural land, though it generates around 26 per cent of the whole value of agricultural production. IRRIGATION PRODUCTIVITY AND WATER USE EFFICIENCY (WUE) The agriculture sector s heavy water use and increasingly volatile water resources places considerable pressure on producers to become more water efficient. The Australian Academy of Technology and Engineering has found that there is considerable potential for greater efficiencies, and that extractions from surface water and ground water can be reduced by 3 5 per cent by upgrading irrigation methods from flood and furrow systems to low pressure sprinkler or drip systems. Whole Farm Irrigation Efficiency (WFIE) demonstrates the efficiency of irrigation systems by showing the amount of water used by the plants as a percentage of total water inputs. A study conducted by Cotton Australia has estimated that during the late 199s, WFIE was around 57 per cent and has since risen over ten years to 7 per cent. Most recent data indicates that on-farm water losses are due to evaporation and seepage across crops (1 per cent), channels (1 per cent plus trail water: 1 per cent) and water storages (18 per cent). The cotton industry has also seen an improving trend in the Gross Production Water Use Index (GPWUI) which includes irrigation, rainfall and water stored in the soil to measure long-term seasonal comparisons. GPWUI shows a 4 per cent improvement between 23 and 21 from.79bales/ml to 1.14bales/ML respectively. Yield increases and more efficient water management systems have contributed to this increase with 96 per cent or irrigators improving their furrowing systems or changing to alternative irrigation methods. CONSUMPTIVE USE OF WATER (GL) 2,13,81 1,898, , ,271 1,84,171 Total agriculture Mining Manufacturing Households Water supply, sewerage and drainage services Other industries Source: ABS, ANZ 9,434,576 PAGE 2

23 VALUE OF PRODUCTION PER IRRIGATED HA Value of production per ha Change in value of production per ha (28 15) Rice $4, % Cotton $5, % Cereals for grain $ % Grapes $1, % Fruits, nuts and berries $25, % Vegetables $26, % Sugar cane $3, % Nurseries, cut flowers and turf $81, % Dairy $5, % All agriculture $6, % Source: ABS, ANZ VALUE OF PRODUCTION PER ML CONSUMED ($ AU PER ML) Change in value of production per ML (28 15) Cereals for grain and seed % Cotton % Rice % Sugar cane % Fruit and nuts % Grapes % Vegetables for human consumption % Nurseries, cut flowers and cultivated turf % Dairy production % Production from meat cattle % Production from sheep and other livestock % Total irrigated production % Source: ABS, ANZ On both the value of production per irrigated hectare and the value of production per megalitre (ML), the horticultural industries of fruit, nuts and vegetables outperform all other forms of agriculture, excluding the nursery, cut flower and turf farm sector. The gains in value over time have varied by commodity, with fruit, nuts and grapes all increasing markedly in value per ML and per irrigated hectare, whilst vegetable production has not increased as strongly most likely as a result of poor farmgate prices. The grains, rice and dairy industries have all performed poorly by comparison while cotton and livestock for meat have made impressive gains. Despite the value of production per hectare and per ML rising significantly, the average rate of return on capital for irrigated horticulture has not kept up with other irrigated industries. As an example, over the nine years to , horticultural industries in the Murray-Darling, including grapes, stone, pome and citrus fruits, all returned on average just 1 per cent on capital invested or less, while rice, dairy and particularly cotton reaped far greater rewards of 1.6 per cent, 1.8 per cent and 5. per cent respectively. PAGE 21

24 AVERAGE RETURN ON CAPITAL MURRAY-DARLING IRRIGATORS, 26 7 TO Commodity Average return on capital (ex. capital appreciation) Rice 1.6% Cotton 5.% Citrus 1.% Pome/Stone fruit.6% Grapes.9% Dairy 1.8% Souce: ABARES, ANZ Figures from the ABS suggest there have been some overall improvements to the value of irrigated production per ML. From , there has been a noticeable increasing trend in the value of irrigated production per ML and a decreasing trend in the amount of water used. However, it is important to consider the factors that influence water use and production such as water availability, water and commodity prices and cropping trends. One element cannot be looked at singularly as Gross Value of Irrigated Agricultural Production (GVIAP) trends are a reflection of a number of influences. As water consumption decreases, yields have not changed dramatically also indicating the growing efficiency of water use. Australia s main water market is the Murray Darling Basin, which makes up 94 per cent of the total volume of permanent entitlement and allocation trade in Australia (as at ). The Southern Basin holds 8 per cent of the Basin s storage capacity and accounts for more than 8 per cent of the total Basin water trading. Much of agriculture s water use is driven by water availability, seasonal conditions, enterprises and the water market. After the challenging drought period in the early 2s, agricultural businesses had to become more efficient with their water use and responded to the conditions through infrastructure and technology improvements and more selective cropping. As the drought subsided and water became increasingly more available after 29 1, there was a 56 per cent increase in the volume of water consumed per unit of economic output produced by the agricultural industry. The graph at right illustrates the trend of water use by industry, with rice being the dominant water user, although production is strongly affected by water availability and seasonal conditions. The area of land utilised for irrigation across most industries increased in , except for rice and grapes. Rice saw a 63 per cent decrease in area cropped in and a 63 per cent drop in water used to irrigate. Major declines in rice production stemmed from the significant reductions in the supply of irrigation water available to growers in New South Wales. This fall was offset by a per cent increase in cotton production with farmers opting more favourably towards cotton, which uses much less water than rice (6 8 ML/ha versus approximately 12ML respectively). The land used for cotton cropping increased by 29.2 per cent and volume of water used for irrigation increased by per cent to 1,432,93 ML. With most industries increasing irrigation areas, interestingly the number of agricultural businesses irrigating decreased by 38 per cent. These decreases were mainly attributed to reduced water allocations and sales, particularly in New South Wales. Of most interest to fresh fruit, nut and vegetable producers is the stability of production maintained despite changes in water availability and price, due to both the high value of production per ML, as well as the capital invested in production systems. Higher GVIAP/ML commodities like nurseries, grapes and horticulture products like vegetables, fruits, nuts and berries are more likely to be grown as they have a higher return per ML. These commodities also have higher tolerance to rising water prices, unlike rice and cotton growers which are heavily impacted by water availability and prices. INDEX OF WATER USE PER FARM, BY INDUSTRY 26 7 TO Cotton Dairy Source: FAO, ANZ Grapes Rice Pome/stone fruit Citrus PAGE 22

25 CASE STUDY Almonds One of the main growth commodities in horticulture is almonds. Almond production has seen consistent growth, totalling 82,333 tonnes in 217. The number of trees planted has been steadily increasing with 4,94 hectares planted in 216. Currently, the almond industry uses approximately 14 ML per hectare for mature orchards, making it one of the highest water consuming commodities. 97 per cent of farmers use drip systems for irrigation which is monitored through soil moisture technology with the aim of improving water use efficiency. With more trees planted, pressure has mounted on irrigation systems and other irrigated industries that are reliant on water. Crop yields are now increasing to tonnes/hectare and almonds are now selling for $7/kg and making returns of $28, a hectare, resulting value per ML of $2. Almond prices are heavily driven by the Californian market, with prices spiking to $13/kg in 215 during the Californian drought. From export sales have increased by 481 per cent with the value of exports in being $7,936.64/tonne. The increase in trees planted is estimated to boost production up to 15, tonnes, with 12, tonnes exported generating approximately $1 million in export revenue. Australian Almonds (Almond Board of Australia) takes the view that increasing almond production will benefit the river communities affected by the Murray Darling Basin Plan, as the water market will ensure that limited water resources are directed to those industries delivering the most value. Though most communities in the almond producing regions may be benefiting (from increased water resources), other commodities are at risk of higher water prices and limited water availability, something with which they will struggle to compete. PAGE 23

26 CONTACTS AUTHOR MARK BENNETT Head of Agribusiness and Emerging Corporate, Business and Private Bank T: E: mark.bennett2@anz.com ANDREW HECTOR Head of Specialised Industries Institutional Bank T: E: andrew.hector@anz.com JAMES MCKEEFRY State Agribusiness Manager Victoria and Tasmania T: E: james.mckeefry@anz.com STEPHEN RADESKI State Agribusiness Manager South Australia and Northern Territory T: E: stephen.radeski@anz.com ALISTER BENNETT State Agribusiness Manager New South Wales T: E: alister.bennett@anz.com MADELEINE SWAN Associate Director Agribusiness Research, Business and Private Bank T: E: madeleine.swan@anz.com CONTRIBUTORS MICHAEL WHITEHEAD Head of Agribusiness Insights, Institutional Bank T: E: michael.whitehead@anz.com ALANNA BARRETT Associate Director Agribusiness Research, Business and Private Bank T: E: alanna.barrett@anz.com CHARLOTTE MURDOCH Agribusiness Graduate Business and Private Bank T: E: charlotte.murdoch@anz.com PAGE 24

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