Food & Agriculture Clash

March 2017 Food & Agriculture Clash What Effect Would a Chinese-US Trade Dispute Have on the F&A Sector? RaboResearch Food & Agribusiness far.rabobank.com Ping Chew Regional Head, Asia +852 2103 2438 Chenjun Pan Senior Analyst, Animal Protein +852 2103 2430 Lief Chiang Analyst, Grains & Oilseeds +86 21 2893 4670 Contents Things are heating up 1 and the scale is a global one 2 Playing a game of chicken 2 Summary Detailed sector analyses based on a low-intensity trade dispute 3 With Republicans now in control of both the executive and legislative branches of the US government, the country increasingly seems poised to tackle its wide trade deficit while addressing the electoral promise of creating jobs. Among other measures, the GOP is currently touting a proposed border adjustment tax as part of an upcoming broader tax code review. This, however, might not be the only measure the White House and Congress have in mind when trying to bring back manufacturing jobs to the US, aiming to level the playing field in terms of trade and investment, especially towards China. Of course, Beijing can be expected to retaliate with similar proposals, and an ensuing trade dispute (which could potentially escalate into a downright trade war ) could not only significantly disrupt Chinese- US trade and investment flows it could also become a major hurdle when it comes to the global movement of goods. Price movements will also be highly volatile in the short term, while the global supply and operational chain could be affected in the longer term. Things are heating up In a political environment that is currently becoming both more unpredictable and increasingly nationalistic, Rabobank is attempting to scope out the what-ifs? of a large-scale trade dispute between China and the US. Although a full-fledged trade war by no means forms our baseline scenario, there are simply too many interplays between drivers, along with a wide range of actions and reactions be they (geo-)political, societal, or economic in nature to fully map out the details and offer a comprehensive scenario analysis. Instead, in this report, we would like to highlight a simple scenario for F&A, based on the analysis of two key produces: soybeans and pork. The consequences are major in these what-ifs, but we sincerely hope calmer heads will prevail. US trade with China is big: In 2016, the country exported USD 115bn to China while importing USD 462bn. 1 Although China exports very few F&A products to the US, agriculture products make up one of the top 5 categories of American imports to China, amounting to USD 23bn in 2016, with the remainder of imports occurring in aircraft, automobiles, computers/electronics, chemicals, and machinery. 2 The main US food & agriculture products that could be affected if China were to retaliate with similar measures are soybeans, pork, DGGS, cotton, orange juice, and consumer foods even in the case of a low-intensity dispute (see Table 1). Meanwhile, consumer food and beverage companies could suffer even more if the dispute were to turn into an even nastier nationalistic trade war. 1 Source: U.S. Census Bureau 2017 2 Source: International Trade Administration 2017 1/5 RaboResearch Food & Agriculture Clash March 2017

and the scale is a global one Setting aside the logic and reasoning behind trade actions and retaliations in addition to the political ability of implementing the actions for both countries a US 45% import tariff on China could lead to a 20% increase in spot prices of soy in China and FOB prices in South America (as detailed below), but perhaps only result in a smaller increase in CBOT futures prices. Direct Chinese domestic price increases for pork as a result of a 45% tariff could be more limited than those for soybeans, as farmers are able to better absorb these with their current margins thanks to a more elastic consumer market. However, input disruptions could lead to an overall decline in Chinese meat production, including poultry, resulting in an even larger second derivative price increase for poultry and pork due to reduced domestic supply. Aquaculture could benefit as a result. The impact of a border adjustment tax could naturally affect foreign companies including US companies who manufacture in and export out of China to the US. The global supply chain could also be affected in the shorter to longer term, ranging from a diversion of trade flows to new plant investments in new locations. The above analysis is by no means exhaustive nor is it deep, but it serves to highlight scenarios that have become more feasible than they were in the past. Looking beyond soybeans and pork, the impact on other US F&A producers and products could also be severe if the intensity of the trade frictions were to become significant. As recently as 2012, we witnessed scenarios in which Chinese consumers boycotted Japanese goods as a result of a territorial dispute over a group of uninhabited islands. In most scenarios, we would see some F&A winners, but they would be found in other countries, especially in South America, and in companies outside of the US and China. In the Chinese market, local companies and non-us foreign companies would benefit by taking market share from their American counterparts. Playing a game of chicken The possible outcome of all of this political rhetoric could well be that the two countries eventually agree to negotiate a package of measures to avoid a full-blown trade war. But it will also depend on a game of chicken, in which a lot of hostilities and protectionist sentiment have recently bubbled up to the surface. Chinese-US tensions are a reflection of deeper rising antiglobal sentiment. Rabobank has written extensively about these changing political winds. Table 1: The Trump White House has mentioned these 11 possible trade measures: 1. Bringing up more cases to the WTO 7. Economic sanctions on Chinese companies 2. A 20% border tax, or border adjustment tax 8. Boycotting Chinese products 3. A 45% tariff on selected, or all, Chinese imports 9. Naming China as a currency manipulator 4. Anti-dumping measures, e.g. on Chinese steel 10. Curtailing Chinese investment in the US 5. Corporate tax structure changes to address Chinese VAT tax relief 6. Increased inspection and customs administration to slow the flow of imports 11. Revising the One-China policy as part of a bargain, even though Mr. Trump recently affirmed the US government s long-held position. 2/5 RaboResearch Food & Agriculture Clash March 2017

In terms of scale and intensity, measures 1-3 could be considered to be low, yet they are already quite severe. Meanwhile, measure 11 could even lead to open conflict if the White House were to attempt to use it as a bargaining chip. Chinese reactions will depend on Mr. Trump's actions, but we can expect them to be selective if only related to the lower-intensity measures. Detailed sector analyses based on a low-intensity trade dispute Soybeans Even if the White House were to take action and raise the import tariff on all Chinese goods to 45%, we believe there is only a limited possibility that the Chinese government would retaliate on US soybeans, given China s heavy dependence on imported beans. Being the world s largest soybean importer (with over 60% of global trade), China imports roughly 86m tonnes of soybeans, of which 42m tonnes come from Brazil, 34m tonnes from the US, while the remaining 10m tonnes stem from Argentina and Uruguay. In our low-probability scenario, if the Chinese government were to boycott US beans, South America would become the sole supplier to meet China s demand. However, the USDA estimated that 2016/17 soybean exports from South America (Brazil, Argentina, Uruguay, and Paraguay) would amount to only 76m tonnes. Compared with China s big appetite of 86m tonnes, this means there is still a shortage of 10m tonnes of beans. Here are some possible consequences, which could occur simultaneously: South America holds about 15m tonnes of soybeans as inventory. China could pay high prices to buy some of these inventories. South American countries (especially Argentina) are also key exporters of soymeal. If more South American beans were shipped to China, this would slow crushing volume and disrupt world soymeal trade flows. The EU and South-East Asia are both key destinations for South American soymeal. As alternatives to soybeans, China might also increase the import of other oilseeds, such as rapeseed, sunflower seed, etc. China could consider importing protein meals and vegetable oil directly. This low-probability scenario will have a massive impact on international oilseed markets. Generally speaking, global vegetable oils and protein meals would soar. Nevertheless, the price impact on the soybean complex in different countries would vary. US Soybean prices would drop in the short term, as the country loses its number-one buyer, China. In the longer term, US soybean acreage might be affected. On the other hand, prices of soy oil and soymeal would increase due to the global shortage, leading to greater crushing margins. China The soybean price would rise, as concentrated suppliers gain more bargaining power. China would have to pay premium in order to attract South American farmers to increase soybean plantation acreage for future seasons. Both soymeal and soy oil prices would also rise accordingly. To offset mark-up, the Chinese government might lower, or even do away with, the 13% VAT on South American soybeans. The government would sacrifice some tax revenue in order to mitigate inflation risk and ensure social stability. South America The soybean price would increase, and farmers would be keen to expand soybean plantation acreage. Soymeal and soy oil prices would also increase, but perhaps to a lesser extent. We could even see an odd trade pattern, in which US soybeans are imported for domestic use, while local production is exported. Or some level of transhipment could occur from the US via South America. 3/5 RaboResearch Food & Agriculture Clash March 2017

EU & South-East Asia Both regions are key import destinations for imported soymeal. The soymeal price would be set to increase due to the global shortage. More soymeal supplies would come from the US; however, the increase of US soymeal exports would be limited due to a lack of additionally available soybean crush capacity in the US. Pork China imports only pork from the US, as American beef was banned in 2003, with poultry following suit in 2015 as a result of diseases. In 2016, China imported 215,000 tonnes of pork, out of total pork-related imports of 1.62m tonnes. China could just suspend US pork shipments due to technical issues or by levying anti-dumping duties. This would lead to increased inflows throughout the grey channel, which already plays a key role in beef and offal meat shipments to China. The gap would be filled by rising imports from the EU and South America. US producers could suffer if they are unable to find alternative markets. However, EU pork production is expected to decline by 1.5% this year, thus rendering EU availability limited in the short term. But the EU has the capacity to expand production if a strategic sourcing arrangement from Chinese companies is in place. Brazil is expected to increase pork exports to China. However, the recovery of the Brazilian domestic market would slow the export rate from Brazil to China. Overall, if a trade dispute were to occur, China s total pork imports might decline not only related to the decline of direct imports from the US, but more as a result of the price increase in the global market. Chinese grey channel activities and volume are expected to increase. In an extreme situation, in which all US pork imports would be halted, considering the US accounts for 13% of total imports in China, the decline rate would be less than 13%. More impact on Chinese domestic meat production would come from the disruption in grain & oilseed trading. The hog farming margin is originally expected to be CNY 300/head in 2017, ceteris paribus. If the soymeal price were to rise by 30% to 50%, the feed cost could go up by 7.5% to 12.5% if, on average, soymeal comprises 25% of pig feed. This would consequently reduce the margin by CNY 80/head to CNY 120/head. Producers still could make a small profit in this scenario, but market volatility would shake out many individual farmers, resulting in a decline in the hog herd. A decline of this kind should be modest, as this year s margin could accommodate some increase in feed cost. In a more volatile situation, a 4% decline in the hog herd and a 30% meat market price hike is probably the limit that the market could endure. If pork prices were to rise in anticipation, farmers would then have more ability to absorb the higher soy feed costs. Poultry would be hurt even more. White bird production is already expected to drop by 5% to 10% in 2017, due to a shortage of grandparent stock. If feed costs were higher, farmers would face too many challenges, leading to more exits from the market. White bird production may even drop beyond 10%. Poultry prices would go up significantly, subsequently impacting consumption. 4/5 RaboResearch Food & Agriculture Clash March 2017

Imprint RaboResearch Food & Agribusiness far.rabobank.com Ping Chew Regional Head, Asia ping.chew@rabobank.com +852 2103 2438 Chenjun Pan Senior Analyst, Animal Protein chenjun.pan@rabobank.com +852 2103 2430 Lief Chiang Analyst, Grains & Oilseeds lief.chiang@rabobank.com +86 21 2893 4670 2017 All rights reserved This document has been prepared exclusively for your benefit and does not carry any right of publication or disclosure other than to Coöperatieve Rabobank U.A. ( Rabobank ), registered in Amsterdam. Neither this document nor any of its contents may be distributed, reproduced or used for any other purpose without the prior written consent of Rabobank. The information in this document reflects prevailing market conditions and our judgement as of this date, all of which may be subject to change. This document is based on public information. The information and opinions contained in this document have been compiled or derived from sources believed to be reliable, without independent verification. The information and opinions contained in this document are indicative and for discussion purposes only. No rights may be derived from any potential offers, transactions, commercial ideas et cetera contained in this document. This document does not constitute an offer or invitation. This document shall not form the basis of or cannot be relied upon in connection with any contract or commitment whatsoever. The information in this document is not intended and may not be understood as an advice (including without limitation an advice within the meaning of article 1:1 and article 4:23 of the Dutch Financial Supervision Act). This document is governed by Dutch law. The competent court in Amsterdam, The Netherlands has exclusive jurisdiction to settle any dispute which may arise out of or in connection with this document and/or any discussions or negotiations based on it. This report has been published in line with Rabobank s long-term commitment to international food and agribusiness. It is one of a series of publications undertaken by the global department of RaboResearch Food & Agribusiness. 5/5 RaboResearch Food & Agriculture Clash March 2017