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Institutional Investment Into Agricultural Activities:Potential Benefits and Pitfalls

Angus Selby – Vice President Morgan Stanley Commodities

Morgan Stanley

LAND GOVERNANCE IN SUPPORT OF THE MDGS: RESPONDING TO NEW CHALLENGES

Washington, DC March 9 and 10, 2009

Please contact author for permission to cite any elements of this presentation : angus.selby@ms.com

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Presentation Themes

1. Fundamentals of Agri Product Supply and Demand

2. Categories and Motives of Different Institutional Investors

3. Investment Strategies

4. Impacts and Results to Date

5. Revisiting the Farm Size Efficiency Debate

6. Conclusion: Potential Benefits and Pitfalls

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Supply Fundamentals

• Key Concerns:

– Soil– Water – Climate Change – Volatile Weather Patterns – Politics and Security (protectionism)– Crop Quality– Technological Advance (genetics)

– Storage and Logistics/Infrastructure

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Arable Land Pressure Global Arable Hectarage Per Capita

0

0.05

0.1

0.15

0.2

0.25

1960 1970 1980 1990 2000 2010

Timeline

Av

e H

a/C

ap

ita

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Source: FAO

Rate of top-soil destruction exceeding that of soil rehabilitation or improved structure on existing arable. There are limits on new land too.

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Demand Fundamentals

• Key Drivers:

– Population Growth– Dietary Shifts in Emerging Markets - Feed conversion ratios– Increasing Urbanisation in LDCs – Biofuel Policies – Historically Low Stock-Consumption Ratios – Quality Differentiation

• Key Destruction Factors:

– Credit shortages – Speculative Premiums– Ethical Issues (eg: GMO)

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Key Investor Categories

• Investment Banks • Hedge Funds and Private Equity Groups • Pension Funds • Sovereign Wealth Funds • Sovereign Strategic Funds • Established Agri-business

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Investment Strategies

• Public Listings - undervaluation of established Public entities allowing quick exposure, lower risk and good upside

• Private sector - pre IPO investment through controlling stakes captures more potential upside but risks are higher

• Sovereign strategies to guarantee food security off-takes, and/or raw material

• Processing, Logistics and Trade Sector – suppliers, research, storage, transport and processing – existing agribusiness has concentrate in this area

• Speculators (land play) ; based on precedents in Eastern Europe

• Longer term equity and operational strategies to complement existing agri-related business interests – eg trading desks , processing industry etc

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Producers

Machinery Suppliers Input Suppliers

Processors

Storage Insurance

Financiers

Marketers/Traders/logistics

Contractors

R and D

Retailers

Incre

as

ing

Risk

Incr

ea

sin

g R

etu

rns

Historical Risk-Return Patterns in the Ags Chain

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Producers

Machinery Suppliers Input Suppliers

Processors

Storage Insurance

Financiers

Marketers/Traders/logistics

Contractors

R and D

Retailers

Incre

as

ing

Risk

Incr

ea

sin

g R

etu

rns

Recent Risk-Return Patterns in the Ags Chain

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Key Investment Destinations by Geography

Industrialised Nations • USA; Canada; Western Europe: Australia

Emerging Markets • Eastern Europe; Russia; Ukraine; Brazil;

Argentina; South Africa; Indonesia

Frontier Markets • Sudan; Angola; Madagascar; DRC

PUBLIC CAPITAL FLOWS INTO DOMESTICCHINESE & INDIAN AGRIC SECTORS

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Patterns of Investment into Publicly Listed Companies Quarterly Capital Flows into Major Agri Commodity Indices

-12

-10

-8

-6

-4

-2

0

2

4

6

Q1-06 Q2-06 Q3-06 Q4-06 Q1-07 Q2-07 Q3-07 Q4-07 Q1-08 Q2-08 Q3-08 Q4-08 Q1-09

Timeline

US

$b

n

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Source: UBS Estimates

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Impact on Land Markets in Ukraine Morgan Stanley

Ukraine Land Markets: Price of Right to Access Long Term Land Leases

0

1000

2000

3000

4000

5000

6000

2007 2007 2007 2007 2007 2007 2007 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008

jun jul aug sep oct nov dec jan feb mar apr may jun jul aug sep oct nov dec

Timeline

USD

/ha

equi

vale

nt

Primary Market - Aggregating individual leases from individual villagers

Secondary Market - Transfers of collective leases from private large scae farming companies - going concerns

Public Market - Values attributed to Land Holdings of International Publicly Listed Companies

Source: A.Selby; Corporate Sources

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Impact on Land Prices in Emerging Markets Morgan Stanley

Source: A.Selby; Corporate Sources

Recent Global Land Price Patterns

0

2000

4000

6000

8000

10000

12000

14000

2007 2007 2007 2007 2007 2007 2007 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008

jun jul aug sep oct nov dec jan feb mar apr may jun jul aug sep oct nov dec

Timeline

US

D/h

a e

qu

iva

len

t

Poland Brazil Zambia Argentina

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Recent Sovereign Land Deals

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Source: GAIA Capital and www.grain.com

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Revisiting the Farm Size: Efficiency Debate

Considerable Negative Press on Global Land Grabs; need for a differentiated assessment and to raise some questions about what are progressive investments and what are likely to be regressive investments

Perspective in the development sector that production scalability at the farm level is a myth, and that small farms are more efficient across the spectrum.

–Selective literature on selective geographies and systems, which incorrectly isolates the production function from the integrated operating environment and its core interrelated elements: finance, inputs, management, storage, processing, logistics and marketing

Direct experience at the Production level suggests that Optimal farm size patterns vary between sectors, and systems.

–Not enough attention to the interrelated operational realities and complexities of the agri-chain and the benefits of aligned objectives, activities and scale.

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What does ‘efficiency’ actually mean in this context?How does it relate to the following:

• Productivity/Output ? • Profitability ? • Food Security ?• Environmental Sustainability ?• Optimality ?• Linkages ?• Vertical Integration ?• Employment ? • Skills transfer?• Capital use efficiency?• Management adaptability/flexibility ?• Ability to manage risk ? • Ability to access and influence policy (lobbying power?)

• Or should it be a Holistic integrated oganisational concept of ‘all the above’ and how they relate to the local context?

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17Farm Size (Different Scale for Different Farm Types)

Eff

icie

ncy

2

3

1

4

8

5

6

7

Small scale producers can be relatively efficient given optimal use of low

cost family labour

Medium scale producers less efficient as forced to enter labor market but too

small to enjoy economies of scales or management

Best commercial farms enjoy economies of scale, mechanisation

and optimality, plus competitive advantages in innovation, marketing and other core factors through the

operating matrix

Best Corporate farms enjoy economies of scale and

optimality, plus competitive advantages in innovation, marketing and other core factors. Capital access generally much better

Inefficient or badly run large scale operations are usually less productive per unit area than poorly operated small or medium scale outfits such as

those at position 6

Occasionally an exceptional business model will scale high

efficiencies over huge areas but this is unusual in the agric sector which is part art part

science

More often than not huge farms are based on extensive or speculative bases which are usually the least productive and inefficient per unit

area due to stretched management

Unproductive small farms typically characterised by

deteriorating soil and water resources, poor practices and/or families with health

(eg: HIV) difficulties

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Variations in Farm Size and Efficiency

Range of efficiencies

significant: Top 10 percent of most farming sectors make 90 % of profit

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Yield and Cost Comparisons between traditional small scale production systems and Large scale professional producers

Traditional Production Technology and

Systems

Large Scale Professional Producers

Zimbabwe Maize

(1980-1990)

1.7t/ha 5.2t/ha

Zambia Maize

(2005-2008)

1.5t/ha 5.5t/ha

Ukraine Wheat

(2005-2008)

2.2t/ha 5.0t/ha

Ukraine Wheat

Costs of Production

(2005-2008)

US$230/t US$130/t

Zambia Maize

Costs of Production

(2005-2008)

US$225/t US$185/t

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Sources: Selby (2006); Conservation Farming Zambia and A. Selby personal analysis

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Farm Types and Farm Sizes

• Optimal farm sizes vary between crop types and systems. Dependent on:

– Production system – Propensity for labour/machinery trade off – Product Value Ratios – also food v cash – Capital requirements– Perishability– Logistics – Markets

Contrasts Illustrated: Eg 1: Staple commodity grains - 10,000ha mechanised farm in Ukraine

Eg 2: Mixed local food security – 2 ha Casava, vegetable and fruit tree farm in northern Zambia

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LAND

PRODUCTION

FACTORS

WATER

Infrastructure& equipment

INPUTS

LABOUR

FINANCE

PRODUCTION

OPERATIONS

SERVICE PROVIDERS

&RnD

STORAGE &

LOGISTICS MARKET

MARKETING

FACTORS

INCOMEEMPLOYMENT

SKILLS

DEVELOPMENT FOOD

SECURITY

MANAGEMENT

FACTORS

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Complexities of the Integrated Operating Environment

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Institutional Investment: Potential Benefits

• Bridge the Capital Gap• Introduce a Sustainable Business Model • Facilitate Enabling Environment • Improve Local and General Food Security• Create Employment• Catalyse Economic Linkages • Local Processing and Value Add• Technology Transfers • Skills Development and Management Training• Market Access • Risk Management Systems and Strategies• Improved Lobbying Power • Environmental Awareness and Sustainability • Facilitate Broader Development Partnerships

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Institutional Investment: Potential Pitfalls

• Monopoly/Cartels• Market Manipulation • Undermine Local Business Development • Land Grabs • Displacement of Local Farmers• Exploitation of Local Communities • Domination of Local Resources• Expatriate Enclaves• Social Instability • Local Food Insecurity • Environmental damage

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Investor Checklist:

How do we define between Good Investors and Bad Investors

• What are the Core Objectives – to build a business? or capture arbitrage?

• Short or Long Term perspective ?

• What Business Model ?

• Past Experience and Track Record in the sector ?

• Location of Investment in the Ags chain ?

• Operating Standards ?

• Impact on Local Communities, and Markets ?

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Conclusions Conclusions

• Land and Agriculture will be increasingly strategic issues in the next decade, requiring considerable allocations of attention, resources and capital

• Within this forecast are exceptional opportunities but also exceptional risks

• It will take a concerted effort of dialogue and collaboration and partnership between the key interest groups to navigate these stormy waters successfully

• Institutions such as the World Bank; FAO and IFPRI have a significant role to play in facilitating these partnerships between governments, rural communities and the private sector agribusiness chain.

THANKYOU !THANKYOU !

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