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Pepper Crop Report

Presented by Alfons van Gulick at the ESA Annual Meeting 2014 Murcia, Spain, 2014

Since 1983 we have seen 4 bull markets and 3 bear markets. Most of us are waiting for the 4

th bear market

to start rather sooner than later, but this is far from certain yet.

Black pepper prices have peaked during October 2011 at around the $7,400 per ton level, but hesitated to follow through with a downward trend. From January 2012 onward prices have been range bound at a lower level for some 16 months only to move up again during June-July 2013 to establish a new high at around $7,800 per ton. What has happened here and is this new push for higher prices justified? In other words “Why do pepper prices remain at the higher levels?” To answer this question we need to go back to basics first, which is the underlying supply and demand situation.

Since 2006 world production has been increasing steadily and is estimated at just over 400,000 tons for 2014. When compared to the start of the current price cycle in 2006 world production increased by approximately 64,000 tons or some 19%. So apparently the higher prices did motivate farmers to produce more pepper. However, when looking at the individual producing countries we can see significant differences. Indonesia hardly increased its production when compared to 2006. In fact production decreased significantly and is one of

the factors why pepper prices started to increase from 2006 onwards. Only from 2012 onwards production moved back to just above the 2006 level and is now estimated at around 60,000 tons for black and white together. In general the area under cultivation in Indonesia is fairly stable, but yields can fluctuate significantly due to weather circumstances.

India produced 60,000 tons in 2006 and today is estimated at 45,000 tons.

Brazil was at 50,000 tons in 2006 and currently only turns out some 40,000 tons.

Only Vietnam saw its production increase significantly from some 100,000 to 140,000 tons. So apparently the price factor was not a big motivator for farmers to increase production other than in Vietnam. This is strange because during previous price cycles we did see an increase in output in most of the producing countries

Why this difference in behaviour? There are a couple of reasons that can be thought of. Most input cost like labour, fertilizers and crop protecting chemicals did increase considerably. The latter two are likely to be the same in most producing countries. Differences are in labour cost, with Vietnam and India probably being the lowest. However, the most striking difference is in the

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yield per hectare with Vietnam outperforming India and Indonesia significantly. So the incentive for farmers to invest in pepper in India and Indonesia is low when compared to Vietnam and Brazil. The yields shown are averages and the problem with averages is that they may give a somewhat wrong picture. Yields in Vietnam and Brazil seem OK, but when taking into consideration only healthy vines and healthy plantations yields are likely to be quite higher. Actually attracted by the high prices considerable new plantings have been made both in Vietnam as well as Brazil. However, these extra volumes are off-set largely by dying vines due to disease and exhaustion. In pursue of higher revenues farmers are applying fertilizers and crop protecting chemicals, but in doing so they shorten the life span of the vines considerably. The need for crop alternation is often

disregarded as a result of which newly planted vines will also have a shorter lifespan than when planted on virgin land. It is estimated that in regions like Gia Lai, one of the largest growing regions in Vietnam, annually some 10% of the planted acreage dies because of the over-use of fertilizers and crop protecting chemicals.

Other factors that may come into play in deciding whether or not to plant pepper are also the attractive returns on competing crops like coffee, rubber, cashew, etc.

The next graph provides a closer look at the production for each origin country over the last 4 years with a forecast for 2014. As can be seen Vietnam is still increasing production to around 150,000 tons for 2014, whilst Indonesia is expected to recuperate from its lower output last year. Rumours have it that the 2014 Indonesian black pepper crop will be lower again, but these rumours seem to be unsupported by facts so far. Weather patterns have not been extraordinary different, although rainfall was a bit heavy during the latter part of 2013. Normally Indonesia, all other factors to be equal, will have a good harvest following a bad one.

The 2014 harvest in India is smaller at around 45,000 tons when compared to last year’s level of 54,000 tons.

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Beginning stock Production Consumption Imports Exports Ending stock Production Consumption Imports Exports Ending stock

Indonesia 25.671 47.000 9.988 0 55.045 7.638 60.000 10.188 0 46.021 11.430

Vietnam 12.863 145.000 5.614 15.074 139.200 28.123 150.000 5.810 6.050 155.000 23.363

Brazil 7.054 39.000 6.519 0 33.050 6.486 39.000 6.675 0 33.050 5.761

India 7.779 54.000 57.193 17.344 16.000 5.930 45.000 58.251 26.500 10.000 9.179

Malaysia 7.789 23.000 8.323 1.021 15.000 8.487 23.000 8.490 1.021 15.000 9.018

China 12.398 35.000 45.679 11.000 3.000 9.719 37.000 47.374 13.000 3.000 9.345

Sri Lanka 543 23.000 3.708 0 17.000 2.835 24.000 3.801 0 17.500 5.534

Others 4.125 24.000 12.360 0 10.200 5.565 26.000 12.731 0 10.200 8.634

Total 78.222 390.000 149.383 44.439 288.495 74.782 404.000 153.319 46.571 289.771 82.263

Black pepper

Beginning stock Production Consumption Imports Exports Ending stock Production Consumption Imports Exports Ending stock

Indonesia 23.752 29.500 6.804 0 41.592 4.856 42.000 6.940 0 32.568 7.348

Vietnam 11.737 122.000 5.614 15.074 116.478 26.719 126.500 5.810 6.050 132.278 21.181

Brazil 6.101 37.000 6.394 0 31.050 5.657 37.000 6.550 0 31.050 5.058

India 7.779 54.000 57.193 17.344 16.000 5.930 45.000 58.251 26.500 10.000 9.179

Malaysia 5.335 20.000 7.843 1.021 12.113 6.400 20.000 8.010 1.021 12.113 7.298

China 5.525 2.000 14.124 11.000 0 4.401 2.000 14.873 13.000 0 4.528

Sri Lanka 543 23.000 3.708 0 17.000 2.835 24.000 3.801 0 17.500 5.534

Others 4.125 24.000 12.360 0 10.200 5.565 26.000 12.731 0 10.200 8.634

Total 64.897 311.500 114.040 44.439 244.433 62.363 322.500 116.966 46.571 245.709 68.759

White pepper

Beginning stock Production Consumption Imports Exports Ending stock Production Consumption Imports Exports Ending stock

Indonesia 1.919 17.500 3.184 0 13.453 2.782 18.000 3.247 0 13.453 4.082

Vietnam 1.126 23.000 0 0 22.722 1.404 23.500 0 0 22.722 2.182

Brazil 953 2.000 125 0 2.000 828 2.000 125 0 2.000 703

Malaysia 2.454 3.000 480 0 2.887 2.087 3.000 480 0 2.887 1.720

China 6.873 33.000 31.554 0 3.000 5.318 35.000 32.501 0 3.000 4.817

Total 13.325 78.500 35.343 0 44.062 12.420 81.500 36.353 0 44.062 13.504

2013-2014 2014-2015

2013-2014 2014-2015

2013-2014 2014-2015

China remains one of the big unknown factors. We know that China is a net importer when considering the substantial quantities of barter trade between Vietnam and China. Estimates go as high as 25,000 tons that disappear across the border into Chinese noodle consumption. We will come back to this later when discussing domestic consumption.

Overall global production is expected to be close to 404,000 tons, an increase of 14,000 ton when compared to last year. Exports are estimated at 290,000 tons.

The table below gives the break down between black and white pepper fundamentals. White pepper production in Indonesia has been picking up well over recent years and

is now estimated at some 18.000 tons, which mainly represents production at the isle of Bangka and some smaller regions like Kalimantan. Possibly production is higher because there is uncertainty about the level of the domestic consumption. China is considered to be the largest producer, but most of this is consumed domestically. Vietnam is filling the gap as white pepper is produced by decorticating black pepper; this as opposed to the other origins where the traditional method through fermentation is applied. So in theory Vietnam’s capacity to produce white pepper is substantial. Normally the average loss on decorticating black into white is some 25-30%. This also explained the increase in price difference between black and white pepper when the general price trend is upward. Skins were seen as production losses. However lately we see that skins are sold as by-products generating some revenue. This in theory should reduce the gap between black and white. Also it increases the output of pepper as the conversion losses are reduced.

Global consumption

Global consumption is estimated at 393,000 tons of which some 238,000 tons is to be consumed in non-producing countries.

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Consensus has it that global consumption is growing by 2-3 % per annum, of which emerging markets take the lion’s share. Possibly that with the slowdown of the economic growth in these emerging countries also the growth in pepper consumption will be less. Future will tell, but assuming a conservative 2% growth means that consumption will increase by almost 8,000 tons per year. The world needs some 33,000 tons of pepper per month to satisfy demand.

Consumption in producing countries

Approximately 38% of global production is consumed in the producing countries, which for 2014 is close to 153,000 tons, with the majority taken by India and China.

When comparing the consumption per capita to the GDP per capita one can see remarkable differences, which can possibly be explained by different habits in spicing up one’s food.

Malaysia’s per capita consumption is quite high, even considering that its GDP per capita is high. As a comparison the per capita consumption in more developed countries like USA and Europe is around 190 grams. Then there is China with a domestic consumption estimated by the IPC (International Pepper Community)

at around 32,000 tons, which is 23 grams per person. Compared to its GDP this seems extraordinary low. We maintain 35 grams per capita leading to a domestic consumption of 47,000 tons, which may still be on the conservative side. Anyhow, estimates of domestic consumption used by various reporting bodies are highly debatable and should be studied in more detail.

Stock levels

For the last two years production did fall marginally short of consumption.

As a result the global inventory position has been declining steadily since its peak level in 2006. We estimate combined stocks in producing and consuming countries around 121,000 tons at the ‘end of the imaginary global crop season’. The stock ratio (global stocks divided by global demand) is decreasing to worrying low levels of some 30% or 16 weeks of demand.

The first impression may be that a global stock level of 121,000 is more than adequate , but considering the fact that in order to fill the pipeline between origin and the end consumer some 92,500 tons is needed a global stock position of 121,000 tons is not that much.

So, we cannot escape the conclusion that the global supply and demand situation is in a delicate balance.

Prices

The following graph shows the relationship between price and stock ratio. Clearly can bee seen that prices move opposite to the stock ratio, meaning that when the stock ratio is lower prices tend to move higher. Coming back to the question at the beginning of this paper of

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whether or not the current high prices are justified, from the above analysis and the ‘stock ratio versus price’-graph we can safely say that they most likely are. Current price levels seem to be defendable and are likely to rule higher as the stress between supply and demand will get more severe. As long as stock ratio’s continue along a declining path it is unrealitic to expect prices to decrease.

That does not mean to say that prices cannot fluctuate. Earlier on reference was made to the ‘imaginary global crop season’. A ‘global crop season’ is a phenomenon that does not exist. Crops are being harvested during different periods of the year and therefore the supply and demand balance will not be the same during the

entire year. Prices may fluctuate with crops being harvested or stocks being liquidated or build. This provides the zig-saw pattern in the supply graph. In any given year there is a difference of 70,000-90,000 tons between the lowest point and the highest point. However by keeping an eye on the global supply and demand balance one can make at least an educated guess of what to expect for the medium to long term.

An important point to note is that during the last 5-10 years or so the structure of the market has changed quite significantly. The number of international trade houses with the capability to move the market has reduced. In stead origin players have become more sophisticated and financially more strong. So the ‘’control’’ has shifted clearly to origin, of course helped by the tight supply and demand situation. More specifically in Vietnam, the most important origin, farmers have acquired the financial strength to hold on to their pepper, giving them a possibility to play the market and, more ofther than not, hold the collectors, warehouses and exporters at their mercy. At the moment an additional factor is that interest rates in Vietnam have come down and collectors are able to take bank borrowings to finance inventory positions.

With current price levels for products like pepper, but certainly also coffee, farmers make at least good double their costs. This should continue to motivate them to plant more pepper. But, as mentioned before, they are also likely to continue to boost their yields through more intensive use of fertilizers and crop protecting measures.

In conclusion we can say that despite the increase in global production the supply and demand balance is still tight. Consumption growth is estimated at 8,000 tons per annum but farmers’ net growth in output seems only to be just enough to cater for this. In theory there is enough pepper to satisfy global demand. But with global stocks at historically low levels for a couple of years now on the one hand and strong holding capacity in producing countries on the other hand we seem to have a coctail that can be quite explosive. Current price levels seem to be justified and we would need to see a significant jump in production for prices to drop to lower levels. Barring any adverse weather circumstamces Vietnam will no doubt continue to grow its acreage, so will Brazil. India may produce a normal crop again and Indonesia, as we have seen in the past, can go back to 60-70,000 output. New growing areas in Cambodia, China, Thailand, etc may also add some volume. Compared to 2014 supply this can make a difference of some 50-60,000 tons or just over 15%, which should be enough to put a lid on prices going forward. However this would leave 2014 still exposed. Future will tell….