Tuesday, July 20, 2010

Garlic Prices Keep Rising

In May there was a lot of attention on garlic as one of the commodities with soaring prices. At the time, there was some expectation that the price would fall after newly harvested garlic came on the market. The government introduced a 2-million-yuan fine for anyone caught speculating or hoarding.

Two months later, garlic prices have risen even higher. According to a July 19 article, since mid-June the price has gone up 21.2% as of July 18 to 6.57 yuan/jin ($.97/jin or $1932/mt). In an earlier post on this blog, the price was about $.50 per lb. in May.

The upward momentum in garlic price is still strong. The price increased 17 days in a row during July.

Bad weather during the winter and spring cut the harvest. According to government surveys in Shandong's Jinxiang County, production there is down 13% this year. Traders anticipated the production shortfall and in the winter started trying to contract with growers to buy their harvest in advance. The price per mu went from about 2800 yuan per mu around the spring festival to 5000 yuan per mu in May.

At the Xinfadi wholesale market in Beijing, the price did fall after harvest, from early April's 11.8 yuan/kg to 7.4 yuan in mid May, but the price has risen sharply since early June. The price was up to 13 yuan on July 17, the highest in many years. Articles indicate garlic prices are soaring everywhere.

The chain of events began back in 2008 when there was a massive increase in garlic production and prices plummeted. Overseas markets were saturated and exporters cut prices to compete. In one region of Shandong, the volume of exports was up over 40% in 2008, but the value was actually down slightly.

After prices crashed, growers cut back on production in 2009. Prices went up again and plantings rebounded this year, but bad weather dampened the recovery of production.

Soaring domestic prices are pushing export prices higher now. According to Shandong customs statistics, the average price of garlic exports from the province are up 170% from last year. The volume of exports has fallen 24% year-on-year. This suggests that export demand is price-inelastic.

Domestic demand seems to be more price-elastic. Garlic is not a necessity, so people stop buying it when the price is high. In May, at least one article reported slow sales. A lot of garlic is being held in warehouses, limiting the volume available on the market. In Beijing's Xinfadi market, the volume of sales is said to be less than one-third the usual amount.

A trader named Zhou says his profit per-jin is fixed, so his profit depends on the volume he sells. According to Zhou, he buys garlic in production areas at 12.6-13.0 yuan per jin. Adding labor, packaging, transportation, the sale price in Beijing is 13.6-14.0 yuan. Zhou says, "I hope the garlic price will go down."

Exploding vehicles

During the summer months there have been a series of incidents where Chinese buses burst into flame. I first noticed this in a story from Beijing last month and saw another story from Tianjin today. Last year, a burning bus killed 24 people and injured 19 in Chengdu. A goole search shows reports of incidents all over the country, including a video of one in Shanghai. One article explains that overloaded buses can overheat in the summer.

Bus that caught on fire in Yan'an, Shaanxi Province, July 14

The problem is not confined to buses. Last month I saw a photo of a passenger car that had burst into flame in Beijing. The news article gave few details (such as what happened to the people in the car) and advised readers to keep their cars maintained in the summer months.

This has nothing to do with the topic of this blog but it's a reminder of potential quality problems as China gears up to export vehicles to the world.

Rice Affected by Flooding; Price Up

Heavy rains in central and south China are affecting this year's rice crop. An article from a rice investors report sponsored by Sinograin (China's grain reserve company) reported that heavy rains had caused flooding, inundating rice fields and causing pest infestations in major production regions of Hubei Province. According to one assessment, this year's rice production could be down 10%. In some areas, production may be down 20%.

Infestations of insects (planthoppers and leaf rollers) have also hit the rice crop in Hubei. Even worse, pests are affecting grain stored in warehouses. Teams from the Hubei plant protection station were sent out to inspect the rice crop in 11 counties. Most rice fields were inundated with water, conditions that encourage sheath blight, rice blast and bacterial leaf blight.

The early-season rice harvest, about 7-15 days away, was also affected in Jiangxi and Anhui Provinces. This could also affect planting of the late-season crop, planted after the early rice harvest.

However, one rice analyst quoted in the article says that it's too soon to tell how this year's production will be affected. He says there was already an expansion of rice planted area this year, and some of the lost early-season crop might be replanted for fall harvest, offsetting some of the flooding losses. A Hubei official says they are starting a campaign to replant.

Rice prices are rising. The 2009 early rice support price was .9 yuan/jin ($265/metric ton) and this year it was set at .93 yuan/jin ($274). According a rice analyst quoted in the article, last year, the market price for early rice was in the .8-.9 yuan/jin range, and this year it will probably sell at .95-.96 yuan/jin ($279-$282/mt), about 100 yuan/mt ($14) more than last year.

Officials hope to head off a big increase by selling their reserves into the market. According to the article, at the end of June the government still held:
Early-season indica rice:
500,000 mt bought in 2008
2.77 mmt bought in 2009
Single- or late-season indica rice:
5.1 mmt bought in 2008
5.1 mmt bought in 2009
That makes a total of approximately 13.5 million metric tons. [This may just be the amount they purchased at the support price; Sinograin probably has more rice reserves than 13.5 mmt.]
They will sell this rice to cool off prices if needed.

Thursday, July 15, 2010

"Grain Banks" Solve Company Cash Flow Problem

"Grain banks" are yet another interesting experiment going on under the radar in China's countryside. A "grain bank" is basically a warehouse where farmers deliver their grain after harvest. The farmer gets a passbook where his deposit is recorded. He can return to the bank and "withdraw" grain products like milled rice, flour, or cooking oil at any time and the value is deducted in the passbook.

The banks seem to have gotten started in 2006 and are still in the pilot stage in selected areas. A short note about grain banks in Henan appeared last week that kindled my interest. A google search turned up a detailed account of grain banks in Taicang city and Suzhou, another description of pilot programs in Shanxi and grain banks set up in Sichuan after the 2008 earthquake, and a description of a grain bank operated by the Beidahuang Co. in Heilongjiang (the descendent of a massive state farm set up to protect the Russian border in the 1960s).

Yiyu Grain Bank outlet in Taicang City.

A major problem with storing grain in houses is loss due to mold, insects, and rats. Articles say the annual losses are 8%-10%, a national total of 15-20 million metric tons. The grain bank supposedly stores the grain in secure facilities and reduces waste. At least one grain bank dries grain.

Farmers don't have to store grain in their houses. In Taicang, Jiangsu Province, after "constructing a new countryside," farmers have moved into new homes (probably apartment buildings) where they don't have room to store sacks of grain.

Farmers don't get paid interest. The "grain bank" basically stores and processes it for free. In Taicang's Yiyu Grain Bank, you can withdraw milled rice equal to 69% of the weight of paddy rice you deposited (this is approximately the amount of milled rice you get from paddy rice) if you withdraw within 3 months. The ratio drops to 67% if you withdraw 3-6 months later and 65% after 7-12 months. You can also withdraw unmilled rice for a 2-fen storage fee and mill it yourself.

"Grain bank" passbook.

Old Chen in Taicang calculates if he held 100 jin of rice in his home, he would have 90 jin left after spoilage, then after milling he would get 63 jin of finished rice. If he keeps it in the bank, he can withdraw 65 jin. Moreover, his family can eat fresh rice, better quality than if he stored it at home.

Farmers can also withdraw their rice at a network of grain and oil shops around the city. They can redeem higher-quality rice, flour, cooking oil, or other products with their passbook balance.

In Taicang, the grain bank deals in rice for home consumption. Grain banks in Shanxi, Sichuan, Henan, and Heilongjiang they deal in commercial grain as well. The Heilongjiang operation works with an actual bank (Minsheng) to give operating loans to farmers secured by the grain.

What's in it for the bank? The article about the Taicang bank spins a story about a grain company employee named Mr. Zhou who worried about wasted grain and thought up the idea many years ago.

The article about grain banks in Shanxi explains the real story. "Grain banks" are actually a scheme designed by the grain bureau. The grain banks are set up by the shaky companies that were spun off from grain bureaus when the market was "opened" in 2004.

Newly privatized grain companies were having trouble getting loans. Cash flow problems prevented them from buying enough grain to keep their warehouses full and to keep their mills running. The "grain bank" apparently shifts the cash flow problem on to the farmer. The farmer delivers the grain to the "bank" and gets an entry in his passbook instead of cash. The "grain bank," a front for a trading or milling company, doesn't have to pay out any cash to get grain in its possession.

It's not clear whether the grain bank actually stores all the grain deposited, or if it employs a type of fractional-reserve banking. Does it get the grain and sell it for cash, and then buy back grain as needed when farmers come to withdraw? Mr. Zhou in Taicang says farmers don't have to worry as long as the bank keeps the grain in storage, but "...if it’s sold there is more trouble."

Some experts worry that this could be a problem waiting to happen. What if "grain banks" are caught by an unexpected price movement that leaves them unable to buy enough grain to meet withdrawals?

The problem for the grain bank is that they have to bear all the price risk. If the market price rises, the value of farmers' grain deposits goes up accordingly. However, if the market price falls, they still have to meet farmers' withdrawals based on the price at the deposit time.

Why does the government like it? It reduces waste of grain and improves "grain security." They probably like it because it's easier to know where the grain is if it's in warehouses than if it's stored in farmers' houses (at least, in theory).

This is another innovation that at first glance looks like a great market innovation. Is it a step toward the commodification of grain and getting farmers accustomed to hedging and other financial transactions? Or is it a throwback to the old-style grain stations of the planned economy?

Sunday, July 11, 2010

Wheat Wars

Two articles last week, "State Reserves Keep Stocking up on Grain: Underground War" and "5-fen per Jin Profit Enticement: Sinograin Market Support Purchase Wheat Mystery", discussed a "wheat war"--hot competition to buy this year's wheat.

Eager subsidized government-purchasers, massive new flour mills, and older mills are competing for a wheat crop of unknown size. Farmers are reportedly holding their wheat off the market. This competition for wheat is bidding up prices, but the wheat market has become so convoluted that it's hard to tell whether this is an artificially-induced shortage.

China has had a support price for wheat since 2005. Under this program, Sinograin Co., and designated regional affiliates buy wheat for government reserves when the market price is below the support price set by authorities each year. This year, COFCO and the state-owned China Grain Logistics Group have also been approved to purchase under the support price program.

The warehouses get subsidized loans from the Agricultural Development Bank of China plus subsidies to cover the costs of purchasing and holding the wheat. A warehouse gets a free loan and a subsidy of .025 yuan for purchase cost and .035 yuan for management costs for each jin of wheat. But the actual costs are .01 yuan, so it adds .05 yuan of profit.

The warehouses find this program quite attractive, so they have been enthusiastically buying wheat to collect the subsidies. They have been so enthusiastic that "grain round-tripping" has become an "open secret" in the industry in recent years. In this practice, old grain from warehouses is sold off and then bought back as new grain through the support price program. The buyer collects the subsidies on the grain that never left the warehouse. This practice was suspected when, in 2008, Sinograin claimed that 80% of the wheat produced that year in Henan was bought through the support price program.

The support price purchase warehouses have been competing with a growing cadre of flour mills to buy this year's wheat. In past years, they would have people lined up outside the warehouse waiting to buy wheat; now they have to scramble to buy it. The support-price purchasers have set up buying stations in villages. Many new grain warehouses have been built, some nearby State warehouses. Big companies like the state-owned agribusiness giant, COFCO, and a Singapore venture, Yihai Kerry, have been opening a string of large flour mills that are competing to buy wheat. One mill in Shandong reportedly can use the county's entire wheat crop. With all these competing buyers, the result is rising wheat prices. Processors are having trouble getting enough wheat to keep their mills at capacity. Some are buying wheat from neighboring provinces.

Procurement under the support price program is supposed to cease when the price rises above the support. The price is now over 1 yuan per jin, well above the support price of .9 yuan for white wheat and .86 yuan for red wheat. Officially, Sinograin has stopped purchases, but local warehouses continue to buy. The support price purchase program is described as "out of control."

Privately-operated warehouses complain that the subsidies give the support-price purchasers an advantage. Counting on the subsidies, the support-price purchasers offer 4-to-5 fen above what private millers can pay and still make a profit. According to one article, "Everyone wants to get a piece of this 'fat meat.'"

Moreover, private flour mills complain that they can't compete with the new large companies who are willing to lose money on their "strategic investments" in the flour industry. COFCO and Yihai Kerry are engaged in processing and trading all kinds of commodities--COFCO is in all kinds of feed, grain, oils, and livestock, Yihai Kerry is primarily engaged in vegetable oils--and they are investing in upstream (their own farms and importing) and downstream (processing and distribution). Competitors in the flour industry think Yihai Kerry can't possibly make money at the prices they pay for raw materials.

The articles say that supply cannot meet demand. There are varying opinions on this year's production. Farmers think it's roughly the same as last year. Some think production is down 20%-30%. Another factor is that farmers have been hesitant to sell, either because they expect higher prices or they were too busy planting fall crops.

Thursday, July 8, 2010

Sow Insurance Moral Hazard

An article in the Yangzhou Evening News last week reports that sows can be worth more dead than alive. According to a worker with the local insurance company, the company has lost money since it began offering subsidized insurance for breeding sows last year, because farmers are filing twice as many claims for dead sows as they did last year.

Comic from Yangzhou Daily: "Sorry brother, I'm waiting to collect the insurance."

Because hog prices have been low, raising sows has been unprofitable. Thus, you spend more on the feed and upkeep of the animals than they generate in sales of baby pigs. They could slaughter them and sell the meat but the indemnity payment for a dead sow is more (1000 yuan).

There is a mixture of fraud and moral hazard (engaging in risky behavior because you know you're insured). The insurance worker reports that he has seen a lot of farmers neglecting to treat sows for disease in the hope they will die so the farmer can collect the insurance. He says there also have been people setting up hog farms in the suburbs that feed pigs swill from restaurants and keep them in filthy conditions "worse than a toilet." He says it would be strange if the sows didn't die in these conditions. In other cases, the farmer raises, say, 100 pigs, but only insured 50. The death rate then appears higher than it actually is.

The death rate for sows is double what it was last year. The company paid compensation for 1300 dead sows in the first five months of this year, up from 700 last year at the same time. In one county, farmers filed claims on 25% of the sows covered.

The insurance company is planning a door-to-door publicity campaign. In the process they hope to catch farmers who are cheating. Insurance will now be refused if farmers feed swill to their hogs. They've also started adjusting the indemnity payment according to the sow's weight.

Farmers can make out even better if they can sell the dead pig's carcass and claim the insurance benefit. Some netizens in Yangzhou reported small ads pasted on walls offering to buy dead pigs. The reported called two of them, both of which offered to buy a dead pig for 20-30 yuan, depending on weight. They claimed to feed the carcasses to fish, but the local fishery station claimed they had never heard of such a practice.

Wednesday, July 7, 2010

Serve the Companies! Communist as Broker

This is not your father's communist party. The slogan of Chinese Communist Party (CCP) members used to be, "Serve the People." Today's CCP has adopted a new mantra of "service," but today's motto in money-obsessed China for party members would be closer to, "Serve the Companies."

I came across a report on "Optimal Service Measures for Boosting Enterprise Development" from the statistics bureau in Xigang, a town of 131,000 people and 64 villages in Zaozhuang Prefecture in southern Shandong Province. The town has 104 party branches with over 2000 members. The town was a "peoples commune" from 1958 to 1984, and it still has a lot of agriculture, but coal-mining is the major industry.

The report portrays the unique role that the communist party has carved out for itself in 21st-century China: a team of management consultants and brokers who orchestrate the development of the economy by planning, organizing, pushing and pulling levers to construct what they hope will be a flourishing economy.

The report sounds like it might have been torn out of an MBA textbook (It might have been). The party is to play a guiding role in economic development, selecting industries appropriate for the local economy, setting up the entire industry chain--raw materials, suppliers, manufacturers, sales channels--and organizing and coordinating it all.

The party emphasizes its "project leadership." The party and government have organized leadership groups for each of 19 local projects. They periodically hold meetings where they hear about problems, coordinate, and troubleshoot.

Party leaders coordinate "resource integration." Leaders assess the available resources and identify industries that can take advantage of them. They establish "industry incubators" and promote entire industry chains. They bring together industry associations and cooperatives.

Party sloganeering about "thought," "study," "vigorous economic construction" seems to be a euphemism for re-programming party officials and the bureaucracy to become servants of industry. They use distance education to train party members on how to facilitate economic development.

Party leaders act as roving management consultants, making "survey visits" to companies for inspections and to give advice. These visits can be crack-downs on safety, pollution, or "coordinating solutions to financial problems" (telling the banks to lend money to the company). The party transmits policies, information, propaganda and guidance.

In its view, the party, government, and business are intertwined. The party sees itself as an indispensable organizer and broker that orchestrates the economy's development in an orderly and easy-to-control manner. The underlying assumption is that a central all-knowing organizer is necessary to prevent society from descending into chaos.

This seems to be a mash-up of at least four undercurrents in modern China:
(1) Traditional Chinese bureaucratic management,
(2) Leninist/socialist state-led industry planning,
(3) Hu Jintao's "scientific development concept"
(4) Jiang Zemin's "3 represents" that justified the party's embrace of private entrepreneurs.

Is this intertwining of party, government, and business the wave of the future with China's ascendance on the world stage (now that the financial crisis has discredited the free market)? There are probably many in Washington and Brussels who would like it to be, and that's a little scary.

Thursday, July 1, 2010

Why A 5th Round of Pork Reserve Purchases?

The Ministry of Commerce, National Development and Reform Commission, and Agricultural Development Bank have announced another round of pork reserve purchases. This is the fifth round since late April. The idea of the reserve purchase program is to prevent the pork price from going so low that farmers kill off their sows, leading to a shortage and soaring prices later on.

An online article notes that the hog price has started recovering in the northern regions and it has stopped falling in the south. So why another round of purchases? The author proposes several reasons.

The hog-grain price ratio is still in the "red" region, under 5:1. According to the regulations for the "hog price alert" program introduced in 2009, when the ratio is this low the government should buy pork for reserves and give 100-yuan per head subsidies for breeding sows and boars on designated farms in "pork surplus counties."

The inventory of hogs is declining, and there are fears that pork supplies will be disrupted. At the end of March the hog inventory was 433.7 million head, down 7.53% from the beginning of the year; the breedable sow inventory was 47 million, down 4.28% since the beginning of the year. The reserve purchases are intended to raise hog farmers’ incentives.

The author suggests that the intervention is also intended to aid the feed industry. Feed mills are squeezed between high corn, fish meal, and soy meal prices and slow sales due to the depressed livestock industry. The pork price intervention is intended to give the entire industry chain a push.

The author suggests that the livestock slaughter rectification program is also intended to address depressed prices for pork. The widespread food safety problems--sale of pork from dead or sick pigs, toxic additives in feed, and pumping water into pigs before slaughter--scares off consumers and reduces prices. The rectification program is intended to restore confidence and increase demand and prices.