The new ‘agrarian’ revolution

We are in for a new green revolution which will complete a cycle in the world economy dating back from the middle of last century. The agrarian revolution which began then was followed by an industrial and an information revolution. A new “green” wave is just around the corner.

Are we really in for changes serious enough to be able to claim that, starting from an agrarian revolution, through an industrial and an information revolution, we are back to another agrarian one?

Behind the triviality of the fact of growing food prices, we are seeing today the start of an irreversible process which leads to a change in the structure of world economy. The most fundamental reason is the approaching Hubbert peak.

Back in 1956 US geophysicist Dr. M. King Hubbert made the prediction that some time after it reaches a peak in the discovery of new oil deposits, the US will also reach a peak in production. Proven oil reserves reached their maximum in the early 1950s. Towards the end of the decade production began to outstrip the discovery of new reserves. Hubbert’s theory was proven with accuracy, and the peak in production was reached in 1970. We have seen a constant decline in the production of crude in the US since.

Applying Hubbert’s model to world oil extraction, we can note the following: The peak in the discovery of new reserves was reached as early as in 1965 (reserves discovered today are on average 5 times fewer on an annual basis than in the peak 1965) In addition, following 1981, world oil consumption annually began to outstrip the discovery of new reserves.

Depending on these two velocities, the forecast is that the production peak may have already been reached in 2005, or will be reached in no more than 10 years.

In spite of a 57% rise in oil prices in 2007, production in oil-exporting countries has declined by 2.5% and will likely remain flat in 2008, according to US Department of Energy data.

• Data show that the combined oil production of the world’s 800 largest deposits currently has been on a constant decline, by 4.5% annually, or 3.8 mln barrels on a daily basis each year, according to Cambridge Energy Research Associates.
• Demand, on its part, will likely reach 116 mln barrels daily by 2030, with a current demand level of 87 mln, according to the Paris-based International Energy Agency.
• Total and ConocoPhillips analyses demonstrate that starting in the fall of 2007, the highest threshold of possible daily production ever possible is 100 mln barrels daily.

These figures are largely sufficient to lend credibility to the Goldman Sachs forecast of 200 dollars-a-barrel oil prices even before the end of 2009. Gazprom’s forecast, announced in mid-June, is USD 250 in 2009. We have already seen USD 140 levels – in June 2008 – when the price was USD 100 at the beginning of the year.
                                                                
If Hubbert is right, before too long, USD 200 per barrel may seem a ridiculously low price for oil. This is also the starting point for the below conclusions on the structure of the world economy, and more specifically, agriculture.

Let us note several reasons for the “revolutionary” changes we are in for. No doubt, the first one has to do with high oil prices. Second is the already much discussed dramatic development in China and India, where GDP growth has been a constant average of about 10%. The direct consequences here are twofold: huge demand for more oil both for industry, and for the automobiles of a wealthier population. Along with that, a direct consequence of a middle class quickly growing in numbers and wealth in these countries is a growing demand for food both for end consumption and in livestock rearing. A third reason for the coming “revolution” in the world’s economy is the battle against global warming. It suggests credible pressure, including economic, against oil fuels and the encouragement of biofuel production.

Let us for a moment imagine that in 2020 in the EU and the world overall, 20% of liquid fuels will be of bio-origin. This would mean that approximately 20 mln barrels of oil currently exported will be replaced with fuel from countries which produce agri-based bio-fuels. Even if we use the rather moderate forecast of USD 200 a barrel by 2020, this would mean that, in a manner of speaking, daily, USD 4 billion will head towards farmers and bio-fuel plants in the US, Brazil, Argentina and Ukraine, instead of the Gulf, Russia or Venezuela. In world trade, this would likely mean a change in the world export of goods of 5%. If we take, however, the 15 largest oil exporting countries, this would constitute more than half of their exports. No matter how calculated, this constitutes redirecting export revenues equal to the GDP of the ninth largest world economy – Canada’s.

This fact brings numerous ramifications: let us mention some. The economic development of populous and lagging regions in many countries will be given a decisive push. Another effect will be stimulating the economic and social development of countries with democratic political systems, at the expense of authoritarian ones, which are most of the oil-exporting countries. The rest of the world will be granted economic independence from the oil exporting countries and their political influence will decline, in contrast to countries with a well-developed agricultural sector. And the fight against global warming will be given a strong push through a reduction in harmful emissions.

How realistic is it, however, for the world to use 20 percent biofuels? Given a price of a barrel of oil of at least USD 75, even without dedicated tax incentives, the production of bioethanol for example (a petrol substitute) is entirely competitive with oil-based fuels. Investment interest towards bio-fuels will be simply unstoppable, even only as economic logic:  supernormal profit will be a fact for a while. Hence the 20% growth forecast for the relative share of biofuels in world consumption is not excessive; more likely, it is very conservative. It may even be that we are in the neighborhood of a 50% share by the end of this century’s second decade.

And what will happen to feeding the poor in the world given food shortages as a result of biofuel production, some would ask. Likely due to social, economic, and political reasons, the debate on genetically modified crops will quickly reach an end in favor of Monsanto – the largest producer of genetically modified crops. Although last and least, a role will be played by the apparent harmlessness of genetically modified crops to human health. And increased investment in agriculture as a result of the need for biofuels will significantly improve yields.

How will all these effects look in Bulgaria, a relatively small economy whose GDP in 2007 was EUR 29 billion, a new EU member and formerly a traditional agricultural producer? The results in Bulgaria may be transposed to less developed countries as well, where agricultural conditions exist and may lend a much more dramatic end effect.

Up until 20 years ago agriculture accounted for nearly 12 % of the country’s GDP, whereas in 2007 its share was 6.2%. About 3 mln hectares are farmed, with up to a total of 4 mln available. The total gross added value of the sector was EUR 1.8 billion in 2007, inclusive of farm crops and livestock rearing.

Source data for our calculations are land prices of nearly EUR 130 per decare (0.1 hectare) in 2007. The price of basic grain crops such as maize was approximately EUR 150 per ton for the same year, with an average yield of 450 kg. The calculations for wheat, as well as crops such as sunflower and rapeseed, both biofuel yielding crops are identical. The price of livestock products is directly derivative from these source prices and conditions, in as much as fodder from these crops is used in that production.

Let us attempt to determine the threshold price which could prevail for agricultural products such as maize, that would guarantee a 10 to 12% profitability of industrial assets for the production of biofuels from that particular crop. We base our analysis on existing and planned facilities for Bulgaria. The result is impressive: the price of maize per ton will exceed EUR 450, as an example. At this price for the bioethanol-producing crop, given the biofuel is sold at market prices, investing in biofuel production will have the usual industrial profitability. Or, in other words, we can expect practically a threefold increase in the price of agricultural produce and its GDP contribution.

The use of high-yielding genetically modified crops resistant to draught and disease, as well as investment in irrigation systems and better agrotechnical processes, will lead to a two-fold increase in the volume of production in 2020. If the forecast GDP growth averages 5%, 2020 GDP will be EUR 52 billion, and the share of agriculture will reach 15.3%. The same holds for the price of end produce. Thus the overall increase in the value of agricultural produce and the sector’s GDP in 2020 should be six-fold relative to 2007 values.

There is no valid reason why the same result will not hold for agricultural production worldwide.  True, modern irrigation and genetically modified cultures are largely a fact in developed countries such as the United States, but it is also true that high profits will stimulate the development of agriculture in countries with high unused potential, such as in Africa and Latin America for instance. Going back to Bulgaria: a 15% GDP share will lend agriculture importance comparable to tourism and will transform the sector from a marginal one to a leader in the country’s economy.

Finally, let us take a look at potential investment in the sector. We can effectively expect a brisk market in land for at least half of the arable land, or 15 mln decares, with average prices of approximately EUR 700-800 per decare in 2020. A well-organized system of public real estate investment trusts already functions successfully in Bulgaria with respect to farm land, and we can expect no less than EUR 5 to 7 billion dedicated only to the acquisition of farm land in the years until 2020. Logic commands that significant investment will be directed towards logistical and distribution centers and warehousing facilities, as well as irrigation facilities and farm equipment, with investment totaling EUR 10 billion, or a ten-fold increase relative to investment in the sector in 2007.

What kind of conclusions may be drawn from the analysis so far? In the coming years, we will witness a completely different green agrarian revolution which is almost entirely driven by a practically unlimited demand and a strongly limited supply, in other words, by the purest possible market “driver” for an economic revolution. And so the result will be on a much larger scale: the overall increase in the total value of agricultural production will be six-fold by 2020.

For this to happen, no significant additional support is needed at the political level; however, a better understanding of the processes is required. Negative sentiment, largely unfounded, may delay a completely logical ascent of biofuels. It is commendable that countries like the US, Germany, Brazil and to some extent the European Commission as a whole have a clear and well-argumented stance in support of biofuels.

However, the same cannot be said of some hyperventilating UN members: “biofuels are a crime against humanity” and the complete lack of understanding of the market logic of food and fuel by individuals such as Britain’s Prime Minister, Gordon Brown, who insists on a reduction of the already negotiated goals on the share of biofuels within the EU. The French administration and farmers have had similar reactions, and have fought relentlessly against growing genetically modified corn.
The truth is that an economically and morally grounded solution to the problem of growing oil prices lies in the next agrarian revolution, based on biofuels and genetically modified crops.