Mar 30, 2022

Russia’s Invasion of Ukraine Contributes to High Prices and Uncertainty 

Much of the conversation around the economic impact of the Russian Ukrainian conflict has centred around the oil and gas industry. However, with both Russia and Ukraine being key agricultural product and commodity exporters, the implications for global markets could be significant.

At a time when prices are already skyrocketing, there is a risk of substantial price increases to everyday staples like flour, potatoes and cooking oil. There are also legitimate worries that some countries may even experience food shortages because of the war in Ukraine.

According to Jonathan Braams, a portfolio manager with AIMCo’s Infrastructure & Renewable Resources team, agricultural commodity prices are expected to remain elevated, at least for the foreseeable future.

“Russia and Ukraine are two very important regions for the global supply of agriculture commodities. If farms in Ukraine can successfully get a crop in the ground (for those fields not already sowed), apply the required inputs, and are able to harvest and sell/deliver to global markets, prices could come down assuming no other significant global supply disruptions,” he said.

“However, decreased supply from Russia or Ukraine, potentially paired with other global supply disruptions, could lead to global shortages resulting in elevated prices sustained over a longer period.”

Wheat prices have increased nearly 75% over the past year. Currently, the front month futures of wheat, are trading around USD 1,100 per bushel on the Chicago Mercantile Exchange (CME).

But wheat isn’t the only commodity being impacted.

Russia is the world’s biggest exporter of synthetic fertilizer. The country supplies more than a fifth of urea, a key fertilizer, to some European nations. The price of potash, a key ingredient in fertilizer, has doubled from a year ago. Ukraine supplies the European Union with just under 60% of its corn and nearly half of key grains for food and livestock feed.

On the surface, increasing commodity prices might seem like good news for farm operations, but high commodity prices don’t necessarily correlate one-to-one with greater profit. According to Braams, increasing prices of agricultural inputs are offsetting commodity price increases.

“The high rate of inflation is felt strongly by agriculture too,” said Braams.

“High prices are having a profound effect on the key input costs to row cropping operations — consider things like fertilizer, chemicals, fuel and labour.”

In order to deal with high prices and alleviate a grain shortage, it might make sense to plant more crops. However, as Braams explains, farming is a lot more complicated than simply planting and selling more.

“You can't necessarily just plant the profit-maximizing crop every year on every plot of land. Having a strong crop rotation is important to make sure you decrease risks associated with pests and diseases and ensure you're maintaining proper nutrient levels in the soil. The result is a better yield,” said Braams.

The present price environment factors into decision-making and the profitability of a large agricultural operation such as Lawson Grains, one of Australia’s leading corporate grain farmers and an asset AIMCo clients hold in their Renewable Resources portfolios.

“Investing in the establishment and maintenance of crops up front without knowing where commodity prices are going to be when you harvest does present risks for farmers and these risks are amplified when input prices are high,” explained Braams.

“There are options to forward sell a portion of your expected crop, however, these options are not perfect. Although futures contracts and other derivatives can be used to hedge international prices and currency movement, production risk and basis (the difference between cash price in a production region and the price that is quoted in the futures market) can complicate things. If you forward sell more than you produce, you may run in to trouble.”

Agriculture is volatile from year to year due to constantly changing commodity prices, production yields, input prices, and of course, the weather. The diversification across regions, crop types, end-use markets, and climate zones is key to constructing a portfolio that can perform strongly over the long-term, across market and climate cycles.

While all this uncertainty plays out on global agricultural markets, Canadian consumers continue paying the price at the grocery store. The latest inflation numbers from Statistics Canada issued in February, show that food prices rose 6.7%, year over year. That’s well above the Bank of Canada’s 2% annual inflation target. While the Bank is attempting to cool inflation by bumping up its key lending rate, the situation in Ukraine is an additional factor that could complicate its efforts, and those of central banks around the world.