Sanctions weighing on Russia’s grain industry

Sanctions weighing on Russia’s grain industry

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 Russian grain farmers are seeing profitability decline dramatically this season due to a lack of Western technology, spare parts and seeds coupled with logistics issues and a labor crisis. The grain industry suffers from rampant uncertainty as the fundamental problems are likely to worsen in the long run.

In 2023, the Russian wheat industry’s average profitability is expected to plummet by 60% compared with the previous season and nearly threefold compared with 2020-21, according to a marketing study conducted by Moscow, Russia-based consulting firm Jacob & Partners, a former Russian subsidiary of McKinsey. The financial difficulties will start affecting output in the 2023-24 marketing year, when wheat production could drop by between 13% and 19%, as farmers move to scale down their businesses.

About 20% of those surveyed claimed that most likely the excess eventually would be lost due to a shortage of storage and transportation capacities.
An opinion poll conducted among the 96 managers of Russian grain companies showed that the biggest problem in the industry is large warehouse stocks. Almost half of the respondents said they have no idea what to do with an excess of grain in the warehouses accumulated due to last year’s large harvest and export difficulties stemming from the economic sanctions levied by North American Treaty Organization (NATO) countries following Russia’s invasion of Ukraine in February 2022. 

About 20% of those surveyed claimed that most likely the excess eventually would be lost due to a shortage of storage and transportation capacities.

“In the current prices, grain stocks worth 260 billion roubles ($3.4 billion) are in peril, normally associated with (a lack of) long-term storage,” said Alexey Poroshkin, an analyst with Jacob & Partners,

He said that to keep this figure from growing even more, Russia will need to export around 4 million tonnes of grain monthly, a relatively high figure even for the pre-sanction times.

Russian farmers also cited labor shortages as a critical problem. To some extent, it was worsened by the September 2022 mobilization, when 300,000 men were drafted into the Russian army, according to official information.

It also is estimated that 500,000 to 1 million Russians emigrated from the country last year. Farmers say these factors severely aggravated a labor crisis that already was an issue in recent years.

 Isolation fears

In addition, Russian grain farmers voiced concerns over a lack of some imported inputs they rely upon. For instance, 19% of the survey participants warned about a shortage of high-quality seeds. One of the market players told the analysts that “until now, we have not seen highly productive Russian varieties of wheat and barley,” adding that on some crops it would be impossible to replace imports in the foreseeable future.

“We will not find an alternative for sunflower, so we will have to reduce its production,” another market participant was quoted as saying.

Mounting problems also are seen on the technical side. About one-third of the companies surveyed admitted problems with their tractor fleets, while 25% have experienced difficulties in renewing their combine harvesters. About 70% of the respondents named the lack of serviceable machinery as one of the critical challenges they face.

In both segments, the problems, to a degree, could be mitigated through the development of “alternative transport corridors,” according to the Jacob & Partners study.

In the wake of Western sanctions, the Russian government greenlighted parallel import — a scheme allowing Russian businesses to import a long list of sanctions goods from countries deemed as unfriendly without the permission of the brand’s owner. This tool proved valuable in some fields but is unlikely to help Russian grain farmers in 2023.

On March 1, the Turkish government halted the transit of goods sanctioned by the European Union and the United States to Russia. Since the beginning of the Ukrainian conflict, Turkey has emerged as one of the key hubs for re-exporting sanctioned goods to Russia. Kazakhstan also plans to restrict transit of export-controlled goods to Russia, and other Central Asian countries have been reportedly warned by the EU about the risks of helping Russia circumvent sanctions.

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Still, as the authors of the study suggest, in addition to Turkey, Russia could try to source necessary goods in Iran and China.

In 2023, Russia’s grain harvest could drop to 120 million tonnes, or even lower, from 153 million tonnes the previous year, owing to problems with the technological base in the industry, Arkady Zlochevsky, president of the Russian Grain Union, said.

“These (problems) mean that due to lack of money, we will not be able to carry out the whole range of technological work,” he said. “In this case, weather risks come into play to the fullest. And as soon as the weather gives some unfavorable factor, the losses from it will be much greater than if in case of the technological sowing.”

Facing financial issues, Russian farmers must cut the use of fertilizers and plant protection agents, use cheaper seeds, and look for other cost-saving solutions. This problem primarily concerns independent farmers, which manufacture most of the country’s grain.

“In agricultural holdings, which have a large concentration of resources, we do not yet see a drop in technological effectiveness,” Zlochevsky said. “But all agricultural holdings produce 20% of grain (in Russia) in total.”

He added that this situation could worsen the outlook for the Russian grain industry in the coming years.

“With the loss of technological effectiveness, the decline (in output) is gradual,” Zlochevsky said. “The accumulated effect of fertility is working for the time being, and the earth gives out more than they (farmers) put in, but this is the sucking of juices.”

Low prices

However, Russian grain farmers do not expect their financial health to recover this year, since domestic prices remain extremely low while the floating export duty eats a lion’s share of profit from export operations.

Zlochevsky warned that grain prices in Russian provinces have fallen below the break-even point. He disclosed that, for example, in the Saratov region, the wheat price dipped below 9,000 roubles ($125) per tonne, while the sunflower seeds market saw a catastrophic slump in prices from 30,000 roubles ($340) to 20,000 ($220) roubles per tonne.   

In theory, soybeans may become the most profitable crop for Russian grain producers next season, but there are no guarantees.

“Many relied on oilseeds but look at the state of the current oil market,” Zlochevsky said. “Oil prices have fallen since (sunflower) oil is dependent on global oil prices, which are now down as two banks collapsed in the US.”

He said uncertainty remains exceptionally high in such conditions.

In an optimistic scenario, Russia could export more than 60 million tonnes of grain this year, Zlochevsky said. However, he admitted that while the available infrastructure would allow for that, and even though prices on the global market remain more attractive, the floating export duty imposed by the government in July 2022 means farmers can’t compensate for the losses they suffer from selling grain on the domestic market.

“The whole marginality is being eaten up by duties,” he said. “In fact, if there were no duties, the exporters’ marginality would be in a normal state, and everything would roll swiftly, as it was before.”

Russian grain farmers have lost around 1 trillion roubles ($15 billion) due to the floating export duty, Zlochevsky said. The losses the farmers suffer on the domestic market due to lower prices are much higher than that figure, he added.

Russian grain farmers have repeatedly called on the authorities to abandon the duty, claiming it performs solely a fiscal function — collecting money for the state budget. Russian officials, however, argue that the duty is needed to control prices on the domestic market and, consequently, to tame food inflation. Russian farmers, in turn, believe there are more effective tools to achieve that goal.

However, it appears likely that the floating duty will remain in place. In fact, Russia is planning to wrest more money from some commodity producers and state companies. Russian Finance Minister Anatoly Siluanov recently disclosed that the government seeks to collect 300 billion roubles ($3.5 billion) as a one-time voluntary contribution from a business. This contribution is being sought to cover the country’s staggering budget deficit.

The leading Western grain traders’ recent decision to exit Russia is likely signaling that the government wants to consolidate control over grain exports.
The Russian federal budget deficit for January and February 2023 was almost 2.6 trillion roubles ($45 billion), already 88% of the budget planned for the whole year. The deficit was attributed to reduced oil and gas revenues and increased spending. Struggling against the looming financial crisis, the government also has discussed raising the income tax. The new measures, if approved, will lay a weighty burden on the already troubled Russian grain farmers.

The leading Western grain traders’ recent decision to exit Russia is likely signaling that the government wants to consolidate control over grain exports.

Viterra and Cargill reportedly will stop selling Russian grain at the beginning of the 2023-24 marketing season (July). The Russian media reported that Western grain companies faced some administrative pressure to leave Russia, though this information has not been confirmed officially.

In December 2022, the governors of three Russian regions appealed to Russian President Vladimir Putin, urging him “to strengthen state control in the field of grain exports,” including by restricting operations of foreign business in this industry.

The Russian newspaper, Expert, reported in March, citing its own sources, that the Russian veterinary body Rosselhoznadzor suspended granting export certificates to Viterra, Cargill and other Western companies operating in the grain market, which technically made it impossible for them to continue operation.

There is no clarity as to why the Russian authorities moved to push foreign traders from the grain market, but Expert said the industry is likely moving toward nationalization, adding that “the topic of food and international trade in it has become an element of big politics, and an important component of Russian diplomacy.”

The publication said “the effectiveness of total state control of the grain industry,” like in the days of the Soviet Union, is far from obvious, but it looks like those days may be returning.

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