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Gro’s CEO Sara Menker at Societe Generale: Market Risk and the Agricultural Sector

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Gro Intelligence’s CEO, Sara Menker, joined Societe Generale’s Michael Haigh on Tuesday, March 1, to discuss global agricultural markets amid heightened volatility. 

This interview has been edited for length and clarity.

Inflationary Pressures and Market Risk

Michael Haigh (Societe Generale): We're going through something I've never had to experience in the last two and a half years in energy markets. We have an energy crisis that started with people worrying about a lack of investment in oil and gas, because everybody wants to move into more sustainable energy, and hence higher prices. Now we have this shock from Russia in Ukraine. So the impact on agriculture is quite dramatic at this point in terms of fertilizer. Can we talk about that? Inflationary pressures that are coming into agriculture? What types of inflationary pressures do you think we're experiencing? 

Sara Menker (Gro Intelligence): It's very rare in markets to see both supply and demand side shocks occurring at exactly the same time. That's the environment that we're in, across products - in proteins, in grains, and in grains that feed into protein. There are all these interdependencies across these products. 

You also then have fertilizer and the cost of fertilizer, which is hugely tied to natural gas prices and natural gas infrastructure. As an input cost, in the U.S., over a third of the cost of production goes into fertilizer. It's not an inconsequential piece of the profitability component for the farmer.

There are two types of inflationary pressures: 

  1. Markets where we have huge amounts of concentration risk, in terms of where certain products are produced or consumed, specialty crops that we actually are not tracking. In which case, a single thing that goes wrong in that one market leads to very long term outcomes. 
  2. Other markets, such as grains and oilseed markets. South America is having a second year of consecutive drought. And both Brazil and Argentina, in terms of corn and soybean production, are the areas to watch. Because, in the market that we're in, if you look at the USDA estimates versus our real time yield models and estimates for Brazilian corn and beans, and the same for Argentina, we expect pretty significant downward revisions on production estimates from the USDA. That can add significant inflationary pressures. On the seed side, you're still tied to the biofuels conversation. And on grains, it's a bigger grain market conversation, but also again, tied back to fuel through ethanol. The connection back to the energy markets and the interconnection between ag and energy is increasingly hard to actually untangle.

Biofuels present an interesting conundrum, I think, to the agricultural world, because biofuels use agricultural products for the production of fuels. It goes back to sunflower oil. Vegetable oil prices have been under significant pressure.

We did a really interesting exercise recently. We looked at all of the commitments that have been made over the next few years over biofuels and the adoption of biofuels and the estimated increase in biofuel production over the next three years. What does that correspond to in terms of the amount of food needed for people? So really taking the full supply chain into account. 

From a calorie standpoint, how many calories are we extracting on an average caloric consumption basis over the next three years? It's the equivalent of calorie consumption for 1.9 billion people. Brazil and the US produce 89% - 90% of the world's ethanol so those two markets are the largest agricultural producers.

We're going to be confronted with some really tough realities around how that translates into our food systems. On one side, we're increasing biofuel production to reduce a carbon footprint.  But on the flip side, there's this unintended consequence around potentially keeping food prices elevated for some time to come.

Haigh: One of the things that we are asked to do, when we think about forward thinking on the commodity complex, is to forecast prices. Unfortunately, we get that wrong most of the time, but we kind of cover ourselves by saying, 'Okay, what could go wrong to the upside and the downside.' Are there any downside risks?

Menker: I would say the crop in Russia and Ukraine is something to watch right now. Our models indicate that those are going to be very healthy harvests. We saw this happen in 2014, prices were up 25%, and then just came crashing right back down. I would say that's one downside risk. 

The second is at what point does demand actually start to drop? What's that tipping point of price? Understanding elasticity is a really important component. Because if you look at the markets - and when I say the markets, I'm talking about the companies that are producing products that we as consumers consume - they're operating on very thin margins right now. And those margins are supported by much higher demand numbers. 

So a world of much thinner margins, combined with a slight drop in demand, I think, can actually lead to a significant precipitous drop in prices and demand. That is a very realistic conversation we need to be having, what that tipping point is when demand will actually start to turn.

Impact of Russia-Ukraine Conflict on Global Ag Markets

Haigh: Ukraine and Russia are members of bread basket Europe. How do you see this playing out?  

Menker: I think we start with the more macro landscape of where Russia and Ukraine, in the Black Sea region as a whole, stand in global agricultural markets. Combined, they produce about 14 to 15% of global production and supply almost a third, about 29 to 30% of global wheat exports. Another key product is sunflower oil. They're actually about 75% of global exports of sunflower oil supplies. Then there's fertilizer, which is tied to natural gas, and fertilizer prices are quite high already. Major buyers of Black Sea wheat are North Africa, the Middle East in particular, and Egypt. 

One of our models is the Gro Drought Index. It measures drought on a scale of zero to five on a consistent basis for the whole world every single day. And then you can weight the location of that drought by a particular crop. So you can weight the drought index to wheat-producing regions in these countries.

One of the big red flags we see is that North Africa and the Middle East today are experiencing droughts that they haven't experienced in over 20 years. So they have extremely high levels of drought, as well as very large dependence on imports from the Black Sea region. 

From a trade flow standpoint, Egypt is going to have to start looking elsewhere. Iran looks like it's going to import almost up to 40% more wheat this year than it did last year. There is a relatively tight wheat market. If you look at global stockpiles, we're looking at 10+ year lows in terms of availability of supply. 

On the more positive side, it looks like both Russia and Ukraine will have pretty good harvests and crops. There's always a trade to be had. The question is for what price, both from the underlying commodity standpoint, as well as the shipping costs. 

The big buffer to sanctions has actually been China, in my opinion. China, and being able to export that wheat into China as an option, changes the dynamics quite a lot.

With China, the one thing to keep in mind is that this has been part of its broader five year plan, which is this idea of what they call absolute food security. In the Chinese context, food security is not self-sufficiency. This notion of absolute food security, which they introduced about three or  four years ago, is this idea of diversifying trading partners, such that you don't have over dependence on a single trading partner.

Future Land Suitability and Supply Chain Resiliency

Menker: Russia and Ukraine are great examples of where warming temperatures have resulted in land becoming more suitable to grow crops that weren't suitable to grow. Some of these newer frontiers will also be driven by not even investment but a natural progression as temperatures increase.

Whereas in some economies, such as Sub Saharan Africa, unfortunately, the shocks have been net negative and are projected to be that - unless we make investments in some of these areas that are net calorie importers around innovations to manage those shocks.

We want to understand the spatial distribution of outcomes, and then say, okay, given that distribution of outcomes, how do we repurpose our world to accommodate for what that reality is under different climate scenarios. The experiences are going to look very different around the world. It will look different in Africa than it will look in North America, but more importantly, it will look very different in eastern Texas versus Western Texas. 

Climate change is also going to be about the predictability of those outcomes increasing or decreasing. So, volatility. Volatility itself is bad because that itself will impact crops very differently. Some regions are certainly going to show significantly more volatility in the outcomes than other regions are, in terms of stability.

Longer term capital allocation in our food systems and agricultural markets becomes a very important conversation to have to be able to mitigate climate change in a world where we continue to be as short term as we are. We have to change that quite a bit for us to be able to build resiliency into the system. 

I think there's a lot of conversation around climate change and carbon -  and carbon sequestration and regenerative ag that are quite exciting. However, the science is still very early in terms of being able to measure sequestration at the field level and scale that at a global level to be able to generate and create the right carbon credit markets that we need, etc. 

But the first set of satellites that are actually going to be able to detect methane and other types of emissions are just going to be launched later this year in Q3/Q4. That, to me, is exciting. 

No matter what we do as corporate citizens today, and whatever we do to reduce our carbon footprint, the outcomes from a physical climate standpoint, from now until 2016, are largely predetermined. But we are going to be able to innovate for the future in such a way that we can be resilient to the changes that are coming. 

It will be a journey to generate the right amount of data, be able to calibrate it, do something with it, but at least we're starting to make progress on the science front that will help us to systematically look at and measure all of this consistently across the world. 

Moving Capital Markets Forward with Data Infrastructure

Menker: Better available, standardized data serves two main purposes:

  1. It reduces volatility in the markets because more people have access to that flow of information, whether it's supply and demand balances on natural gas or oil or understanding power, etc., on a real time basis. 
  2. It allows for much longer term capital allocation to occur and for markets to think on a longer term basis. 

In agricultural markets, very little of that data infrastructure existed, and more importantly, very few agricultural markets are even traded on formal exchanges because agriculture really represents 10s of 1000s of different products. Each one has a very different set of biological rules that govern how they grow and how they’re produced. And the demand side is very much fragmented as well. 

So I set out to build Gro, which is a platform that ingests all of the disparate data sets that have anything to do with global agriculture, not just exchange traded ones. And then not only to standardize and normalize that data and make it more real time, but also to take that data and convert it into insights and knowledge. 

In our case, our challenge was taking in very, very large amounts of data, distilling it into some set of much smaller set of data sets that people can consume and understand - to be able to understand supply and demand balances on a real time basis for every combination of agricultural product everywhere on earth, every single day. Everything from the grain markets to specialty crops like black pepper, vanilla, fresh produce, proteins, dairy. It's the full ecosystem and supply chain, not just a specific part. 

What we've done is leverage vast amounts of environmental data that comes from satellites, weather stations, etc - combined with fundamental ground truth data, whether it's from government agencies, private companies that report yields in different countries, etc. - to create machine learning based yield forecast models that help us forecast supply every single day throughout the growing season for every district that grows that crop. 

We've been able to leverage ground truth. You always want to keep yourself accountable because ultimately agricultural production and yields manifest themselves in physical outcomes, physical outcomes that we can measure. 

That is our edge. It's leveraging our understanding and the domain expertise that exists within our team to build the right types of models, to generate the insights that we need as a world, and to be able to move capital markets forward.

Driving Dialogue Across the Ecosystem

Menker: We work with corporates, financial institutions, and public sectors/governments.

Corporates - If you think of Corporates, it's again across the supply chain, so input companies, companies that are in the middle of the supply chains, processing, trading the physical products, etc. And then at the edge, retail, people who are distributing fresh produce or proteins on supermarket shelves. 

Financial Institutions - On the financial sector side, there are three categories:

  1. Lenders, who are designing credit models or looking at credit portfolios to assess risks for lending that occurs, again, across these products. 
  2. Insurance companies that insure a lot of agricultural products against oftentimes weather related risks and outcomes
  3. Asset managers, everything from quant funds to macro funds to equity funds that could be using our data as signals to trade markets. 

Public Sector - Governments use our platform and customized versions of our platform for managing national strategic reserves. Lots of countries are net importers of products and don't have infrastructure to support the knowledge that they need. Public sector is also in the form of nonprofits, public institutions that are supporting oftentimes initiatives in developing markets.

The role of Gro is an objective arbiter of dialogue, of conversation, of truth, of knowledge, and honesty of what these answers are, to be able to ask some of these hard questions. We have data to support the conversations in the dialogues that we foster. Then you can start to drive change.

It's about bringing many of the players across the ecosystem - some of the world's largest businesses and asset managers and governments, but also small nonprofits, academia, really small companies as well - to be able to have that full ecosystem-based and systems-based approach to driving that dialogue.

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