Over the past few months we’ve been speaking about the environmental inspections in China and the rising cost of agricultural chemicals. In recent discussions with Chinese factories, it seems there are a few more factors at play and the changes underway today are structural rather than cyclical.
Firstly, the focus by the Chinese government isn’t just on the chemical sector, they have concerns about pollution and overcapacity in the steel manufacturing and mineral sectors as well. In fact, there is a strong argument for over capacity being the real issue across all sectors and pollution is just the by product, therefore the measuring stick when it comes to controlling it.
If that’s the case, then the current crackdown on pollution is really a crackdown on capacity.
We have a supplier with a small factory producing intermediate chemicals for Carfentrazone. This factory has been closed now for over 50 days at a cost of USD6000 per day. This owners dilemma is to find the funds to invest in cleaner processes and start production again as soon he completes the work, sell the business to an investor who can complete the work or shut down entirely. The truth is that the government is happy with any of these outcomes.
What does this mean for agricultural chemicals? In the short term there are going to be shortages as factories are closed down. That’s the stage we are at now. As some of the closed factories will fail to reopen, in the medium-term supply will remain constrained.
The question of what happens in the long term will depend on how much the prices of agricultural chemicals increase. If they increase significantly, the remaining factories will reinvest but this time in extra capacity. If they only rise slightly, the markets may find a new equilibrium where over-supply is no longer the issue it once was, environmental concerns have been addressed and prices have all risen to some extent.
The take out for Australian farmers is this may be as good as it gets for the cost of chemicals and we will have to wait a period of years for the picture to become clearer.