In 2021, Ukrainian wheat production totaled 26.8 million tonnes. Russian wheat production totaled 76.5 million tonnes. Collectively, the combined production from both countries represented 13.2% of global output. Belarus wheat production in 2021 was 7.8 million tonnes.
Sanctions are soon to be levied against Russia as well as against the Russian breakaway territories of Donetsk and Luhansk. Sanctions may also well be levied against Belarus in the coming days for aiding and abetting the Russian invasion. Russia, the Ukraine and Belarus generate the bulk of their hard currency via exports of low value agricultural commodities, minerals, chemicals and petroleum products. If the intent of the sanctions is to cripple Russia, then the world should prepare for substitutions of not just petroleum based commodities, but also agricultural and mineral commodities.
It will be difficult for global governments to fully block export sales of the basics of life from Russia; transshipments from Russia through China will certainly take place, which will be revealed should China and Chinese friendly states reduce their global order book from traditional exporters or mysteriously start exporting commodities or semi-processed chemicals that were previously in scarce supply. However, circuitous movements of grains to circumvent sanctions increases the global cost to Russia; in a price takers market, all commodities should remain elevated in price as a result.
More specifically to the Ukraine, the Donbas region represents an important producer of wheat, which might directly also fall under sanction bans. Planting, maintaining and harvesting crops in the midst of a war zone will be a challenge. It would seem self-evident that when millions of able bodied Ukrainians flee to EU countries, there will be fewer farmers and laborers to generate output. Should the Ukraine completely fall, guerilla war by insurgents may commence thereafter, which would have a negative impact on Russian laborers imported to manage the expropriated farms. As well, there is a cultural stigma involved; Russians have been historically accustomed to viewing Ukrainians as nothing more than a servant and serf class, doing the jobs that Russians consider beneath their status. After Russia redistributes the richest agricultural lands to the Oligarchs, there will be a labor shortage, few Russians willingly will work on Ukrainian farms, even if those farms are owned by Russian billionaire oligarchs. I would fully expect a significant reduction in Ukraine agricultural output, for years to come.
The Ukraine has been referred to as the “breadbasket of Europe” for a legitimate reason.
Ukrainian farm practices are primitive by western standards. Offsetting the lack of modern agricultural management are natural bounties derived from incredibly rich chernozemic soils that are, frankly, the envy of the globe; so much so that Russian oligarch support for the Putin invasion will be paid for with a land grab.
Displacement of Ukrainian production will represent too herculean a task for remaining global producers to fully offset. It is estimated that more than 55% of the total landmass of the Ukraine is farmable land, and of that amount, roughly 80% would be deemed as class A quality. The class A lands represent a massive central band running from one end of the country to the other. 44 million hectares of arable land in the Ukraine routinely produce more grain, with less work, than all of Canada, which has roughly 50% more farmable land, but nothing even remotely close to the quality of the soil formation that is found in Ukraine. I own some Canadian farmland containing black Chernozen soils and can attest to the productivity. In fact, if I were able to directly own Ukrainian farmland, implement modern farm management practice (no till, crop rotation, manure and organic compost based fertilizers, drone surveys, GMO seeds, etc.), I’d give up equity investing altogether, the economic return could be that high.
Approximately 1/4 of the world’s entire black chernozemic soil formations are contained within the Ukraine. This soil holds moisture better than other types, has an organic content almost 3X that of other agricultural soils; even a bad farmer can make a good living, provided they grow crops on black Chernozen. Russians, being bad farmers, have coveted that specific soil formation in the Ukraine for decades.
In the big picture, the war is clearly, to me, a geopolitical move supported by an economic underpinning.
Controlling both the natural gas supplies, the oil supplies and the wheat supplies to Europe will result in a continent completely dependent upon Russia. If Putin was successfully able to subdue and then subsume the Ukraine, Russia would then own ALL of the basic commodities required by Europeans to even exist. Think of an OPEC style cartel for wheat, and the shift in pricing that would result; well, you get the picture. We aren’t talking about billions, or even tens of billions of increased annual costs to consumers, but a magnitude beyond that. In a cartel style setting, that Ukrainian farmland is worth many, many, trillions of dollars. Almost everyone in the media assumes the Ukraine to be just another eastern European backwater. Unequivocally, it is the possessor of THE most valuable agricultural real estate on the planet. Control of this agricultural basin permits Russia to call the shots on basic wheat output and could apply usury pricing at will. China will call the shots on manufactured goods output pricing. The alliance between Russia and China to control both ends of the production spectrum could, effectively, over time, reduce the remainder of Europe to a region of consumer serfs. This underutilized agricultural bounty in the Ukraine, much more so than an unconvincing expression of uniting Slavic peoples, represents the logical, greed driven, rationale for the Putin invasion.
In fact, one key warning sign of Russian intent to take over the Ukraine was right in the open, long before military exercises in Belarus were noted, and we all missed it.
Russia has, since the fall of 2021, withheld precursor chemicals needed to manufacture fertilizer for the global markets. In hindsight, it appears that Russia was planning to heavily fertilize confiscated Ukrainian farmlands, in time for a spring planting, and reap windfall rewards. Putin budgeted for an Afghanistan style surrender at best, a Blitzkrieg style capture of Ukraine at worst, without even a hiccup in the 2022 growing season. At no time did the military model a drawn out war, a war of attrition or a decimation of the workforce. Ukrainian wheat production is now broken for the 2022 growing season.
The burden of replacing Ukrainian shortfalls will fall on the shoulders of remaining large exporters. Canada represents a relatively sizeable wheat producer, with 2021 production of 21.7 million tonnes. This production rate was 38% lower than prior years due to a significant drought in the key growing regions. Above average winter moisture levels in late 2021 and winter 2022 have largely restored the soil moisture levels to normal. Resolution of the drought conditions suggests that Canadian production offers potential to rise sharply in 2022, possibly enough to partially offset a dramatically reduced yield from the Ukraine, but not all. A, thus far, little mentioned point, is that basic wheat prices will remain high during and post-conflict in the Ukraine.
Canadian Pacific Railway, the recent purchaser of Kansas City Southern railway, seems to be in a “sanction/conflict” sweet spot.
22% of CP freight hauling comes from grain, 10% comes from fertilizer hauling, 20% from energy, chemical and plastics transport. Only a moderate freight haulage is tied to consumer products. The weighting is so overwhelmingly agriculturally themed that a pickup in freight, combined with freight charges that could be tolerated by farmers shipping high priced wheat, could increase top and bottom lines considerably above current analyst guidance. Any economic losses in Russia due to sanctions or supply disruption are to the benefit of Canada, which then flows directly towards a major transporter of the products, that being Canadian Pacific Railways.
With respect to potash based fertilizers (NPK) Canada represents as sizeable producer as Russia and Belarus combined. The producers of Canadian potash are located in the center of that country and the output, in order to reach European or other markets, logically would be shipped via rail to ports. Canadian potash mines have indicated that in 2022, they will be prepared to raise volumes produced by perhaps 15%.
Canadian Pacific provided preliminary 2022 guidance for freight volume expectations of possibly 8% before war broke out. That looks woefully understated at this point. The additional demand for wheat and fertilizer/ag minerals alone could add 9% to the total volumes, before pricing changes. Add to that the bulk petroleum shipments, and CP might produce the highest revenue increase, percentage wise, in almost a quarter century. The elevated earnings that should result could either be used towards a faster repayment of the debt costs associated with the Kansas City Southern acquisition and additional rolling stock to support growth in 2023.
Putin, and by association, Russia, has done something unforgivable.
Western bureaucrats, who always gauge the wind prior to publicly advocating the use of sanctions, only to later quietly remove them; politicians, who need to be legitimately shamed in public to even consider being responsible, even they might opt to hold fast on sanctions for multiple years, despite the fact that removing Russia from the global supply chain will add to inflation for all.
An opportunity exists to change the narrative on inflation, for at least a time; it could be marketed as being “for the greater good” to aid the war effort. This is no longer a cold war, it has turned hot. Provided that populations witness a legitimate effort by western nations to localize supply chains and wean themselves off of Russian commodities, European and North American leaders could sell that story to the media and make it stick for a time. If concrete results were shown, even I might buy into the premise.
Sanctions are a double edged sword, simple precursor chemicals that represent the mainstay of North American nitrogen fertilizer production might be held back by Russia as a countermeasure. Western nations typically don’t win a test of wills against Russia, maybe this time will differ. If not now, then when? The only way to eliminate Russia as a threat to global democracies is to eliminate global dependence on key Russian commodities; that could represent a novel secular trend to be monitored.
The act of removing Russian output from global trade will increase profit margins for the remaining producers and would effectively set higher floor prices on many commodities, going forward, that will ensure a base level of profitability, even in economic recessions.
Global supply models for Ukrainian wheat and other bulk agricultural products will be revisited soon by major investment firms. Oil pricing is THE hot topic globally but is extremely well covered; agricultural output and the movement of that output may also produce windfall profits for more than one growing season, given that lay of the land. Railroads generate far more reliable operating margins, year in, year out, than do the producers of commodities they are charged to transport.
CP reported a 53.8% EBITDA margin in 2021. Consolidating the lower margin Kansas City Southern Railroad business will reduce gross margins for a time, but increased transport volumes could, as merger efficiencies take hold, fully offset the previously forecast decline. KSU generated 12% of its 2021 revenues from the hauling of grain, 5.1% from corn and other food commodities, 29% from chemicals, petroleum products and coal; in total, almost half of its 2021 freight hauling revenues arose from transporting products that are now highly sought after, will presumably be more scarce for the duration of the Russian invasion and potentially be priced as a “sellers market” for some time after the conflict, should the west decide to permanently reduce dependence upon Russian suppliers.
Many determined the acquisition of KSU to be overpriced for Canadian Pacific.
In light of the current inflationary cycle, that purchase now looks quite astute. And, does a consolidated 50% + EBITDA margin not signify monopoly pricing power?