01 Outlook 2015 Tues 0900 1030 KAREN SCHNEIDER
Welcome, everybody, to Outlook 2015. It's our 45th Outlook Conference since they started in 1971. But 2015 also marks 70 years since ABARES' predecessor, the Bureau of Agricultural Economics, was established in 1945. The Bureau began with just 22 staff, and its task was to collect and analyse data on the agriculture sector and the economy more broadly.
The domestic and international environments have obviously changed enormously over those 70 years, and so has the research focus of the Bureau. We've been active in the big policy debates over that time, from the removal of price supports and subsidies to trade reform, climate change, and natural resource assessments. Over those 70 years, the Bureau's commitment has been to provide rigorous and objective advice to governments based on economic, scientific, and social evidence. I hope we've challenged the way people think about some of those key policy issues and that we continue to do so for many years to come.
But back to the business of today, and we have a terrific lineup of participants at this year's conference. We have international speakers, including on our panel this morning, as well as domestic producers, investors, bankers, and analysts from all parts of the agricultural industry.
As Leigh said, the theme of the conference is "The Business of Agriculture-- Producing for Profit." And that's recognition of the whole range of challenges that agriculture faces-- to remain competitive, to build on the opportunities from growing world food demand, and to provide profitable returns at the farm gate that will drive continued investment. It also acknowledges that the business of agriculture is as challenging as business in any other sector in terms of the skills, technology, and managerial competence required to make a profit and attract investment, whether it's a small-scale family farm or a large corporate enterprise. And I want to focus today on the question of investment and specifically about whether rates of return in agriculture are likely to attract the investment needed to drive on-farm productivity and profitability, on whether traditional financing models will provide the necessary capital, and some of the issues we're facing in ensuring appropriate investment in infrastructure beyond the farm gate that will support the profitability of the sector.
But firstly, I'll run through our medium-term outlook for commodities, which takes us out to 2019-'20. And there are always two main assumptions that underpin the forecasts, and the first is economic growth. And the outlook for growth in the short term could probably best be described as subdued. We're expecting global growth to remain at 3.3% in 2015, to strengthen next year before moderating to around 3 and 1/2% by 2020.
Lower oil prices are expected to support the global economy in the short term but could weaken economic prospects in some of the world's largest oil and gas exporters as their revenues decline. Economic recovery in the United States is expected to support growth in the OECD, but conditions in Japan and Europe remain weak. We're likely to see high levels of public debt persisting in Japan and some Eurozone countries that will constrain government spending and be a downside risk to the outlook.
In China, the government's expected to continue its managed slow down over the outlook period, with growth declining to about 6 and 1/2% by 2020. That's much lower than we've seen over the past decades but still strong enough for China to remain a driver of world economic growth over the outlook period. Export performance in many of the emerging economies is expected to be assisted by our assumed recovery in the US and by the continued growth in China.
The second assumption is the exchange rate, and it drives the value of our commodity exports. We expect to see the depreciation against the US dollar continue over the short term to average $0.83 in 2014-'15, and year to date it's been about $0.87. And then we expect it to continue down to around $0.76, and that's close to its 30-year average.
That's driven by a decline in the terms of trade, mainly reflecting minerals and energy commodity processes, the narrowing interest rate differentials between Australia and the US, and financial market sentiment. There's obviously uncertainty around the actual level, but I don't think that direction is disputed. And I'm going to come back a bit later to look at what that uncertainty could mean for export returns.
We're expecting the value of agricultural production to be lower in 2014-'15 than the highs of last year but to recover in '15-'16 to more than $53 billion, assuming average seasonal conditions. Fisheries and forestry production will take that total to more than $59 billion. We haven't shown that on the graph there. The weaker dollar will increase average export prices in Australian dollar terms, and we're forecasting a rise in farm export earnings to $40 billion in '15-'16 and more than $41 billion by the end of our projection period.
Some of the specific commodity movements we expect over the next year are an increase in the value of wheat and sugar exports by more than 10% on the back of volume increases, higher returns for beef and dairy because of increases in world prices, and lower export values for barley and lamb because of volume declines. And speakers in our commodity sessions this afternoon and tomorrow are going to expand on those forecasts and look at some of the issues that will drive production and exports out to 2020.
But I'd like to touch very briefly on farm performance. And nationally, farm cash income of broadacre farms is expected to fall a little in 2014-'15 but to remain about 20% above the 10-year average. In the west and South Australia, income will come off the previous high because grain production is down from the record in '13-'14, and it's largely the same story in Victoria.
In Queensland, droughts remained widespread, leading to lower grain production but boosting incomes because of the high cattle turnoff. Even so, broadacre incomes are 10% below the 10-year average. It's much the same in northern New South Wales. But in the south of New South Wales, there's been a recovery in incomes because of increased grain production.
We've heard a lot about debt in the past year, and it remains problematic in some regions and some sectors. But at the national level, farm debt has changed very little. Many businesses have taken advantage of lower interest rates or good cash flow to pay down debt, and most of that's come through the use of cash surplus or profits.
In drought-affected regions, there's been an increase in debt of about 5%, mainly to cover cash flow shortfalls. But overall, equity ratios have remained quite strong. There's also a set of factors, some of which I've mentioned, that we expect will provide support to farm incomes in the next year. And they're the ones shown here.
To go back to the exchange rate, our analysis shows that for every further $.01 decline in the Australian-US dollar exchange rate, total farm income is likely to rise by about $320 million. That takes into account the increase in export earnings from a lower dollar and the rise in the prices of imported inputs, such as machinery and fertilisers.
Lower interest rates could be significant for some businesses, depending on the scale and structure of their debt. Overall, debt servicing accounts for about 8% of total broadacre and dairy costs. Most of the benefits are likely to be felt by larger farms that'll have increased capacity to expand and invest. The lower oil price environment will also contribute to lower farm costs. Fuel use is about 6% of broadacre costs, and there could be indirect benefits in lower off-farm transport costs if these are passed along.
And changes in policy settings are likely to support farm incomes as well. We've already seen some of the benefits of the recent free trade agreements starting to flow through. For example, there's been a really significant increase in exports of cherries to Korea since the agreement came into force in December last year.
There are upsides and downsides to all of these factors. Some of them may only be short term, but the overall impact on farm incomes in the short term is likely to be positive. Of course, the weather remains the greatest uncertainty, and it could have a bigger impact on farm incomes in some regions than all those factors combined.
But I want to return to the investment question and consider whether the farm sector is well positioned to take advantage of export opportunities. Increasing production to meet growing world demand for food will require on-farm investment in land to increase scale and in technology to boost productivity, as well as off-farm investment to support efficient infrastructure, especially in transport. On farm, some argue that major transformation of Australian agriculture is required and that new financing structures and sources of capital will be needed for that to happen.
Over many years, Australian agriculture has been financed from traditional debt and equity sources, with owner equity playing by far the major role. There are some new structures in that other equity category in the graph, and they include leasing. But most of that category is also owner funded to some extent. That level and structure of financing has supported major structural changes, consolidation of farms, and a sector that's competitive internationally.
But there's a question about whether that will be sufficient as investment requirements ramp up to meet the productivity and production challenges created by increasing global food demand. Other sources of capital, such as institutions, are increasingly interested in agriculture worldwide to capture returns and diversify portfolios. Attracting that capital into Australian agriculture will require rates of return that are competitive with agriculture elsewhere and with other asset classes and that are commensurate with the risks.
Here we have the rates of return and the risks generated by relatively large Australian farms. Returns are defined as the average rate of return on total capital, including capital appreciation over the past 10 years. And they're derived from our farm surveys programme. Risk is a measure of the volatility of those returns over the same 10-year period.
We've also taken the annual returns and risks of alternative assets, a term deposit or cash, and the ASX 200, including dividends. There are many other asset classes, but we've chosen those because they represent accessible forms of investment and in the case of ASX exposure to different sectors of the economy.
The line now here between the term deposit and ASX 200 shows the returns and the risk of different combinations of those two assets. And if you compare farm businesses with that line, you can see that they tend to cluster around it. Cropping and vegetables offer the highest rates of return, and dairy sits roughly on that line. And they are returns that are similar to those available from those alternative investments, given the risk involved. The beef sector falls under the line. It probably reflects the highly-variable seasonal and market conditions over the past 10 years, as well as major changes in land values in Northern Australia.
But in a very general sense and with caveats, such as the time period we've chosen and the aggregation of industries, the graph tells us that compared with alternative uses of capital commercial-scale farm businesses in Australia could be good investments. Returns are commensurate with the risk profile, and that investing in Australian farms can be a good strategy for owners of capital seeking exposure to this sector of the economy.
But the capacity to attract capital will depend on other factors too, including the scale of investment that institutions are seeking, and that can be very large for institutions such as superfunds, lack of knowledge about the agriculture sector by potential investors and how to manage its risks, and how to align the incentives of those who manage farms with those of investors. That might require some innovative thinking about financing structures and instruments, but we're seeing enough of it happening at a medium scale to suggest that there aren't insurmountable impediments to expanding the sources of financing available to Australian agriculture.
Off-farm. there's a serious question about investment in infrastructure to support profitable agriculture. We've done work at ABARES over the past year on supply chains for wheat and beef, and it highlights the urgent need for investment in transport and the reforms needed before that's likely to happen. Transport costs can be a significant component of total costs for some producers.
This takes ABARES' farm survey data on the on-farm costs of producing grain in Australia, and Australian Farm Institute data on a case study of the cost of transporting grain by road and rail from farm to port in Western Australia. And you can see that the off-farm transport cost is as big as the major on-farm costs, and those costs are also significant for beef. So keeping domestic transport costs down has the potential to make a real difference to our international competitiveness and to the profitability of farm businesses.
A number of factors influence those costs, including the condition of the infrastructure, road access restrictions, and congestion around city ports. The poor state of some rail lines and a lack of funding for maintenance have led to some lines being closed in rural areas. That's inevitably led to some wheat freight being transferred from rail to the local road network, and that's increased pressure on the already-stressed road system. It also raises questions about how increased maintenance will be funded, as many of the affected roads are the responsibility of local councils and they face declining revenues. And it highlights the need to consider the interdependence between different parts of the transport system when making investment decisions.