In our last article we emphasized the need for more market research, an area where we fall far short of our grain industry’s needs. From one end, we must stay on top of global grain production and export trends to understand competitive challenges we face; from the other, we must pay more attention to consumption-trends, industry-structures, and supply-chains in order to target export opportunities in end-markets.
We had left grain market research largely in the hands of grain companies, mainly bulk-traders in global markets. They had to understand global market dynamics and guide local production trends as best they could in their trading interests. They got support from public agencies, who shared a vested interest in trade and economic growth, but the primary market research responsibilities fell on grain companies.
We embarked on our trade-facilitation mission because we did not believe the bulk dependence of the grain-economy was serving producer interests well. Primacy of bulk-exports hindered diversification to higher-value crops, and squeezed producer-margins. Also, taking comfort in our past growth record, stakeholders were not aware of the competitive threats coming from lower-cost, emerging grain-regions.
We are trying to bring attention to these competitive threats, and as slow as it may be in coming, we sense growing awareness of these threats, and the necessity to be looking for alternative export-channels. But in order to convince producers of direct-export prospects, we need to present more concrete evidence of market potential, which is only going to come from more in-depth research into targeted markets.
Thus, market research is as important an element of our trade-facilitation mission as promoting the virtues of our grain economy to prospective buyers. As we develop revenue-sources and attract contract-research funding, we will expand our capacity with a dedicated market-research team. In the meantime, we have to be content with what we have got, and dig into our existing knowledge and experience base.
Here we are drawing on some our past work, a study we had done a few years ago on China’s wheat-flour supply-chain. After looking into consumption, production, and import trends, we had examined the structure of the flour-milling industry and its technological advancement. We had identified wheat export opportunities that would allow millers to produce higher grade flours to meet new market demands.
In the abysmal state of our current trade-relations with China, we are not at all sure whether these exports would materialize now, but there is always hope of these opportunities coming back in the near future. At least, we thought this study would serve as a useful template for the type of market-research we need to do more of to find new export markets, and target prospective buyers in those export markets.
China’s wheat demand and supply
China’s two food-crop staples are wheat and rice, with annual consumption at about 120 MT and 140 MT a year, respectively. Rice consumption per capita has been quite steady at a little less than 100 kg/year, while wheat consumption has been on the rise but only modestly, about 1% per annum, now at about 90 kg/year and expected to reach the same level as rice in 10 years. Historically, rice used to be the southern staple and wheat the northern one, but that distinction is now fading.
The split between these two staples is the same as in Korea, Japan and India; China consumes about the same of both as Korea, but more than India (by 25%) and Japan (by 55%). Per capita wheat consumption in other parts of the region is about the same as Japan, but rice consumption is higher, particularly in Thailand and Vietnam (latter 2.5 times China). Thus, there is little income effect on per capita consumption of either wheat or rice; by all accounts culinary traditions seem to dictate the mix.
In the graph below, in addition to rice and wheat, you also see China’s per capita coarse-grain consumption, which unlike these two staples has been on a much more rapid rise, from 120 to 180 kg/year in 10 years, by 50%. These crops are used primarily for feed, and reveal the sharp increase in meat consumption (as well as in milk and eggs) we talked about in our earlier article. This has been the big affluence-effect on Chinese diets -- meat, always there, but now consumed in larger quantities.
Going back to wheat, China’s consumption per capita is already among the highest in Asia Pacific, but still fairly low compared to other parts of the world. The US and Argentina consume more than China by modest margins (15% and 35%) but others like EU, Ukraine, Russia, Canada and Australia consume much more, 2.3-3.0 times.
Given the rice in the mix, China’s wheat consumption is never going to reach these high levels of wheat consumption. But based on culinary trends we observe, it is conceivable that annual per capita consumption may reach 150 kg. The prevailing rate of growth, 1% per annum, can be met through domestic yield increases, but if the pace of growth is faster, China may not be able to escape importing more wheat.
In the last 50 years China’s grain production increased from less than 30 MT/yr to 130 MT/yr. As a result, China became the 2nd largest wheat producer in the world, only 12% less than the largest, EU. This was the result of persistent yield-increases as land allocated to wheat production did not change much, increasing from 25 to 30 million hectares but than falling back to the same level -- mainly giving way to corn.
Before the reform era, the 1960s and 1970s, China’s annual wheat imports were about 5 MT, 15% of its consumption. Into the first two decades of the reform-era, 1980s and 1990s, some years wheat imports reached as high as 15 MT. By the turn of the century, production increases through higher yields had caught up with with consumption -- China had finally achieved its long standing goal of self-sufficiency.
Since this time, domestic wheat production has been higher (albeit with a small margin) than consumption. But some years wheat imports still topped 5 MT, as in addition to achieving self-sufficiency China was trying to build up its reserves of what it considered an essential food-source. Its wheat-stocks reached more than 100 MT, 40% of the world-total and enough to sustain its own consumption for an entire year.
Now that the critical food-security goals have been achieved (in both wheat and rice domains), China’s priorities in both agriculture and trade have shifted. There is a sense that yield-increases have already plateaued (now at the same level as the US), shifting the focus in agronomy to quality improvements through seed-breeding. China is determined to protect land already allocated to agriculture but further increases are unlikely, particularly in view of irrigation and environmental concerns.
Thus, we are unlikely to see much increase in wheat production, at best sub 1% per annum but even that is unlikely to be sustained. However, if wheat consumption rises above domestic production, China is not going to limit imports. If consumer preferences driven by dietary or culinary trends give rise to more wheat imports, nobody will stand in the way. With huge trade-surpluses, the last thing China will limit are imports along the food-chain -- signs of affluence are always welcome.
Flour industry and technology
The next link in the wheat supply chain after production is milling. One way or the other 100 MT of wheat end up at flour mills – residual going to seed-supply for next year’s harvest, into the animal-feed-chain, or to food-processing plants. The flour milling industry is highly proliferated with more than 4,000 mills and ridden with overcapacity – annual capacity at more than 250 MT but actual grind only 85 MT.
More than half are small mills with less than 100 T daily capacity. There are 500-1000 mills in the medium-range with daily capacities varying in the 100-400 T range. There are about 350 mills above 400 T/day, but even that threshold is small in today’s standards; modern ones can grind more than 4,000-5,000 T per day. The larger mills achieve better utilization, but most if not all, still have some capacity to spare.
The scale-factor makes technology adaptation and automation possible, at lower cost with huge quality advantages. First, higher extraction rates can be achieved, thus more flour output from a given wheat intake. Second, grading, mixing, cleaning and purification become easier and more effective, thus milling becomes more forgiving of the wheat-quality intake. Third, flour can be produced with the desired particle-size, ash-content and other attributes most suitable for the end purpose.
In view of these advantages the obvious question to pose is why China’s milling industry is taking so long to consolidate. One factor is the industry’s cost-structure; material costs (wheat intake) make up 80-85% of the value of flour. Embedded in those costs are inbound transportation, mostly trucking. Producers tend to opt out to the nearest flour-mills, as small and primitive as they may be, delivering wheat with their farm-trucks. These mills, creatures of the collective era with their capital costs already sunk, keep operating as long as they can cover their operating costs.
Another factor that prolongs the staying-power of these primitive mills is that their principal customers are local, catering to traditional buns and dumplings, uses that are very forgiving of flour-quality. As we will get to later, these are the principal uses of flour in China. As the market shifts to breads, pastries, and bakery-products, the staying power of primitive local mills will vanish -- a flour market still in transition.
China’s advances in milling technology are fairly recent, going through a four-stage evolution. The first (1950-1980) was the introduction of break-and-reduction systems, high extraction rates but high ash-content and large-particle flour – slow, low-volume but requiring little power. In the next state (1980-2000) milling became more energy-intensive, at lower extraction rates, but producing more refined flour.
In the third stage (2000-2009) both extraction rates and ash-control improved but the main focus was on energy efficiency. At this stage local manufacturers emerged, in the same class as world leaders like Buhler. In the fourth stage (since 2010) local manufacturers became more prominent with new equipment offerings and control systems – purification, ash-control, particle size control, yield improvements, etc.
The latest mega-mill designs are modular, 500-800 T/day capacity units, sometimes installed in multiples at a given plant-site. The leading milling technology companies have become the principal suppliers to domestic mills as well as exporters to global markets. China’s largest milling group (Wudeli) has long relied on local technology but now the state-owned industry leader (COFCO) also opted for local technology.
In the last 10 years China manufactured and installed 100 milling-lines a year, 1000 in total. If all these new milling lines were all installed in China, they could now be grinding more than half of China’s flour needs (45-50 MT), but with older mills still operating, their share is only 25-35%. Now there are about a dozen mega-mills – some 5,000-6,000 T/day, others 2,000-3,000 T/day. In the next few years the number of mega-mills is expected to double, 20-25 mills with a capacity to produce 35% of China’s flour needs, and not too long after their share will exceed half.
According to some estimates the largest milling group in China, Wudeli, has the capacity to grind more than 60,000 T/day – largest North American milling group Ardent has less than half that. The other two large groups, Yihai and COFCO, together are as large as Wudeli. Though these three industry leaders achieve much higher capacity utilization, their combined market share is estimated at 25% – at full capacity they could achieve double that share. In the coming years these industry leaders are expected to continue their expansion by building more mega-mills.
Consumption and flour-use trends
Quality improvements in China’s food-chains over the last two decades are evident from not only food-processing industries but also in flour-milling – automation and technology adaptation as well as consolidation. The improvements achieved in flour-quality are quite staggering across the board, particularly in specific purpose flour varieties, but still, standards are not quite up to par for certain uses.
In order to relate to flour-attribute requirements, it is important to understand where flour is used. As evident from the chart below, there are huge differences between China and the West in this regard. Traditional foods – noodles, steamed-bread and dumplings – account for close to two-thirds of flour-use in China. While bread-making takes up more than half the flour use in the West, this share in China is a mere 3-4%; cakes and cookies account for 40% in the West but half that in China.
Traditional flour-uses in China are much more forgiving of lesser quality wheat-flour, as long as the all-important 'white-colour' requirements are met (dictated by ash-content). To a large extent, even primitive mills can meet this demand, which is the main reason why these mills can still stay open in the face of competition from large, advanced mills. But this grade of wheat-flour is inadequate for baking – be it bread, cookies or cakes. In baking, still a very small share of flour-use in China, flour quality is much more critical, in terms of particle-size, protein-content and other attributes.
Technology brings huge advantages to the milling process, not just in terms of higher extraction rates and fuel efficiency but also cleaning, blending and purification. Automated processes allow mills to control the wheat-mix best suited for the intended flour-use as well ash-content and particle-size. Also, advanced mills have quite a bit of tolerance in their wheat-intake by being able to clean, remove impurities and sort different grades before the wheat enters the milling process.
If the flour demand profile stayed the same, the milling industry already in place can live within the confines of China’s current domestic wheat supply with minimal imports of special wheat-grades. The industry will continue to consolidate with advanced mills, which no doubt will expand their capacity and market share, and further improve the quality of flour produced for traditional as well as other uses.
However, flour demand is not staying the same: major shifts are already underway and will gain momentum in the coming years, increasing demand for imported wheat varieties. In this regard we should bring attention to two particular trends that the local wheat supply will have difficulty accommodating, both driven by western influences embraced by affluent or aspiring segments of Modern China.
The first market segment to focus on is the bakery industry, which is growing at 15-20% a year with both domestic and foreign bakery-chains expanding their footprint all across the country, determined to cover every affluent city-block. All sorts of western-style pastries are becoming popular and widely consumed, but the most significant trend is the bread-revolution. China grows both higher and lower protein wheat that in principle could cater to the demand for regular breads, cookies and cakes, but local flours are not adequate to fuel the growth in high-end products.
The second market segment that deserves attention is western-style pastas and flat-breads. The legend has it that Marco Polo had introduced noodles to Italy, but now the Chinese are taking to Italian food with a vengeance – pizza chains (low and high end) are spreading like wild-fire while Italian restaurants are popping up on almost every city-bloc. Pizza or pasta looking foods can be found everywhere, but anybody who takes pride in cooking or eating struggles with what can be made from local flours. Like bakers, chefs are at best improvising, waiting for flour quality to improve.
These market segments used to be treated as niche or artisan, with the most discerning importing their flours while others try to make do with local supplies. But now even at these early stages, with only a third of China’s population taking to these tastes, the market is already as large as the EU. The pasta-flour market is already as large as Italy’s, a market hard to imagine catering to without durum.
Like bakers or chefs, major flour-millers are improvising, but eventually they have to wake up to the potential of an emerging mass-market, which otherwise will fall into the hands of niche-mills. China’s wheat-supply is not going to meet these needs, and millers are going to turn to imports -- a huge market for durum, hard-red and even soft-white that we as the a leading producer of all three must turn our attention to.
Our wheat export prospects
Looking at our wheat exports to China over the last 25 years, whether as a share of their imports or share of our exports, we clearly observe an erratic pattern driven by opportunism on both sides. This is the case in all bulk-trades we are so dependent on, with little evidence of a strategic effort to sustain let alone grow export volumes. When our trade-relations were much better, our share of China’s wheat imports were significantly higher, as high as 70% earlier and even in 2015 40%, compared to less than 10% more recently, a fraction of our total wheat exports, mere 2-3%.
Now that our trade relations are at an all-time low, with threats coming from both sides, it may sound pointless to be talking about exporting more wheat to China. But still, it is worth looking at the opportunity in case our relationship gets mended to go back to the way it was a few years ago when China had become our largest grain-export destination, taking 20% of our exports, same as China’s share of global grain trades. Or let us treat this as a hypothetical case-study to learn from as if we were considering the wheat opportunity a few years ago before the trade-relations soured.
China is now one of the two largest wheat producers in the world, just behind the EU. Earlier in the reform era it was a net wheat importer to meet its consumption needs. As result of persistent yield-increases, it became self-sufficient into the 21st century. But it continued to import to build up its stocks, now the largest in the world – 40% of global-stocks, enough to cover almost an entire year of its own consumption. These stocks were built up opportunistically looking for low prices through bulk-trades; sizeable sales volumes came our way as well but not high in quality or price.
China now seems self-sufficient in wheat, but not in all the varieties of wheat it needs. Moreover, as consumption increases, China may have to import more as it has largely exhausted it production capacity, in terms of both land and yield-increases. It is likely to look after its basic needs domestically and import special-grade wheat varieties demanded by consumption trends, largely driven by western culinary influences – breads and pastries from one end, pastas and pizzas from the other. The types of wheat China needs are the varieties that we are known for, creating export opportunities for us, not huge but still significant, 5-10 MT/yr range.
These new export opportunities, however, are not going to materialize through bulk-channels. The needs are specialty-grades to produce high-quality flour for specific uses, such as durum for pastas, hard-red for bread, soft-white for other pastries. The growth in these consumer markets for these products is evident, and not showing any signs of abating any time soon; furthermore, inadequacies of local flours are evident to bakers and chefs, not to mention product quality to discerning consumers.
We tried to provide insights into the flour-milling industry, how it has advanced in recent years, now with the capacity to produce refined flours with specific attributes for different uses. The technology is there but not the wheat-intake to produce the types of flour the market demands. Mills are set up with automated lines to produce highly differentiated flour varieties, only if they could add the types of wheat-grades they need to the regular wheat-intake they receive from domestic supply sources.
These advanced mills are currently in the hands of the three major milling-groups -- Wudeli, Yihei and COFCO. The mega-mills they operate, and building more of, are too large to be dedicated to any particular flour-type, but the technology they use allow them to dedicate specific-lines (automated for intake and grind specifications) to specialty-flours with specific attributes. This modular technology also allows boutique-mills to emerge to produce specialty flours at or near major urban centres.
Our previous market discovery efforts had revealed that large mills could take 5-10 container loads of specialty-wheat (e.g. durum, hard-red or soft-white) a week to feed the milling-lines they dedicate for specific flour-varieties. The boutique-millers, stand-alone flour-companies, or in-house milling operations of large bakery-chains, are likely to focus on particular flours. Thus, they will require larger volumes of specialty-wheat in relation to their overall flour-output, still in the order of multiple container-loads a week -- durum if focused on pasta-flour, hard-red for bread-flour.
To realize these export prospects, we naturally have to rely on direct-sales channels. We need to target specific millers, determine their requirements for particular wheat varieties, and propose containerized identity-preserved shipments on regular schedules. To engage in consultative-sales efforts, all three industry leaders are visible targets to approach, but identifying the most suitable boutique-millers will require more market-discovery. There may be strategic advantages in engaging with COFCO first, a state-owned-enterprise that can easily open the market for all despite our tense trading relations with China and the import difficulties standing in our way.
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