The ABCD of Soybean Tariffs Shows America Will Be Okay

(Bloomberg Gadfly) -- If you want to know who'll suffer most from the 25 percent tariff that China is considering slapping on U.S. soybean exports, don't look to American farmers or Chinese carnivores. The real victims are much more likely to be the grains processors that stand between those two groups.

To see why, consider the oddities of the soybean market. Most consumers encounter the legumes as edamame beans or the raw material for tofu and soy milk, but the trade is dominated by less visible uses. Almost 80 percent of the global crop is turned into meal for animal feed, and a further 15 to 20 percent goes into making cooking oil and biodiesel, with only a sliver left over for human consumption.

In addition, China's approach to its soybean industry is highly unusual for a country that generally seeks self-sufficiency or diversity of supply in key commodities. It's overwhelmingly dependent on imports, with about 85 percent coming from just two countries, the U.S. and Brazil. There's a finely honed balance between the northern and southern hemispheres, too: During China's winter, when South American farmers are busy growing the next year's crop, the country is almost entirely at the mercy of the U.S. harvest for its imports.

There's another factor to consider. While soybean oil squares up against palm oil, rapeseed, sunflower, and the like in a fairly competitive cooking fat market, soy meal is close to a miracle food for livestock farmers. Its protein content is up to four times higher than for cereals, meaning that animals given soy-doped feed bulk up faster and get better prices at market. While there are other ways of adding protein to feed -- ethanol-processing waste, meal by-product from other oilseeds, even ground-up livestock and fish -- soy accounts for more than half the global market.

That shows why processors should be the weakest link in the chain connecting U.S. Midwestern farms to Asian rice bowls. China's appetite for meat looks insatiable as incomes rise, so its livestock herd is only going to grow. Those animals would starve or be slaughtered if American farmers switched to other crops, resulting in volatile prices in the short term and rising ones in the long term. As a result, a Chinese government that has long regarded food inflation as a threat to political stability has sound self-interested reasons for keeping the American soy industry afloat.

The pain will mostly be felt by the oversized processing industry that turns U.S. beans into Chinese meal and oil -- but that sector is well-placed to take it. Operating income from the oilseeds unit of Wilmar International Ltd., the biggest foreign soybean processor in China, touched its highest level in at least nine years last year, and was at a four-year high at China Agri-Industries Holdings Ltd., controlled by state-owned Cofco Corp.

The crush margin on U.S. soybeans -- a measure of the profit earned by local processors -- is up about 12 percent over the past month alone, and approaching some of its healthiest levels in three-and-a-half years. Add 25 percent to the cost of the American crop and those spreads would narrow, but still remain comfortably in the black.

That probably explains why China appears so sanguine about putting levies on such a critical trade.

For homegrown players like Cofco and Jiusan Oils & Grains Industries Group Co., a spell of weaker margins or even shutdowns would be no more than doing their patriotic duty. For overseas processors like Wilmar, Bunge Ltd., Cargill Inc. and Louis Dreyfus Co. BV -- the legendary ABCD of the global agriculture business  -- it might be enough to force them out of the market altogether.

Beijing has been trying for years to reduce overcapacity in the coal, steel and aluminum sectors, but the country still has more soy crushers than it needs. Raising costs to squeeze the least profitable players out of business looks more like a feature of China's game plan than a bug.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

1. The "A" stands for Archer-Daniels-Midland Co., the biggest shareholder in Wilmar.

To contact the author of this story: David Fickling in Sydney at dfickling@bloomberg.net.

To contact the editor responsible for this story: Katrina Nicholas at knicholas2@bloomberg.net.

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