Summing up the Dow-DuPont Merger

In a record year for mergers and acquisitions, Two elders of corporate America have announced their intention to combine and split off into three separate companies.

What does it mean for farmers?

Short and sweet, there's going to be a whole lot less competition in the agricultural seed and chemical (aka crop protection) industries, which will cut into the incomes of farmers struggling to manage falling commodity prices and stubbornly high production costs. 


We'll get to the assumed repercussions of the Dow-Dupont merger, but let's start with what we do know for a little context. 

After several flush years, American farmers are going to have a hard time wringing out profits in the near future. Revenue is down, input costs have not budged, and farms that took on high-cost land during the commodity boom are already grasping for cash. USDA reports show "cash crop receipts have declined 22 percent since 2012, but costs associated with manufactured inputs, seeds and rent declined just 1 percent in the same period" (Farm Futures). According to the Kansas City Reserve, operating loans for farmers were up 25 percent in the second quarter over the previous year

The reason for the decline in revenue is simple: The world has become awash in commodities. Thanks to an overall pattern of favorable weather conditions, productive genetics, and sound agronomic practices, American farmers are producing record harvests of corn, soybeans, and other row crops. At the same time, global demand has weakened, and upstart countries, such as Brazil, have rapidly industrialized their agricultural industry to compete in the export market. 

Since its entry into the WTO in 2001, the principle agent of global commodity demand has been China; but as its economy has slowed, so has its appetite for agricultural imports. Any talk of China, global trade, and agriculture starts with soybeans, which are a prime example to illustrate the macro-economic fundamentals that currently affect most American commodities in the world. China purchases soybeans as feed for its swine industry and, in turn, satisfy the appetite of its growing middle class for meat protein. Per the USDA, China imported 74 million tons of soybeans in 2014, accounting for 84 percent of its total supply. This hefty figure stems from "tariff cuts made during the mid-90s when China was negotiating accession to the World Trade Organization" (China Economic Review). 


China's importation of soybeans and other cereal grains has benefited the United States more than any other country to date, but South America poses a serious treat its market share. The two wolves standing at the door are Brazil and, to a lesser degree, Argentina.  

Despite potential catastrophic effect to the environment, Brazil has rapidly ascended to become the chief exporter of soybeans in the world, with almost 57 percent of its crop expected to leave the country. Conab, the Brazilian ag ministry's forecasting agency, projected in its November report a record harvest between 101.2 million to 102.8 million metric tons in the 2015-2016 season (Bloomberg). Although its estimates are slightly lower, the USDA Foreign Agricultural Services sees the 2015-2016 Brazilian harvest on track for 100 MMT, just 8.35 MMT behind the U.S. (World Agricultural Production, December 2015). The difference comes down to yield, as the U.S. is likely to produce 3.25 metric tons per hectare versus Brazil's 3.00, on roughly equivalent land area. Favorable weather could narrow the gap considerably

Besides being first to the market, American farmers' have relied on the country's advanced logistical infrastructure to stay price competitive with their Brazilian counterparts in the global market. The state of Mato Grasso, the powerhouse of Brazilian soybean production, is located at the country's center away from ports. However, beyond transportation, U.S. advantages are difficult to find. Brazil generally has lower production costs, and these savings peg their breakeven price considerably less than American farmers. With soybeans expected to fetch between $8 and $9 in 2016, current breakeven prices for farmers in the Midwest run from almost $10.50 to $12.50, depending upon soil type, rent costs, and other selected conditions (Farmdoc Daily, Agricultural Business Management News). The rising value of the dollar and the devaluation of the Brazilian real also make Brazilian soybeans cheaper in the global marketplace, as exchange rate savings cover any costs lost to transportation. Per Rabobank, an exchange rate of 2.9 BRL/USD would make $8.54 the breakeven price for producers in Mato Grasso. As of this writing, the current exchange rate is 3.94 BRL/USD.

Further complicating the matter for American farmers is the new political situation in Argentina, which produced roughly 61.40 MMT of soybeans in 2014/2015, good for third place on the planet. However, a high export tariff on raw commodities to prop up its processing industry has kept Argentinian beans from hitting the global market. Newly elected president, Mauricio Macri, has pledged to cut the tariff from 35 percent to 30 percent immediately and eliminate it altogether within seven years. Macri has also said he would lift currency controls, weakening the peso against the dollar, in order to spur investment, economic activity, and foreign consumption of Argentinian goods. 

American farmers are staring down too much supply at an uncompetitive price thanks to a strong dollar, which just got stronger after Fed's interest rate hike. The U.S. is expecting soybean ending stocks of 465 million bushels, the highest since 2006/2007. Overall global ending stocks are estimated at 82.86 MMT, an increase of 26.65 MMT since 2013 (USDA World Agriculture Supply and Demand Estimates). Barring some unusual event--a huge expansion in the Chinese pork herd, catastrophic crop failures in North or South America, or the economic collapse of Brazil (probably the likeliest of the three)--there's no way for American agriculture to grow or sell its way out of this right now. Recession has hit farm country.



There are a variety of factors that influenced the Dow-DuPont merger, and the Wall Street Journal has a great number of articles that touch on the effects of cheap capital and activist investors, to name a few. But it would be negligent for any commentator not to point out that a prolonged outlook of downward commodity prices motivated the companies to bring together their agricultural operations and cut costs. In the quarter ending in September, total revenue for DuPont was down 30 percent, "hurt by a reduced share in the U.S. soybean market" and "the weak Brazilian real"(Agrimoney). Monsanto initiated this momentum toward consolidation among the agrichemical and agribiotechnology companies with its failed bid for Syngenta over the summer. Dow and DuPont were merely the first, and possibly not the last, to pull it off.

Theoretically, industry consolidation makes too much sense not to continue. With less income in farm country to pay for their products, chemical and biotech giants are going to merge to shave off costs. In the process, they will also reduce competition in a sector already dominated globally by a handful of players. What were six international firms that controlled the global seed and crop chemical market--including Monsanto, Syngenta, Bayer, and BASF--is now down to five. Less competition on pricing means product costs stay relatively high, which leaves farmers in even worse shape financially.

The National Farmers Union said that having just five major players ‘would almost certainly increase the pressure for remaining companies to merge, resulting in even less competition, reduced innovation and likely higher costs for farmers.’

As evidenced in the graph above, farmers are already struggling to manage production costs that have surged exponentially since 2010. Farm production expenditures for 2014 have been estimated at $397.6 billion, a $30.3 billion increase from 2013. For crop farmers particularly, combined crop inputs (chemicals, fertilizers, and seeds) are $56.2 billion, accounting for 27.8 percent of total expenses. While that's not the bulk of their outlay, farmers have no margin for increased cost. Any projections for a decline in 2016 expenses are based on assumptions that farmers will walk away from high-cost and high-rent land and choose not to purchase certain seed technology traits, such as resistance to rootworms, which will surely have unintended consequences down the line (more on these options, as well as the cost of genetically-modified seeds in a later post).

Corporate tie-ups also threaten research and development budgets by shifting energy from product innovation to cost-cutting and market consolidation (Forbes). Whatever one's feelings about GMO technology, farmers are facing the prospect of having fewer tools at their disposal while their current ones are gradually losing efficacy, i.e. glyphosate/Roundup. At the risk of oversimplification, crop protection chemistries are a generation old, and there are no silver bullets in the pipeline. In addition to saving money, one of the most compelling reasons for crop and chemical companies to merge is to create synergies with their products and intellectual properties. Thus, Monsanto, the global leader in biotech seed sales, targeted Syngenta, its chemical counterpart (see graph at beginning of section). The Dow-DuPont combo (and subsequent spin-off entity) would form the largest biotech company in terms of overall seed and chemical market share. 

Boxed in economically, American farmers can look to a few potential developments that might brighten their prospects for profitability: 

  1. Brazil. Although a competitor in sales, Brazil is an unlikely ally against expensive farm inputs. It's noteworthy that none of the big biotech companies are Brazilian, which means none of their products are denominated in the Brazilian currency. Although it cheapens Brazilian commodities internationally, the devaluation of the real makes purchase of seeds and chemicals more expensive for Brazil's farmers. There's a strong possibility that they may forego expensive seed technology and crop protection purchases, which--when joined with the cost-reduction decisions of American farmers--could pressure manufacturers to reduce prices.
  2. Existing Competitors.Will one of the other current, smaller players aggressively price their products to distinguish themselves and capture market share? It would be worth looking a little more closely at Hughes Hybrids, which currently doesn't have a footprint outside of the Midwest.
  3. China National Chemical Corportaion, or ChemChina. Can ChemChina do what Monsanto couldn't and take over Syngenta? A state-owned company, ChemChina could disrupt the market with substantially cheaper crop protection products. Will American farmers buy from (a) an unproven manufacturer and (b) a Chinese company, particularly in an environment of heightened national sensitivities? Of course, they have no qualms buying from Swiss and German firms, but that's a subject for a different time.
  4. Alternative markets. In a word, is this an opportunity for the non-GMO market to mature? Given a satisfactory premium, will farmers choose cheaper non-GMO hybrid seeds? Although certification requires a three-year transition, what are the impacts on organic production?