By Dave Ramaswamy, Africa Agribusiness Magazine
Sunny Verghese is Co-Founder, Group Managing Director & CEO of Olam International, one of the world’s biggest agricultural commodity trading companies. Verghese established Olam in 1989 and leads the company’s strategy, planning, business development and management.
Dave: What is your view on pricing natural capital? People have talked about the carbon tax. What option do you prefer, and what’s more economically and environmentally sound?
Sunny: It’s a catch-22 situation. No country wants to bell the cat, to perform the difficult task. They say that if they are the only country that applies the carbon tax, then their producers and exporters will get a disadvantage compared to another country. So while intellectually a lot of countries accept that in order to change behavior in terms of carbon emissions, we need to price carbon, nobody wants to bell the cat. So unless this will be something that all [UN] member countries will implement concurrently, I don’t think this will happen. Nothing’s going to change.
Dave: Okay. So based on your work in Africa and being vertically integrated in commodities from sourcing to branded products, why did you decide to fully integrate from being just a trader of commodities? Going up and down the value chain?
Sunny: The way we look at where to participate in the value chain is we do profitability analysis as to where the profit resides. Is it upstream of the grower/planter? Is it mid-stream at the processor? Then we ask ourselves how we can attract a slice of the profit.
If it is distributed upstream, do we have an ability? Can we really enter upstream and successfully capture the production economics in terms of farming and plantation management skills? If we believe that it’s doable, then we want to invest there. It is very nuanced, so there is no strategic orthodoxy as to where we will similarly invest.
We only invest when we know that we have a competitive cost to production, both capital cost of production and cash cost of production. That will allow us a cost position below the marginal cost producer’s cost of production.
Dave: Can you give an example with a particular commodity, like coffee?
Sunny: If you take coffee, you know Brazil produces coffee at about roughly $1.25 per pound for Arabica coffees.
So we know the commodity prices are cyclical. If you go upstream and become a producer/grower in a deep down cycle you start bleeding. You will not bleed, however, if your cost structure is below the marginal cost producer’s.
Therefore [we look at] the capital cost of producing in a particular country and the cash cost for producing. If your cost structure is below the marginal cost producer’s then even in a deep down cycle in coffee prices you are profitable. You can ride it out. In a normal cycle, and especially in an up cycle, you’ll be significantly more profitable.
These are long-term investments. To plant coffee, the first full maturity is in seven years. So you have to wait for seven years. You can’t make a speculative guess that coffee prices are going to be high seven years in the future. But, if you know that you’ve got a cost structure that is competitive and below the marginal cost producer you’ll be riding through every cycle.
Dave: That is impeccable logic.
Sunny: So, we invested in Laos, we invested in Tanzania and Zambia, Ethiopia, Brazil. Win 4 of those countries we have a high margin of safety between our total cost of production and the marginal cost producer’s cost of production. So in Laos we produce coffee at roughly 80 cents, in Zambia at about 85 cents, in Tanzania at about 90 cents, in Ethiopia at about a dollar, but all this is significantly lower than Brazil’s cost of coffee.
When coffee prices start going down, as they are now, it will still hold, we believe, above the marginal producer’s cost of production. And if it dips that way it can’t hurt anything. So that is the strategy.
In every commodity we look at that. We saw cashews were grown in 19 countries around the world, with millions of small owner/farmers and fragmented production. The farmer makes 6% to 7% of the profit.
When we looked at almonds, 75% of the profit was made by the grower. And almonds can really only can be grown in four countries because the crop is quite sensitive to the agro-climactic conditions.
Dave: For almonds, it is places like California in the U.S., Australia, Chile and South Africa.
Sunny: If you understand where the profit pools are, and you believe you have an ability to organize and capture the production of economics, then you invest on that basis. That’s what we do in 21 crops that we farm and produce ourselves across 26 countries.
Dave: Let us look at comparative advantage. You know China and India can be looking at consolidating farm holdings, and being self-sufficient in food. But sub-Saharan Africa has a comparative production advantage for key food commodities. So, how do you think Africa plays a role in supplying the food needs of India and China?
Sunny: Well, 55% to 60% of the world’s arable land is in Africa, but considerable investment needs to go in to build that infrastructure to make that arable land fully productive. You need to make long-term bets in farming, because it’s not something you can pull out and abandon a year after you invest it. You need the certainty of being able to make agriculture investments—whether it is governance or good infrastructure. For Africa to realize the potential is a long way off. And there have to be significant private/public partnerships to really exploit the potential.
Dave: Which countries in Africa—please name your top three preferences—are better producers compared to others in the next five years?
Sunny: Typically we look at a few factors. One is we want countries with low population density where land is not a big issue. So Gabon is a good example. It has 1.6 million people, a lot of land and not too much cultivation. So, one factor is population density, availability of land.
Second is labor, cost of labor and the trajectory of wage/price inflation. If you’re feeling wages are going to go up very fast in this country because of the developing economy, then you might be priced out. So, you need to understand not only what current wage costs are, but you also need to have a point of view on wage/price inflation.
Also, what is the capital cost of production? What does land cost? How are land prices increasing? Are the focus of government policies pro-business and pro-investment? Can you look at the communities and be equal partners to manage your supply chains? Because you will need them to support it. If they are against you, you have no hope of establishing assistance long term.
Dave: I know you mentioned Gabon, but what are two other countries?
Sunny: We have farm plantations in Nigeria. We’ve got a couple of [oil palm] plantations in Ghana and Liberia. We’ve got rice farming in Nigeria. We have forestry interest in Congo and in Gabon.
Dave: I know you would like most farms to consolidate into clusters or cooperatives. You have this outgrower model where you give input and you have buyback arrangements for the output.
Dave: In the last seven years there has been a huge issue made of these large land deals in Africa. And many of them have failed. Going forward, how do you think this land acquisition process will evolve?
Sunny: Many people made the mistake of believing that the [central] government confers the land to you. The government can transfer legal title to you, but in our view customary rights are more important. If a person’s forefather has cultivated that piece of land, then—according to human rights convention—that has precedence over any legal right. A lot of people come from overseas to invest there, they don’t understand this. They feel the government has given them the title and therefore the title is clear.
Dave: Sure, that has been the case in most instances.
Sunny: You have to go through a pretty intense farm consent process with the local population. You need to understand what the customary rights are and you want to respect those rights. So people make lots of mistakes in not going through a proper evaluation process. If you don’t recognize customary rights, things can blow up.
Dave: Based on your experience in African countries, what would be your message to regulators or policy makers?
Sunny: Clearly they have to make agriculture the priority sector and they have to ensure an environment that allows planning for long-term investments. It should not be ad hoc, but the law, a law of parliament so that investors have predictability when they are investing. It should not be the case that in four or five years, the government changes and a new administration might reverse all these policies. Foreign investors need the security of policy lasting for the lifetime of the project. That has to be through an act of parliament. It should not be politically partisan; it should be consensual and broad-based.
Second, is for them to facilitate upscaling in terms of agricultural training. Very few people in Africa want to do any agriculture. The average age of the African farmer is 64 years old.
Very few want to do farming by choice. It’s a tough job. So you have to make it more exciting and you have to have programs to encourage younger farmers wanting to come into the business. Unlike the U.S. or other places, in Africa land is not very expensive, so you won’t need an inter-generational transfer of wealth to enter the business. For a new entrant, land is relatively cheap. So even a young guy who has an entrepreneurial streak can contemplate getting into it.
Dave: I know you have to run now. Thanks for your time, Sunny.
Sunny: You are welcome.