Nigeria's Flour Millers Struggle to Cope with Price Spikes, FX Challenges

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Tuesday, August 24, 2021 / 1:26 PM /  by Proshare Research / Header Image Credit: News Central

 

Nigeria's flour industry has had a hard time finding its way back from a COVID-19-induced downturn. The lockdown of the economy in Q2 and Q3 2020 along with a host of other factors led to a shortfall in the actual demand for flour and a massive disruption to flour supply chains. In 2015, the Global flour market was valued at $200.50billion and was expected to reach $243.94 billion by 2020, at the forecasted CAGR of 4.4%. However, amidst the COVID-19 crisis, the global market for Flour in 2020 was estimated at only US$228.2 billion.

 

On the local scene, the wheat milling industry has not proven to be immune to the effects of the prevailing economic conditions in the country. Not only has it put a squeeze on corporate revenues and trimmed down profits, it has also led to product replacements in consumer budgets. Analysts have, however, noted that the Nigerian demand for flour-based products is seasonal in nature. This is because demand surges at certain times in the year when alternative staples are not in season and are thus relatively more expensive. For example, prices of non-wheat-based, essential cereals such as rice, and maize have recently risen sharply by 44.4% and 117% respectively. At the same time, the prices of leguminous staples such as beans, and peanuts have appreciated by 159.3% and 63.63% respectively over the same period.


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These should ordinarily imply a boost in the local demand for wheat-based staples however, as with local challenges, the global wheat market saw average prices leap from US$560 per bushel in January 2020 to US$ 607 per bushel in November 2020 before sliding to US$577.25 per bushel in December 2020. Q1 2021 saw the price of wheat turn upwards as the wheat price rose to US$642 per bushel in January 2021 and US$650 per bushel in March 2021 as the price settled at US$726.75 per bushel in May. June 2021 saw the price of wheat dip to US$693.5 per bushel. The July 2021 price recently shot above US$707 per bushel pushing up the retail price of wheat flour globally, including in Nigeria (see chart 1 below).

 

Chart 1 The International Price of Wheat per Bushel January 2020-June 2021

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Source: Trading Economics

 

The biggest wheat exporters, on the other hand, have seen further increases in their free on board (FOB) prices in the last month. Argentina: $280/ton; Australia: $294/ton; Canada: $362/ton; EU: $280/ton; Russia: $268/ton; and United States: $318/ton as of August 9, 2021, wheat quotes for the leading wheat producers were: Argentina: $280/ton; Australia: $294/ton; Canada: $362/ton; EU: $280/ton; Russia: $268/ton; and United States: $318/ton.

 

It hasn't helped that these big suppliers' production, output, and exports have all witnessed significant drops across markets. Russia's output fell to 72.5 vs. 85 (85.35 LY); Canada's production fell to 24 vs. 31.5 (35.18 LY); and the United States' production fell to 46.18 vs. 47.52 (49.69 LY); and global ending stocks fell to 279 vs. 292 LY (288 LY). As a result, Argentina and Australia will see a $9/ton hike, while Canada will see a $42/ton increase, Russia will see a $29/ton increase, and the EU will see a $38/ton increase.

 

The millers' plight is exacerbated by the ever-increasing cost of freight in Nigeria, as well as the increased FOB rates that Nigeria-bound goods face. According to media reports from earlier this month, between 2015 and 2019, Nigerian businesses paid foreign shipping lines a total of $45 billion (about N21.6 trillion) in freight costs.

 

The shippers' prediction for the end of June 2021 cost of freight numbers was roughly $60 billion (about N28.8 trillion), assuming cargo throughput stayed at the same level, based on the trend in freight rate increases over the prior five to six years.

 

Since 2020, the freight charge in Nigeria has increased even further. Shipping companies increased freight rates to Nigerian ports in January 2020, with increases ranging from $1,500 to 1,140 Pounds or equivalent on all 20- and 40-foot containers. Due to a lack of empty containers, the freight charge for shipments from Europe and Asia to Lagos had reached an all-time high by May 2021, going from around $3,500 for a 40-foot container to $13,500.

 

The demand for the wheat-based product being fairly price-elastic implies that the burden of every new rise in costs is absorbed largely by the millers and bakers, for instance since 202o, while a basket of similar commodities has increased in price by an average of over 50%, bread prices have only increased by 28%. The rest of the inflationary burden has been borne by the millers and bakers.  Yet, a potential fair rise in the price of wheat and flour-based products in local markets is capable of imposing increased pressure on the earning of the poor and socially vulnerable as bread represents a major part of their daily diet.  The same way other flour categories such as yam flour have equally experienced a hike in price, portending a tough outlook in 2021 for producers of flour-based products as well as consumers although to a lesser degree.


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A likely third wave of COVID-19 could lead to a forced total or partial lockdown of the economy in Q3/Q4 2021 which may have damaging consequences for the flour milling business as a relapse in demand and an extended disruption to supply chains could see retail prices soar as millers try to cope with falling inventories of finished goods and rising replacement costs. Although, early estimates of Q2 2021 GDP growth rate suggest growth of between 2.5% and 3.5% on the back of a weak base, the Delta variant of the virus has the potential of causing a reversion to the soft state the economy was in, previously. In Q12021, the economy only managed to record a gross domestic product (GDP) growth of 0.51%, fears of a third wave of Covid-19 could mean that there could again be a slip in both demand and output in Q3 and Q4 2021. As of the end of July, the federal government had placed seven states including Lagos on a red health alert.

 

If supply disruptions persist in the face of flattening demand many millers would see their businesses tank by Q4 2021 as both top and bottom-line earnings begin to shrink.

 

The Macroeconomy of a Flour Bust

 

Economy

The Nigerian economy fell into a recession in the third quarter (Q3) of 2020, after the country's aggregate output contracted for two consecutive quarters Q2 -6.1% and Q3 -3.6%, since then the economy has seen a fragile reversal of its negative growth, by rising 0.11% in Q4 2020 and 0.51% in Q1 2021. The manufacturing sector grew by 32.10% in Q1 2021 which was 3.62% higher than the previous year's figure of 28.47%, the manufacturing sector contributed 15.27% to GDP in Q1 2021 which when compared to the first quarter of 2020 amounted to a growth of 2.29%. Fiscal policy has been expansionary in 2021 with the federal government initiating several conditional cash transfer (CCT) programmes to stimulate demand. However, manufacturers have had to contend with higher excise duty on imports as well as the depreciation of the naira. Hence, the complex combination of macroeconomic factors adversely affecting the grain millers could lead to a major food crisis in the months ahead as millers find it increasingly difficult to sustain breakeven production levels.

 

Impact of the commodities market/crude oil price

Crude oil prices have followed an upward trend since November 2020 rising to as high as $75/barrel last month, this however feeds into the price of diesel a major cost item for millers and bakers. This has also resulted in a major drain on the real income of consumers who have to spend more of their income on cooking gas and kerosine which have also seen a price increase as a result of the rally in oil price.

 

Environmental/Public health crises

The COVID-19 pandemic forced the economy into a lockdown in March 2020, since then Manufacturing activities have shuffled ahead slowly with several factories closing down while some have operated well below their optimal capacity. Despite the administration of the COVID-19 vaccines, there are concerns about the possibility of a third wave owing largely to the low percentage of the population that has been vaccinated (Lagos state is reported to have vaccinated only 1% of its population as of July 2021 while Ekiti state is reported to have vaccinated only 2% of its population, as other states have been alleged to have vaccinated less than these %percentages). On a brighter note, however, the second round of vaccination commenced on August 16, after the government took possession of 4,80,000 doses of the Moderna vaccine. Meanwhile, the situation of insecurity in the country has worsened in 2021, the Northern part of the country- has seen a spate of kidnappings, banditry, and protracted farmer-pastoralist clashes which have thumped down economic activities especially in Nigeria's Sahel belt- which also happens to be the country's growing area. 

 

Policies and Regulations

Nigeria produces only roughly 400,000 tons of wheat out of the 4.7 million tons that it consumes annually. In other words, the country presently produces about 8.5% of its required supply for confectionary flour bakeries and the production of pasta and other wheat-based foods. The Central Bank of Nigeria (CBN) had however restricted the access of millers to dollars for the import of grains including wheat. The foreign currency restriction subsequently placed the millers in an impossible position of ensuring a steady supply of milled grains despite the severe shortage of domestic supply. This has meant that millers have had to look for sources of foreign exchange to import grains and predictably this has led to a large premium on the official import & export (I&E) window rate of exchange putting a squeeze on grain importers and chiselling away at their operating margins. The differential between the rate at the official window and the parallel market amounting on average to around 20% of the official rate.  For instance, as of August 18, the dollar sold for N411.75 and N510 in the I&E FX market (FMDQ) and Parallel market (Aboki FX) respectively. This disparity represents the additional cost incurred by the Millers which does not encourage investment in the sector.  


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Nigeria's FX reserves rely majorly on receipts from crude oil sales and since crude oil is a primary commodity with a low Product Complexity Index- the resultant price-swings that occur now and again in the international oil market adversely affect the country's Fx reserves. The huge backlog in the demand for Fx, which has reached up to $2bn, as well as the shortfall in the supply of Fx very quickly drives up the rate at which the Naira exchanges for the dollar. The country's reserves have been trending downward since April 2021, when it settled at $33.42bn before dropping to a 13-month low in July reaching $33.33bn. However, barring any substantial increase in the demand for Fx, analysts expect the Naira to stabilize towards the end of the year. This is on the back of the planned FG borrowing of $6.2bn and the over $800m to be borrowed by the Bank of Industry.

 

However, at the moment there is an FX-induced increase in the cost of production of millers, food product manufacturers and bakers. Nigerian millers and bakers have struggled to maintain prices. However, in the present circumstances and situation they are in, it's anyone's guess how much longer they'll be able to keep up with the balancing act before conceding to passing on the additional cost of production to consumers.

 

A Peep into Structure and Character of a Business

In all, there are up to 21 flour millers in Nigeria, six of which own 80% of the market share, which suggests that the market similar to the cement industry, is an oligopoly, which may be characterized by the following:

 

i)        Wheat production is climate-dependent

Although cultivated under different climates and soil types, wheat is best suited to temperate regions with rainfall between 30 and 90 cm (12 and 36 inches). Nigeria, however, is a tropical country and in spite of the best efforts of the millers in trials to match seed varieties with soil types with the aim of establishing new heat resistant and tolerant seed varieties of wheat in the country, Nigeria will probably never be able to cultivate wheat at a commercially viable, profitable quantity and yield. Attaining the production levels or yields of global wheat production leaders like China, India, Russia, and the United States is definitely a tough act to follow.

According to the United States Department of Agriculture (USDA) report in April 2021. The total wheat sown area in these top four wheat-producing countries in 2020/2021 was reported to be India: 31.4; Russia: 28.7; China: 23.4; US: 14.9 (mln ha) respectively. While production stood at China: 134.33; India: 107.9; Russia: 85.4; US: 49.7 (mln t) for the same period.

 

i)        Deficiency in the local supply of wheat

The total domestic wheat production in 2020 was about 200,000 metric tonnes, which was less than the expected volume due to unfavourable weather conditions and poor seed varieties. Apart from being grossly insufficient to meet demand, local wheat does not have the necessary gluten quality needed to be viable in bread-making flours, as a result, flour millers have to bridge the support gap with an average of 4.7 million tons of imported wheat annually. Meanwhile, the Flour Milling Association of Nigeria (FMAN) has made extensive investments in several programmes targeted at bridging this gap with local alternative in the medium to long term. Presently, an estimated N500 million is invested by FMAN annually in critical areas of need and developmental programmes including seed trials, research, training of smallholder wheat farmers and reimbursing the various farming research institutes in the country to ensure that the current local production levels of wheat improve significantly. The following are a few of these programmes:

  • The FMAN out-growers initiative which is under the Federal Government Wheat Acceleration Scheme in the 20/21 farming season will be providing input loans to the benefiting farmers.
  • Planned Wheat Farmers Service Centres in 15 Local Government Areas in the wheat-growing belt of Kano, Jigawa, and Kebbi state, where farmers would be trained on modern method of threshing of wheat, while at the same time increasing the direct offtake for the close to 5,000 farmers involved in the out-growers programme.
  • FMAN Partnership with Private agriculture development institutions such as Oxfam and Babban Gona to support wheat production through its out-growers scheme for 8000 smallholder farmers in the growing areas of Kano, Jigawa, and Kebbi.
  • FMAN's Certified Seed Production Program where 150 tons of seeds are distributed to over 3,000 farmers.
  • Establishment of a Research Farm to test Mexican and Sudanese seed varieties while partnering LCRI and IAR on teaching farmers better agronomic practices.

 

ii)             Seasonality

Flour-based products tend to be in high demand in the dry season at which time other food crops are in short supply. Producers, therefore, build inventory in the wet season and later drive large volumes of turnover in the dry season. Importantly, the flour milling industry has a peculiar seasonality associated with the Cost and availability of wheat.

 

iii)         Elasticity of Demand

The demand for flour-based products is price elastic, which implies that industry participants strife to keep prices moderate.    


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Stopping an Implosion

The flour milling business is too important to Nigeria's food sustainability and security plans to allow it to collapse in the current economic downturn. The thunder of a flour storm should not be followed by the lightning of flour scarcity. To avert a consumer uprising against rising food prices the government needs to adopt a few measures in the short and medium-term:

 

Short-term

  • Give millers access to foreign exchange at the I&E window
  • Help local farmers acquire improved wheat seed varieties with extension support


Medium-term

  • Revisit the strategic national grain plan to increase and hasten local grain production.
  • Provide extension support on improved grain varieties through collaboration with local and foreign grain institutes.
  • Allow tax concessions that ply along predetermined backward integration programmes (BIPs) structured with stated sunset clauses and annual local output targets. Failure to meet targets would attract a reversal of concessions.
  • Government should provide the infrastructure that would help millers reduce logistic costs along distribution corridors which may be achieved through digital supply chain monitoring and management across states and markets.


If the domestic grain milling business is not to implode while the country struggles to supply needed grains to citizens due to all the aforementioned challenges like the current economic hardship, restriction from FX window, dearth of infrastructure, among others, the government must be proactive rather than reactive, hunger should not be a cloak before the government stitches a policy framework that protects millers and the consuming public from looming chaos.


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