Author: Brian Cordischi, Chief Investment Officer, Carnegie Private Banking
Russia’s invasion of Ukraine in February 2022 highlighted the weaknesses in Europe’s energy system and made energy security a significant issue. After the outbreak of war, energy prices initially rose sharply, and volatility increased – but food prices also rushed to record levels. The consequences were particularly severe in the poorer parts of the world. The UN’s sustainability goal of achieving zero hunger before 2030 has become more distant.
Agriculture and our way of producing and consuming food is, like the energy system, in need of a comprehensive adjustment, both from a sustainability and health point of view. Sustainable food is an interesting investment theme, since food production accounts for around 25 percent of global greenhouse gas emissions. In recent years, we have witnessed a series of disruptions in the global food system from factors such as Covid-19, war, and extreme weather.
Today, we are fully aware of how vulnerable the sector is from a security perspective. In several aspects, we have created an effective but fragile system, which leads to poorer health, increased environmental destruction, water shortages, and reduced biodiversity. These negative externalities risk getting worse without change. As with energy, restructuring the food system requires large investments in the coming years.
Everything is energy
The availability of food has shaped human history and development. It has determined which societies and countries have dominated, often triggering revolutions and shifts in power. Thanks to the innovations of modern agriculture (fertilisers, pesticides, genetic modification, etc), the global population has increased by nearly six billion people in the last 100 years. We have put Malthus pessimism behind us, as agricultural productivity has improved enormously. The most important explanation is access to cheap energy in the form of fossil fuels, which power the machines of modern agriculture and are used as raw materials in the production of artificial fertilisers and pesticides. About half of all food production today is made possible by nitrogen-based fertilisers. Producing these requires large amounts of natural gas, which is why the increase in gas prices after the outbreak of war in Ukraine also made fertilisers more expensive.
The food chain also generates greenhouse gases in many other ways. Restructuring the food system is therefore an important part of the larger energy transition away from fossil fuels. This is not an easy task in agriculture either – the transition takes time and requires a new, sustainable but at the same time efficient system. A complete return to organic farming, without artificial fertilisers and pesticides, is impossible if production is to feed eight billion people (as recent experience in Sri Lanka has shown). In addition, the population on earth is growing and people’s living standards are improving – which will lead to an increased demand for food by more than 50 percent up to 2050.
The fragile system
Agriculture has succeeded in increasing the yield of several crops, and thus also food production. However, productivity in the world varies greatly. Large parts of Africa have significantly worse agricultural productivity than North America and Europe. Just like global manufacturing chains, agriculture has made use of increased specialisation and efficiency. Harvests are maximised by focusing on a few standard varieties that are grown where the conditions are best.
It creates an efficient but highly fragile system, which has made more and more countries dependent on imported food. The uniformity of agriculture is also due to the diet becoming more similar in different parts of the world. The processed industrial food of the West – cheap to produce but rich in sugar, fat and carbohydrates with lower nutritional value – has become increasingly widespread. Overweight and obesity-related diseases are increasing rapidly. Over the years, humans have grown 6,000 different crops, but today more than half of all calories come from rice, wheat, and corn.
Specialisation and import dependence make the system vulnerable if the export of important crops, or fertilisers, fails. The invasion of Ukraine broke the supply chain from a region that accounts for nearly a quarter of the world’s wheat exports. At the same time, sanctions against Russia, the world’s largest fertiliser exporter, contributed to rising fertiliser prices. The chain effect resulted in rising food prices globally during the first half of 2022. Some 20 countries responded with export restrictions on certain crops, for example wheat in India and palm oil in Indonesia. Today’s deglobalisation trend makes such ‘food nationalism’ an increased risk for import-dependent countries, especially in poorer parts of the world.
Another risk is climate change with increased occurrence of extreme weather that causes drought, fires, and floods. It can destroy individual crops, but above all lead to the erosion of fertile agricultural land, with poorer crop yields and reduced food production in the longer term. In the UN’s worst-case scenario, the crop yield could fall by 30 percent while demand increases by 50 percent. Already today, productivity growth in agriculture is levelling off in many parts of the world. It is also common to use too much fertiliser and pesticides, which can damage the environment in other ways.
Climate refugees are a politically charged issue. Africa will account for most of the population growth expected over the next 50 years. Many African countries already have a difficult food situation today, with inefficient agriculture and food shortages. If countries’ population growth exceeds resource availability and countries do not build up a better and more sustainable domestic agriculture, climate refugees will become a more common phenomenon. Europe is the geographically closest destination – and we already witness a series of negative political consequences from the refugee flows of recent years. Climate factors could force 216 million people in the world to live in poverty by 2050, the World Bank has predicted.
Modern agriculture has extensive environmental costs. Deforestation, overconsumption of fresh water and overuse of fertilisers and chemicals damage water and land. Agriculture is one of the sectors that has the biggest negative impact on biodiversity. At the same time, agriculture’s future harvests are based on functioning ecosystems with biological diversity.
A large part of food production requires pollination by insects. Studies show that 75 percent of all insects have disappeared in the last 30 years, and according to the UN, 40 percent of all insect species are at risk of extinction within a few decades. Three quarters of all crops that depend on pollination are at risk, corresponding to 35 percent of total food production. We are likely in a sixth mass extinction, where one million animal and plant species could disappear, according to the UN.
World food production now derives from fewer than 200 species, of which nine crops account for two-thirds of total food production. If disease knocks out the harvest for any of these, crisis is a fact.
Several catalysts, such as the EU taxonomy, the Kunming-Montreal Biodiversity Framework and increased consumer interest, all point towards investing in the transition to a more sustainable food system. There are several verticals with interesting investment opportunities. Let’s look at five of them.
Foodtech: This area includes everything from vegetarian meat and dairy alternatives to health food, products that improve animal and plant health and natural enzymes, probiotics, and additives. In recent years, a large investment bubble arose in the sector, where many companies had difficulty finding a clear path to profitability. We are therefore very selective in our investments in this segment and prefer exposure to agriculture-related companies in areas such as agritech and fertilisers where valuations are lower.
Agritech: New technology takes on a key role in realising agriculture’s great efficiency potential. Already today, growers could reduce their emissions by nearly 30 percent if everyone behaved like the 10 percent most efficient farms. Efficient and environmentally friendly use of fertilisers is key since agriculture today overuses fertilisers by an average of 40 percent. Precision technology can optimise the amount of fertiliser considering soil conditions, weather forecasts and the current needs of the plants. Agritech includes everything from software that analyses weather and soil data to precision tools for planting, spraying and irrigation.
Fertilisers: Producing nitrogen-based fertilisers is an energy-intensive process and both phosphorus and potassium are limited resources and hence, important to preserve. Despite negative environmental consequences, today it is impossible to feed the world’s population without these raw materials. However, it is possible to use them more wisely and find alternative processes with a smaller climate footprint. If the demand for food continues to increase, however, there is a structural demand for fertilisers. We prefer companies with focus on phosphorus and potassium, where the supply of raw materials is limited.
Biodiversity and circular economy: Improving biodiversity is important for securing our future food supply. There is a shortage of investable companies that focus entirely on biodiversity. However, another sustainable opportunity is the transition from linear to circular production to reduce waste and pollution. Often it is about designing products for easier recycling and a longer shelf life. Both areas are prioritised in the EU taxonomy, and interest from investors is likely to increase in the future.
Agricultural land: Increased demand for food in combination with more uncertain harvests because of climate change and degraded soil mean that there may be a shortage of fertile agricultural land in the future. Private investments in a portfolio with such real assets can be an interesting way to increase diversification.