Are We at the End of the Chilean Salmon-Farming Roller Coaster?
Since the 2008 ISA crisis the Chilean industry has experienced a challenging period with volatile supply, rising costs of production and financial losses. This dynamic has reversed recently and Chilean salmon farmers have returned to profitability. Our expectation is that this period of profitability will last.
Salmon supply volume growth driven by recovery and new legislation
By the end of 2018, the Chilean salmon farming industry expects to recover the 100,000 tonnes lost as a result of the algae bloom in Q1 2016. The algae destroyed 100,000 tonnes of salmon production capacity. Approximately 60,000 tonnes were supposed to be harvested in 2016 and approximately 40,000 in 2017. The expectation is that supply will expand only slightly in 2017, while considerable growth will be achieved in 2018 (see Figure 1). Initially, smolt release was expected to decline relative to 2014 and 2015, but most recent figures show increasing smolt release, which further supports the 2018 recovery expectation. However, we expect that the new legislation will not allow significant growth relative to 2015 production. The new regulation allows for a maximum of 3% growth in region 10 and 11, and only if biological performance is good. Therefore, a recovery is possible but further growth beyond this is not.
Consequently, after 2018, volume growth in Chile will be limited. Growth of two percent to five percent is possible, provided good biological conditions on the farms. In regions 10 and 11, growth will be capped to three percent but could be less if there are biological issues. In region 12, at least for the next six years, growth can be higher but this region has a relatively minor share of total Chilean production.
Figure 1: Chilean Atlantic salmon supply and expectation
Costs are improving in Chile—at least relatively speaking
In the past few years, costs of production have increased dramatically in Chile, transforming Chile from the lowest to the highest cost producer of farmed salmon. Biological costs are the main driver, namely cost related to SRS and lice. Comparing Norway and Chile, Norway has enjoyed a major advantage in the cost of production in the last few years. This is due to the weakness of the NOK, better biology and lower smolt prices (due to large scale and modern hatcheries). However, in the last few months, further lice issues and low harvest weight in Norway, as well as a strengthening of the NOK, have reduced the Norwegian cost advantage from nearly NOK 10/kg to just a few kroner.
Furthermore, cost expectations are good for Chile. The lower biomass in the industry due to the algae bloom has improved the biological conditions, with mortality now dropping well below recent averages, even when excluding the algae bloom effect. New medication, especially Parmaq’s SRS vaccine, is showing promise against this diseases that has plagued the industry for many years. At the moment, only a few farmers are using the vaccine but as the satisfactory results become more known, use is expected to increase. In the next few years, as the vaccine gains acceptance, it may be possible to eliminate the use of antibiotics (and approximately 1 USD/kg of cost). Moreover, there are other innovations that will impact the Chilean industry, especially in the field of lice control. If lice numbers are successfully lowered, costs could decline further.
We can conclude that costs in Chile are improving relative to market leader Norway and deem it possible that in the future absolute costs will also decline.
Prices supported in the short term but declining gradually afterwards
While we expect prices for Chilean products to be supported, and even increase, in the short term—including in Q4 2016 and 1H 2017—price levels will start to decline after this (see Figure 2). The decline is likely to start in 2H 2017 and will probably last throughout 2018. This is due to the recovering supply in both Chile and Norway and the effect of demand on the current record price levels. Nevertheless, we do not expect a price crash or a return to low price levels. This is because global supply growth in 2017 and probably in 2018 will still be below long-term demand growth. Also because the profitable state of Chilean farmers will prevent any panic selling to service debt or pay for feed costs—something we witnessed in 2015. The Chilean salmon industry is increasing its marketing efforts in key markets such as the US, which should, in the medium term, support demand and consequently prices. The industry is also increasing marketing efforts and cooperation in growing markets, especially China, where Norway faces increasing supply challenges. Finally, we expect that Brazil—a key and very profitable market for Chilean salmon farmers—has bottomed out in 2016. From 2017, demand from Brazil will start to gradually improve, although it is unlikely it will become the growth engine we saw in the years before the Brazilian crisis.
One possible scenario, albeit very hard to predict, is that Chilean volumes will surprise positively in 2018, above our current forecast. This is based on the possibility of improving growth rates due to use of better (high growth) feed and other productivity boosting inputs — made possible by the recent return to profitability. In addition, we may see the positive effects of the SRS vaccine and other medications on lice. Put together, these factors could contribute to better fish growth and larger supply growth in 2018. If this does occur, it will likely impact prices but should not impact the profitability margin per kilo of the Chilean farmers, as volume growth due to improving biological performance will also cause cost per kilo to contract.
Of course, as always in salmon farming, we cannot rule out unexpected negative events such as algae bloom, volcano eruptions or social unrest, which have impacted the industry in the recent past. However, at least with the end of El Niño condition (and start of La Niña), the likelihood of a new algae bloom is far less likely.
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Profitability likely to be maintained, at least for the medium termGiven these expectations, we can say with a degree of confidence that the recent (Q3 2016) return to profitably in Chile after virtually 2 years of losses is set to last. Due to the new legislation capping growth to three percent (relative to 2015), we do not expect a return of the Chilean rollercoaster. And, although there will always be some volume and price volatility in the Chilean and global salmon industry, it is unlikely to be of the same magnitude as seen in the past. Lastly, a stronger than expected volume growth in Norway in 2018 could also impact prices and the profitability of the sector, but at least for now it seems that Norway is also experiencing both sea lice issues and legislative limits to growth.
Where to go from here
Gorjan NikolikSenior Analyst - Seafood Read more