International Commodity Management , IIPMB

1. Gross margin prospects for harvest
2018 – the Brexit crops
Decision making is now underway for UK cropping ahead of this
autumn’s planting season and, to an extent, for 2018 spring
plantings. Group 3 soft milling wheat looks like a key contender
of interest, with barley outside of a malting contract a key area
of concern. If current timelines are anything to go by, the back-
end of the 2018 crop will be marketed in a post-Brexit world.
Introduction
A broad-brush look at crop profitability can help give some headline
indication as to how crop areas may well change in the upcoming
growing season. To do this we have looked at crop gross margins
using current forward prices and estimated average costs and yields.
These will clearly change as time progresses so aren’t meant to be
treated as predictions of the final outcomes but as indicators of how
national cropping trends may change.
Aside from the usual drivers, 2018 crop profitability has the weakness
in sterling to consider and the possible reality that some of the crop
will be marketed in a post-Brexit world. Although the 2018 crops are
unlikely to feel the full brunt of Brexit implications, it is useful to
explore what the future implications might entail.
Gross margins for harvest 2018
Figure 1 gives an overview of the gross margin estimates for harvest
2018 and compares the results from this time last year for the 2017
crop – not the final outcome for 2017. Please do keep in mind that
individual farms and fields will see a large degree of variability around
the assumptions made here. As such, for local decision making, there’s
no substitute for real data.

3. This year sees six new entries in the gross margins table. The most
notable of these is the nabim Group 3 soft wheat, plus four new
additions to the spring gross margins table. The tight supply of Group
3 varieties over the course of the past season (2016/17) has seen
prices move to a premium over bread milling wheat. While we have
worked on the principle that this premium will not carry into 2018/19,
the relative strength of the group 3 premium (versus that for bread
wheat) and lower variable costs (largely the reduced nitrogen
requirement) leads to a favourable gross margin.
For winter feed barley, we have specified this as representing two-row
varieties, which produce a relatively poor gross margin (before straw).
However, 6-row type varieties have grown in popularity in recent years
– delivering higher yields at some additional cost. The base
publications used for yield and cost assumptions don’t make provision
for 6-row feed barley and as such, it is not possible to make direct
comparisons to the other crops.
Other key changes in this year’s estimates, compared to last year are:
 The value of all like-for-like gross margins have increased for the 2018
harvest. This is a reflection of the increased pressure on crop supplies
this season, which coupled with a weaker sterling, has supported
prices – although this has been partly offset by higher costs.
 Despite weak premiums, bread wheat returns appear to be on par with
feed wheat. Competitive yields of newer group 1 and 2 varieties are
the key driver here with the premium likely to play more of a role in
influencing agronomic decisions i.e. applying additional fertiliser for
protein later in the growing season. Clearly, relative yields, costs and
quality can vary from field-to-field, so variation in comparable
performance should be expected.
 With a move to a greater area share of wheat varieties with quality
potential in recent years, the supply of domestic feed wheat in the UK
has tightened up. This, combined with a rising spring barley area in
recent years has caused the prices of feed barley and feed wheat to
move away from one another (a £20/t difference is assumed). As a
result, the ranking of spring feed barley has slipped. Note that the
value of straw is not included and can make a marked difference in
some regions. Despite the slip in feed barley performance, this may

4. not reduce the amount of spring barley in the UK arable rotation given
the importance of the crop in managing black grass.
 Malting barley gross margins have suffered far less in their relative
performance due to stronger quality premiums over feed barley.
However, due to the increasing amount of spring barley in the
rotation, anything grown outside of a contract faces a risk of ending up
in the feed market with no premium.
Productivity vs. Profitability
When looking at the gross margins of the crops it is easy to get caught
up in the highest value margins. However, it is just as important to
understand the return on investment of the crop.
Figure 2 shows the gross margin for each of the crops but also how
much revenue the crop is generating per £1 spent on variable costs.
This analysis is slightly limited in that it doesn’t account for fixed costs,
for which there is no reliable national “average” due to the huge
amount of variation between businesses.

5. Figure 2 shows how profitability and return on investment don’t
necessarily go hand-in-hand. In scenarios where access to working
capital is not limited, the efficiency of its use is less of an issue and so
profitability becomes the dominant driver. This, essentially, is how the
UK arable sector is operating right now. However, should access to
working capital be limited, potentially as a result of Brexit, the
implications on the UK cropping mix could be marked.
Rise of the Group 3s?
Over the last couple of years there have been some material changes
in the UK wheat supply – namely the arrival of high yielding nabim
Group 1 and 2 varieties. The growth in the share of the wheat area
occupied by these varieties has depressed bread milling premiums.
Whilst the area share of the bread wheat type varieties has been
rising, that for Group 3s has been squeezed. As such, whilst the bread
premium has contracted, the Group 3 premium has been relatively
strong. As we have seen in the headline gross margin estimates, this
has propelled the relative performance of the Group 3 category.
Figure 3 looks at how two key variables impact on the Group 3 gross
margin relative to bread wheat.

6. When there is little difference between the bread and Group 3
premiums, the difference in profitability arguably becomes
insignificant. In fact, with Group 3s requiring less nitrogen input (as
protein requirement is lower), the crop can cope with slightly lower
premiums before its profitability versus bread wheat is impacted. On a
similar note, due to typically lower nitrogen requirements, the Group 3
gross margin will be more resilient in the face of higher fertiliser prices
in the event of further sterling weakness.
It’s wise to keep in mind here that we assumed equal yields between
the bread varieties and the Group 3s. This will of course vary from
farm-to-farm and influence decision making.
We are currently working on some further analysis of the Group 3
sector, which is a segment of the UK wheat market that could well
become more important going forward. This is because soft wheat is a
bit of a niche in the global export market and the UK might need to try
and exploit this feature more in a post-Brexit world.
Effect of oil content on OSR gross margin
The gross margins calculated for winter and spring oilseed rape (OSR)
in Figure 1 assume an average oil content of 45%. Above 40% oil
content, a premium is received (1.5% of the OSR price for every 1%
above 40%). Below 40% a similar penalty is applied.
Figure 4 illustrates how the gross margin of winter OSR is affected by
the oil content. Essentially, a 1% increase in oil content increases the
gross margin by £16/ha, based on the model used in this analysis. For
example, the gross margin of winter rapeseed achieving a 45% oil
content will be £80/ha higher than if the oil content is 40%.

7. A similar trend is seen for spring rapeseed, although the incremental
increase (an average of £11/ha) in gross margin is lower for each 1%
rise in oil content. The gross margin of spring rapeseed with a 45% oil
content is £55/ha higher than for an oil content of 40%.
Higher oil contents can, to some extent, help to mitigate lower yields.
For winter rapeseed, the gross margin increases by £32/ha for each
0.1t/ha rise in yield. The gross margin for winter rapeseed with a yield
of 3.4t/ha and 45% oil content is the same as winter rapeseed with a
yield of 3.6t/ha and 41% oil content. The best scenario, of course, is
to aim for optimal yield and maximum oil content.
The impact of a weaker sterling on gross margins
Since the vote to leave the EU, sterling has become progressively
weaker against a basket of other currencies. As a scenario, we have
considered the impact of a further 10% decline in the value of sterling
relative to other currencies.
For this analysis we have considered the cost of crop protection to be
unaffected. This is largely due to the elasticity of using chemicals, as
the desirability to apply chemicals may fall as prices rise. We have
considered a 10% rise in both the cost of fertiliser and also in the price
per tonne of the crops.

8. The largest increase in gross margin following further weakening of
sterling comes from group 3 soft wheat, with a rise of £108/ha – the
relatively high price (versus other crops) and lower fertiliser
requirements are the key drivers here.

10. On the whole, spring crops benefit less from a currency devaluation,
due to lower yields.
What impact could a tariff wall have?
As we have mentioned in our two most recent Horizon reports (Post-
Brexit prospects for UK grains and The WTO and its implications for UK
agriculture) the UK faces the possibility of WTO style tariffs post-
Brexit.
Figure 6 shows a simplified summary of EU import tariffs. For wheat
and barley, instead of assuming the “cliff-edge” tariffs of €95/t we
have used the scenario where the UK can export to the EU under a
non-specific third country Tariff Rate Quota (TRQ). For oats, there is
no similar TRQ with the exception of that granted to Ukraine. The
practicalities and processes of administering tariffs can become
somewhat complex and so in this analysis we have taken a very
general view.
The reality of any tax or tariff is that it is likely to be passed back the
producer, impacting the profitability of primary production. The scale
to which a tariff impacts a crop’s gross margin is complicated by the
net trading position (whether the UK imports or exports more) of a
crop – or even a type of quality within a crop. Let’s take wheat for
instance:
 Say the UK has a surplus of medium grade bread wheat, which needs
to be exported. UK exports to the EU would incur a tariff, which would
then be built into the price paid along the supply chain.
 At the same time though, the UK could be short of high protein bread
wheat. Here, a tariff on exports going to the EU would be much less

11. relevant. Furthermore, if the UK had reciprocal tariffs in place, UK
prices for that specific grade of wheat could in fact rise.
This demonstrates that the impacts of tariffs are not straightforward
and it isn’t simply a case of multiplying the tariff by the yield to
establish the impact upon gross margin. Clearly, where the UK has
grain to export e.g. barley, the tariff impact will be hardest felt. For
less export dependent crops e.g. certain grades of wheat, the impact
of tariffs could be more subtle and become more apparent when the
market is in periods of domestic over supply.
Without a tariff on shipments to the EU, the incentive to grow OSR
increases versus surplus grain crops. As such, tariffs could have a
marked impact upon the relative performance of combinable crops and
the UK cropping mix.
Closing comments
Brexit aside, the production economics that sit behind UK combinable
crops continue to evolve. ‘Wheat’ cannot be taken at face value and
needs to be treated as a number of market segments – the rise in
prospects for Group 3 wheat is a classic example of this.
Barley, after becoming an increasing ‘go to’ crop to assist with black
grass control faces some profitability challenges. Whether this will be
enough to reverse largely agronomy-based decisions remains to be
seen. This may in fact open up more of an opportunity for spring
wheat, with an anecdotal rise in interest over the last year or so.
Prospects for OSR profitability appear to be stabilising, with UK prices
taking support from currency and crop production issues e.g. cabbage
stem flea beetle damage.
Many are expecting further falls in the value of the pound as we edge
closer towards Brexit. Whilst supportive of crop prices and margins,
this clearly makes input use efficiency (productivity) an important area
of focus versus international competitors.

12. UK crops that are creating a surplus over domestic requirements are
likely to be hardest hit if the UK faces tariffs on exports into the EU
marketplace. This would clearly have a negative impact on
profitability, but changes in the cropping mix isn’t necessarily a
certainty: Economics Vs Agronomics!
Key points
 Group 3 wheat has grabbed attention with lower costs and comparable
forecast premiums to bread wheat;
 Barley profitability is a cause for concern outside of a malting contract
due to the increasing spring area in recent years;
 Crop profitability and return on working capital don’t go hand-in-hand;
 Winter OSR profitability is holding its ground and could see future
improvements in relative performance if certain cereal crops are hit by
EU import tariffs;
 Crops with relatively high yields and low inputs would experience the
most benefit from further weakness in the pound.