Frank Drum and Ben Matigian examine the infrastructure gap in Australian agriculture and the potential for strategic infrastructure investment in the sector.

The food bowl of Asia – fact or furphy?

Recent research and political debate within Australia has focused on Australian agriculture’s potential to be “the food bowl of Asia”— statistically possible, but commercially unlikely.

A recent study by the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) projected that the real value (in 2007 US dollars) of Australian production of agri-food products to be 77 per cent higher in 2050 than in 2007, with the value of agri-food exports projected to increase by 140 per cent over the corresponding period.¹ ABARES highlights that realisation of these projections is highly reliant on sustained productivity growth and the development of underutilised land and resources in areas such as Northern Australia.

Research such as this has generated considerable debate within the industry, with agri-food producers questioning whether the necessary productivity gains can be achieved. Industry participants identify variable seasonal conditions, scarce water resources, reduced research and development funding and finite land resources as key factors that will inhibit the necessary productivity gains required.

In addition, processors and exporters further down the supply chain highlight strong competition at ports from non-food related products, ageing road and rail infrastructure and regulatory burdens as key challenges to growth in Australian agri-food exports.

In 2013 NAB Advisory spent time engaging with industry stakeholders to better understand the infrastructure gap in Australian agriculture. Industry associations, businesses, consultancies and government bodies across a broad range of subsectors were consulted to ensure that commercial, political and social viewpoints were integrated into NAB’s analysis. Some organisations involved in meetings included; Dairy Australia, LiveCorp, Landmark, AACO, Sunrice, Cargill, Warrnambool Cheese and Butter, Harvest Moon, Burra Foods, Australian Country Choice and the Australian Horticulture Exporter’s Association.

We focused on identifying what strategies and structures existing industry participants were using to enhance their supply chains and what role the banking sector and private investment community can play in supporting the sector.

Critical infrastructure issues

The discussions highlighted three key issues:

1. Standard and availability of existing infrastructure

Industry participants unanimously agreed that the quality of existing road and rail infrastructure and competition at ports is a major constraint on the movement of agri-food products within and out of the country.

Poor road and rail quality is resulting in increasing transport, compliance and health and safety costs, and slowing the speed to market of some products — critically important when delivering perishable goods and linking into ‘just in time’ logistics timetables. Additionally, competition at ports from non-food related products was resulting in slower loading times leading to rising shipping and storage costs.

Given that the level of throughput remains one of the key drivers of profitability in road, rail and port infrastructure, any efficiency gain that can support higher sustained throughput could present a significant financial reward to investors.

For example, NAB analysis indicates that within the grains industry average port capacity utilisation on a state by state basis is at best 76 per cent and at worst as low as 46 per cent, analysis that is supported by a quote recently made by Alison Watkins (CEO GrainCorp) that stated that average capacity utilisation at port in NSW was as low as 30 per cent.²

Much of the inefficiency in port utilisation relates to bottle necks in the rail network, with many lines operating with significant speed restrictions (some as low as 20km/h) causing higher operating costs, and many operating with substantial weight restrictions as they are unable to safely carry heavier loads.

The poor quality of rail infrastructure is extremely significant when you consider that the average train can carry over 2,000 tonnes of grain, while the average truck hauls between 40-45 tonnes. This means the average export vessel takes 18 trains to load. But the same vessel needs almost 900 truck trips – a massive difference in efficiency and a considerable increase in cost to both the industry and the broader community. Despite the clear efficiency advantages, statistics provided by GrainCorp suggest that the proportion of grain arriving at their ports by road has been steadily increasing from around 15 per cent to over 30 per cent.

NAB analysis suggests that to replace and expand the Australian grain industry storage/handling and port network $3.9 billion in funding would be required, with 83 per cent of funding requirements relating to the replacement of existing infrastructure. Both important points in considering the attractiveness of the size of the investment required and the type of investors that may be attracted to Brownfield developments and the potential investment returns associated with that.

2. Privatisation of large scale infrastructure

The ongoing adoption of ‘just in time’ delivery and use of take or pay contracts in service delivery contracts with third party logistics providers means stakeholders need greater certainty in the quality, reliability and delivery of infrastructure.

The privatisation and regional-based management of infrastructure such as rural and regional rail networks presents significant challenges to achieving the aforementioned outcomes. This is particularly the case for those industry participants moving product through sections of the supply chain managed by multiple operators with differing maintenance and management timetables.

For example, in Victoria the state’s railway assets are maintained by Metro Trains, V/Line and the Australian Rail Track Corporation (ARTC), with one food processor commenting that “High rail traffic, ad hoc rail maintenance and ongoing line closures is increasing the need for collective rail management, with high rail traffic and line closures resulting in delays in load times and paying out of take or pay contracts at considerable cost to the business.”

3. Variability in regulations and regulatory burden

A bugbear of many industry participants surveyed was the inconsistency in the type and application of regulations across states. In early November 2013, ABARES released a report on the issue titled “Review of Selected Regulatory Burdens on Agriculture and Forestry Business” highlighting that “rural businesses are governed by around 90 Acts administered by the Australian Department of Agriculture, as well as those common to all businesses. This represents roughly 8 per cent of the total stock of Commonwealth Acts for an industry that contributes around 2 per cent to Australia’s gross domestic product.”

The sheer geographical size of the Australian agriculture sector often means that the production, processing and exporting of agricultural products can occur across multiple states. Variable weight restrictions for trucks and trains can result in higher traffic on transport networks, degrading the quality of infrastructure further and significantly impacting the speed to market.

The collective approach of government and industry around this issue presents considerable opportunity – certainty and consistency around regulation and niche concessions could provide both a benefit to business and the broader community.

For example, in 2010 SunRice (Australia’s sole processor and marketer of rice) in partnership with Deniliquin Freighters, was granted a special permit by the New South Wales Government’s Roads and Maritime Services. This concession enabled the construction and running of two purpose-built, 36.5m A-Double road-trains which were 10m longer than a regular B-Double road-train. This enabled the trucks to carry two Twenty Foot Equivalent Units (TEU) shipping containers of up to 30 tonne gross weights on specific routes from the mill to rail terminals in the region.

This resulted in a 13 per cent increase in milled rice per load than trucks were previously permitted. This substantially lowers the overall cost of transport and provides SunRice (who pay on a per container basis) with significant productivity gains. It also benefits the local community and the state with larger trucks funnelled onto specified routes and an overall reduction in truck volumes.

Infrastructure investor financial requirements

It is also extremely important to recognise the divergent requirements of investors when considering infrastructure development.

Infrastructure investors seek to achieve a total return that comprises both income and capital appreciation that would outperform inflation by a certain margin. In a nutshell, the basic principles for investors in the space would include:

• long duration of the assets;
• inflation-linked ‘predictable’ returns; and
• low risk of capital loss.

The challenge facing the agricultural sector is to consider how its infrastructure fits into above categories. Review the historical profitability within the sector and you find significant volatility in returns, so predictability will be a major roadblock.

Generally infrastructure projects that are supported by the private sector have the backing of long-term off-take agreements that are underpinned by a quantifiable level of resources or a clearer indication of usage in terms on traffic. Investors and financiers will look to these agreements to understand the long-term cash flows available to services debt and equity.

When we look at agricultural production, there are many variables that come into play that are outside the controls of the operators such as weather patterns, disease and domestic and international trade regulations. The uncertainty of production volumes over the long term is a key impediment on the ability of the producers to sign up to long-term off-take agreements.

Where to from here? Key challenges and opportunities.

This debate highlights a number of challenges and opportunities facing the agricultural sector:

How do we close the gap between the needs of the industry and the requirements of the investment community from a risk and return perspective? Are appropriate mechanisms in place to alleviate the risk aversion of investors to the inherent volatility in agriculture?

Many of these challenges are discussed in another article in this publication titled “Large scale greenfield agri-business development: parallels between agri and resources.”

How can industry and government work more closely to develop appropriate valuation models?

To date, government agencies, industry associations and lobby groups have spent considerable time and expense identifying the scale of the infrastructure gap i.e. location, reliability and quality of the existing infrastructure footprint.

This information, while significant, fails to provide both federal/state governments and private investors with the relevant financial metrics to support a decision to invest in regional specific or supply chain level infrastructure projects.

Are federal and state governments appropriately communicating with the industry and the finance sector the statistics available on industry so they can make more informed decisions on industry and project development? I.e. are regional production data, state and port-based trade flows, pricing information and modelling techniques appropriately available to those in the best position to make a commercial decision?

In the current fiscal environment, federal and state governments are becoming increasingly cautious around broad-based sector funding, unless large-scale sustainable socioeconomic benefits can be illustrated. Support appears to be shifting to regionally-focused or business-specific assistance in conjunction with co-funding from stakeholders and private third party investors, where tangible economic benefits within a clearly defined commercial framework can be identified.

For example, Tasmanian Irrigation Pty Ltd (TI) was established on 1 July 2011 as single state-owned company responsible for the development and operation of publicly subsidised irrigation schemes. TI develops schemes as public-private partnerships. This means that TI works closely with private landholders to work out how much water is wanted and shares the cost of building a scheme between the public and the private sector. A total of $220 million has been set aside by the

Commonwealth and Tasmanian governments to progress the irrigation development.

To date, through the funding, combined with private capital raised via the sale of water entitlements, the development program has realised a tranche of nine highly reliable irrigation schemes either built or in construction phase. TI’s new and inherited irrigation schemes will have the capacity to deliver a minimum of 100,000 megalitres annually. This kind of development improves the carry capacity of the land in the area, lifting productivity, attracting new or existing industry and potentially further investment to support the associated growth in agricultural production.

1. ‘Food demand to 2050 – Opportunities for Australian Agriculture’, Australian Bureau of Agricultural and Resource Economics and Sciences. 2. CEDA CEO Vision: Capturing the Global Food Boom – 23 May 2013.

This article was first published in Corporate Finance Insights – February 2014. Read more articles.

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