AnnuAl RepoRt
po Box 781
2007
8 Church Street, St Helier Jersey Je4 0SG
Channel Islands Reg no. 89973
www.blackearthfarming.com
Black Earth Farming ltdAnnuAl RepoRt 2007
Disclaimer
this report contains “forward-looking statements”. all statements other than statements of historical facts included in this report, including without limitation, those regarding the company’s financial position, business strategy, the company’s management’s, or as appropriate the directors’, plans, objectives, goals, strategies and future operations and performance and the assumptions underlying these statements are forward-looking statements. Such forward-looking statements involve known and unknown risks and uncertainties, and other factors which may cause the actual results, performance or achievements of the company, or indus- try results, to be materially different from any future results, performance or achievements expressed or implied by such forward- looking statements. Such forward-looking statements are based on numerous assumptions regarding the company’s present and future business strategies and the environment in which the company will operate in the future.
Supplementary USd* equivalent figures found in this report in relation to company financial information are provided solely for the convenience of users as described in note 2 (d) to the consolidated Financial Statements and do not form part of the audited consolidated financial statements. the descriptive section titled “report on Operations” is based on the audited consolidated financial statements of Black Earth Farming limited (the “company”) and its subsidiaries (the “group”) as at and for the year ended 31 december 2007, but does not form part of the audited consolidated financial statements.
AnnuAl GeneRAl MeetInG
Black Earth Farming ltd (“Black Earth Farming”) hereby invites shareholders to participate in the annual general meeting on Friday, may 30, 2008 at 2.00 p.m näringslivets hus (room:
industrisalen) at Storgatan 19 in Stockholm, Sweden. rep- resentatives from Black Earth Farming will be available at the meeting to answer questions.
Participation
holders of Swedish depository receipts (“Sdrs”) wishing to attend the annual general meeting shall be recorded in the register of shareholders maintained by VPc aB on Friday 23 may 2008, and must notify the company of their intention to attend the meeting no later than tuesday 27 may 2008 at 1:00 pm. the holder of the Swedish depository receipts shall state his name, personal or company identification number, address as well as telephone number.
Notice of participation
holders of Swedish depository receipts can give their notice of participation by:
– by mail at the address:
annual general meeting, Black Earth Farming ltd, PO Box 781, 8 church Street, St helier, Jersey JE4 0Sg channel islands
– by telephone +46 8 753 46 75 or – by fax +44 1534 823 344 or
– by e-mail to agm@blackearthfarming.com
Nominee-registered shares
holders of Swedish depository receipts which hold their receipts through nominees (Sw. förvaltare) must request a tem- porary registration of the voting rights in order to be able to par- ticipate at the general meeting. holders of Swedish depository receipts that want to obtain such registration must contact the nominee regarding this well in advance of Friday 23 may 2008.
Voting forms (Sw. röstkort) will be distributed to the holders that have complied with the above requirements and the voting form must be brought to the annual general meeting.
Proxies, etc.
if a holder of Swedish depository receipts intends to be repre- sented by proxy, the name of the proxy holder shall be stated.
For holders of Swedish depository receipts who will be repre- sented by a proxy at the meeting, a proxy form is available at the company’s website on www.blackearthfarming.com. the signed proxy form should be sent or mailed to the company at the above stated valid addresses.
CAlenDAR oF eVentS In 2008 Annual General Meeting: may 30 Interim Report, January-March: may 26 Interim Report, January-June: august 22
Interim Report, January-September: november 17
InFoRMAtIon CHAnnelS
Financial information about Black Earth Farming can be accessed and ordered on the company’s website www. blackearthfarming.com
pRInteD InFoRMAtIon MAteRIAlS
Printed annual reports can be received upon request sent to info@blackearthfarming.com
InVeStoR RelAtIonS gustav Wetterling + 44 [0] 2071 178 100
gustav@blackearthfarming.com
InteRnet WeBSIte www.blackearthfarming.com
SDR tICKeRS
– First north market: BEF SdB – reuters: BEFsdb.St – Bloomberg: BEFSdB:SS
AnAlYSeS oF BlACK eARtH FARMInG
Firms that publish analyses of Black Earth Farming include:
carnegie investment Bank aB, E. Öhman J:or Fondkommis- sion aB, J.P.morgan Bank international, nomura international plc, Pareto Securities.
units
1 hectare (ha) = 10,000 square meters 1 hectare (ha) = 2.47105 acres 1 metric ton = 2,204.622 pounds (lb) 1 metric ton = 10 centners
“AGRo-Invest Group”
the company’s subsidiary OOO management company agrO-invest and its subsidiaries, including OOO management company agrO-invest-regions.
“Black earth”
a soil type which contains a very high percentage of organic matter in the form of humus, rich in phosphorus.
“Black earth Farming” or the “Company”
Black Earth Farming limited, a company incorporated in Jersey, channel islands, under the 1991 law with company registration number 89973, including its subsidiaries, unless otherwise is apparent by the surrounding context.
“Black earth Region”
a territory located in parts of russia, Ukraine and kazakhstan endowed with Black Earth.
“Cadastre”
a russian state register of real property including details of the area owned, the owners and the value of the land.
“CIS”
commonwealth of independent States which consists of the former republics of the Soviet Union, excluding the Baltic States. the following countries are included armenia, azerbaijan, Belarus, georgia, kazakhstan, kyrgyzstan, moldova, russia, tajikistan, turkmenistan (associated member), Ukraine and Uzbekistan.
“Crop year”
an crop year in Europe typically begins in late summer with the seeding of winter crops and ends approximately one and a half years later depending on when the crops is being harvested and sold.
“Directors”
the current directors of the company.
“ear”
the grain-bearing spike of a cereal plant.
“eu-27”
the following EU membership countries: austria, Belgium, czech republic, cyprus, denmark, Estonia, Finland, France, germany, greece, hungary, ireland, italy, latvia, lithuania, luxembourg, malta, netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, the United kingdom, Bulgaria and romania.
“Fallow land”
land which is not being cultivated.
“Fungicide”
chemical or physical agent that kills or inhibits the growth of fungi.
“Germination”
the first stage in the development of a plant from seed.
“Grains”
generic name for wheat, barley, oats, rye, rye-wheat, durra millet, maize and rice
“Grain elevator”
Building or complex of buildings for drying, cleaning, storage and shipment of grain.
“land in ownership”
land where the company has obtained the, in the central cadastre, registered rights of ownership to the land.
“land under control”
refers to all land under the company’s control, including fully registered ownership, long term leased land and acquired cropping rights (Pais) in the process of being registered as ownership rights.
“Monoculture”
growing the same crop on the same piece of land year after year.
“oblast”
an administrative region of russia.
“oilseeds”
a wide variety of seeds which are grown as a source of oils, e.g. cottonseed, sesame, rape seed, sunflower and soybean.
after extraction of the oil the residue is a valuable source of protein, especially for animal feedstuffs.
“ooo”
“closed joint stock company”, the russian equivalence to a limited liability company.
“pai”
a share in jointly-owned land received by a farm worker (in the company’s transactions often comprising approximately 2 to 17 hectares of undefined land).
“Russian export taxes”
russian export taxes for relevant crops, currently valid until 30 June 2008: Wheat 40%, Barley 30%, Sunflowers 20% and Oil seed rape 20%.
“SDR”
the Swedish depository receipts issued representing the Shares according to the general terms and conditions for depository receipts in Black Earth Farming.
“tillers”
a shoot that sprouts from the base of a grass plant
“VpC”
VPc aB, the Swedish central securities depository and clearing house with address regeringsgatan 65, Box 7822, SE-103 97, Stockholm, Sweden.
“Öhman”
E. Öhman J:or Fondkommission aB, company registration number 556206-8956, Box 7415, SE-103 91, Stockholm, Sweden.
General Shareholder Information
terms and Definitions
Content
Report on Operations
The Year in Brief ... 2
Harvest report 2007 ... 4
Business Concept – Vision – Strategy... 6
Business concept ... 6
Vision ... 6
Strategies ... 6
Elevators ... 6
The Market ... 8
Black Earth Farming ... 12
Background ... 12
Organisational structure... 12
The Black Earth Region ... 13
Land acquisition ... 13
Developing Russian agriculture ... 15
Modern industrial farming ... 17
Crop Management ... 18
Financial specifics of agriculture ... 19
The Share ... 20
Risk Considerations ... 21
Appendix I – Directors’ Report and Consolidated Financial Statements Directors’ report ... 3
Independent Auditors’ Report ... 10
Consolidated Statement of Income ... 11
Consolidated Balance Sheet ... 12
Consolidated Statement of Cash Flows ... 13
Consolidated Statement of Changes in Equity ... 14
Notes to the Consolidated Financial Statements ... 15
1
The Year in Brief
– Total amount of revenue for the 2007 financial year was equal to RUR 521,762 thousand or USD*
21,256 thousand in comparison with only RUR 12,300 thousand or USD* 501 thousand for the year 2006. The increase is explained by the start of the extensive crop production in 2007. Back Earth Farming generates revenue from two different main segments, namely crops, which is the larg- est segment by far, and milk. The crop segment primarily generates revenue during the autumn as opposed to meat and milk which has more equally distributed revenue streams throughout the year.
– The sales of crops during the period comprised about 69 percent of the total amount of reve- nue and amounted to RUR 358,279 thousand or USD* 14,596 USD thousand to the harvest of 2006/2007. Revenue of crops in 2006 was RUR 10,361 thousand or USD* 422 thousand.
– About 57% of total crops harvested in 2007 had been sold by the end of the year.
– Loss before income tax amounted to RUR 377,568 thousand or USD* 15,381 thousand. As a result no dividends were either declared or paid during the period in question. In 2006 the amount of loss before income tax was equal to RUR 208,011 thousand or USD* 8,475 thousand.
– The largest cost items that significantly affected the result for the twelve months of 2007 were general and administrative expenses that amounted to RUR 356,230 thousand or USD* 14,512 thousand.
– As of December 31, 2007, the company had approximately 289,000 hectares under management and several additional opportunities in the pipeline or in the process of execution.
– Loss per Share for 2007 amounted to RUR –4.86 or USD* –0.20,
– On December 28, 2007 the Company’s shares were successfully listed in the form of Swedish Depository Receipts on the First North market place in Stockholm. Outstanding shares as at 31 December 2007 were 119,566,667.
The Year in Brief
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Breakdown of 2007 Total Revenue
Crop sales 69%
Dairy products 4%
Other revenue 0%
Gain on revaluation of biological assets 27%
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Proportion of 2007 harvest sold in 2007
Sold 57%
Inventory 43%
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Operating and net result development MUSD
Net loss Loss before income taxOperating
loss Gross profit Total
revenue 2006 2007
Profit & Loss
(USD* thousand) 2007 2006
Total Revenue 21,256 501
Gross profit (loss) 9,910 (514)
Operating (loss) (6,781) (6,396)
Profit (loss) before income tax (15,381) (8,475)
Net (loss) (15,788) (8,371)
Balance Sheet
(USD* thousand) 2007 2006
Total Assets 490,235 123,860
Property, plant and equipment 105,960 31,589
Land 43,985 17,700
Cash and cash equivalents 300,412 77,939
Total equity 399,081 122,648
Non-current loans and borrowings 77,386 –
Investing Activities
(USD* thousand) 2007 2006
Land plots 27,116 17,675
Property plant and equipment 63,493 15,560
1. Excluding land plots, mainly production machinery and equipment
Margins
(%) 2007 2006
Gross Margin2 27% –102%
Operating profit margin –32% –1277%
Net profit margin –74% –1671%
2. Gross margin less gain on revaluation of biological assets
Land holdings
(hectares) 2007 2006
Land under control 289,000 129,000
Whereof
Land in ownership registration 247,100 115,000
Land owned 29,100 7,000
Long term leases 12,800 7,000
Hectares cropped 53,451 5,900
Ratios 2007 2006
Loss per share (USD*) 0.20 0.23
Total Debt/Total Equity 19.4% n/a
Total Equity/Total Assets 81.4% 99.0%
Average number of employees 799 37
1
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Operating and net result development Thousand hectares
Land under control Land in
ownership registration
Long term leases Hectares
cropped 2006 2007
Land owned
3
Harvest report 2007
2007 started with the fields under snow and the winter oilseed rape and winter wheat came out of the winter in a good condition with potential. The spring drilling started late in March and proceeded in a satisfactory way with good establishment of spring barley and spring oilseed rape. The later sown sun flowers and corn maize were also well established with drilling fin- ishing by about the 10 May. The lack of rain in April 15mm was ideal for establishing a large area of crops quickly. The late delivery of some spraying machin- ery meant that our spring weed control in some crops was far from ideal. The last 15 days of May were not only without rain but with day time temperatures over 30 Celsius. This had an adverse effect on both the winter and spring crops. The winter wheat did not produce the ears that we were anticipating and the spring barley lost tillers reducing the number of ears per square metre. The sun flowers and corn maize however thrived in the warm conditions. There was approximately 30mm of rain only during this month.
June remained warm but not over hot with 45mm of rain. This meant that we did not have a large disease burden on the crops and we were able to save on fungicide applications although there was not enough rain to produce a good yield from our winter crops.
July saw us start the harvest of winter oilseed rape in Kursk. This crop was not only affected by the May weather but also the quality of the seed that we used on part of the area. We began the harvest of wheat towards the end of July. The dry weather enabled us to proceed with harvest throughout August includ-
ing the spring barleys and oilseed rapes at a good pace and with virtually no drying of crops required.
This was a great saving, as in most cases it was the farm’s first harvest and the full infrastructure for grain treating and storage had not been developed. The effect the weather had had on the yields was partially mitigated by the rapid rise in commodity prices. The sun flower harvest in Voronezh went well, the warm weather was just what this crop needed, and the mar- gins were dramatically enhanced by the prices.
No sooner had we finished harvesting spring barley, than we were back in the fields drilling win- ter oilseed rape for harvest 2008. This went into dry seed beds and germination was patchy but Septem- ber rains gave a good second germination. The win- ter wheat was mostly all drilled within our cut off date of 20 September and established well as a result of sufficient rain. The majority of the wheat went into the winter with 2–4 tillers and the winter oilseed rape with 4–6 leaves. The snow fell during November and pro- vided good protection through out the winter. We look forward to the 2009 harvest of these crops.
A great deal of effort was put into preparing all the management and staff prior to the crucial events in the agricultural calendar. This took the form of inter active seminars with power point presentations and in the field commissioning of machinery with the aid of the dealers qualified staff. The staff not only adapted well to the new, large machinery but also put a lot of effort into producing work of a very high standard. We are most grateful to all the production staff for their loy- Sture Gustavsson
Regional Production Director – Kursk Report by:
Mark Lewis Regional Production Director – Tambov
Rob Coleman Regional Production Director – Voronezh
Harvest report 2007
alty and commitment in what is sometimes extreme conditions. Many lessons were learnt by manage- ment and staff during the 2007 season and everyone was able to begin the 2008 season with a great deal more efficiency and productivity.
The proportion of different wheat qualities in 2007 year’s harvest approximately comprised 30% of the wheat output being classified as Class 3, another 30% as Class 4 and the remaining 40% as Class 5.
Class 3 normally has the highest price due to being of superior quality; however, Class 4 is normally exported, therefore occasions when prices for Class 4 are higher than Class 3 do occur. The aim for the company is to increase the general quality of output,
i.e. increase amount of Class 3 and 4. Improving the quality of Barley output so that a larger portion can be sold as Malting Barley, since malting quality roughly implies a price premium of up to 40%. Higher qual- ity crops can be achieved by ensuring higher quality seed inputs, why the Company retained some Wheat and Barley to be chemically treated and then used as seeds for the 2007/2008 harvest season. This not only ensures the quality of the seed but is also an econom- ically sound practise since it generally reduces your cost for seeds by more than it would have generated in revenue if sold, thereby helping to improve margins for the following harvest.
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Gross Margin per Crop Gross Margin, %
Wheat Corn Barley Sunflowers Rape 69%
41%
–14%
36% 41%
Breakdown of clean harvest 2007 Breakdown of crops sold in 2007
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Corn 1%
Barley 37%
Rape 12%
Sunflowers 4%
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Wheat 41%
Corn 2%
Barley 30%
Rape 21%
Sunflowers 6%
2007 Harvest summary
Gross Crops retained Average price Gross Margin
Type of Harvest for seed use Crops for sale Crops sold in received per for crops sold
main crop (tonnes) (tonnes) (tonnes) 2007 (tonnes) tonne (USD) in 2007 (%)
Wheat 49,262 3,000 46,049 22,865 225 36%
Corn 1,311 1,311 1,311 241 41%
Barley 42,477 1,800 36,723 16,918 205 41%
Sunflowers 3,815 3,650 3,650 516 69%
Rape 12,859 12,291 12,213 297 –14%
Total 109,724 4,800 100,024 58,274 250 30%
Besides the above quantities a total of about 2,659 tonnes of Rye and waste grains were harvested and sold
5
Business Concept – Vision – Strategy
Business concept
Black Earth Farming’s business concept is to acquire and cultivate agricultural land assets in Russia, pri- marily in the Black Earth Region and secondarily in other regions endowed with fertile agricultural land.
Vision
Black Earth Farming will leverage off its unique skill set and first-mover advantage to rapidly develop a critical land mass and generate persistent profitabil- ity in one of the fastest growing agricultural markets in the world. And thus create substantial wealth for its shareholders over time.
Strategies
Black Earth Farming seeks to maintain a balance between seizing adequate land acquisition opportu- nities and cultivating land already under its control. To acquire and cultivate land require considerable capital and management resources but constitute the foun- dation in realising the vision of creating shareholder value. With a view to optimize the use of resources the Company applies the following strategies:
– Control of land: The Company’s land acquisition process begins with a visual analysis of the current field conditions and an overview of historic operat- ing results. If the result of this pilot study is positive, the Company will perform a more thorough analysis including a detailed study of the land conditions and the percentage of land that can be used for farm- ing operations. The Company prioritizes land which is geographically close and with sufficient commu- nications to one of the existing production clus- ters. Additionally, Black Earth Farming prioritizes land with access to elevators, railroad and loading capabilities.
– Economies of scale: The Company establishes pro- duction clusters, on the land under control, which have individual profit responsibility and are gov- erned by professional management with support from the central organisation. The central organi- sation coordinates investments and purchases of seed, fertilizers, fuel and other inputs. The coordina-
tion attempts to optimize the utilisation of manage- ment resources and capital. In order for the return on investments made in machinery and equipment to be optimized, the ambition is that the land area in each production cluster shall amount to at least approximately 10,000 hectares.
– Best practice/technology: The Company applies modern farming practices supported by mod- ern machinery in order to optimize the agricultural operations. Best practice in farming is achieved by employing a combination of international and local expertise. Modern machines, optimally calibrated, reduce for example wastage and the consumption of fuel. Additionally, soil analyses which will deter- mine the selection of crops and the optimal amount of fertilizers needed for each farm are performed.
– Diversified product portfolio: To diversify the Com- pany’s operational risk and improve the productivity and the margins, Black Earth Farming has a long- term strategy to offer higher value-added products.
– Vertical integration and processing: To further improve margins, increase cash flow diversification and reduce exposure to commodity price volatility, Black Earth Farming evaluates selected process- ing such as production of rape and sunflower oils.
For the purpose of increasing the profit margin it is part of the Company’s strategy to gain control over a larger part of the value chain through especially investments in elevators and in specific industrial processing capacity.
Elevators
As stated above, Black Earth Farming considers Grain Elevators as an important part of its strategy to reduce exposure to commodity price volatility and increase the profit margins. It is also maybe the most imminent project in terms of Vertical integration and processing.
Although not yet finalised the Company has continued to develop its Grain Elevator plans and strategies over the preceding period. Besides the already acquired 60,000 ton elevator, three sites are now at the detailed planning phase and it is anticipated Black Earth Farm- ing will go out to tender on the first three sites at the
Business Concept – Vision – Strategy
end of spring/start of summer 2008 in order to aim to have three, seventy thousand tonne facilities (possi- bly more) built and operational for 2009 harvest. The process of “green field” building of such facilities is a complex one and there exists many issues that require considerable lead in planning times such as Utility usage and supply contracts, railroad permissions and approval, local government approval, completing the Due Diligence process for each of the sites and ensur- ing all project designs meet Russian standards.
The medium to long term perspective is that Black Earth Farming continues to build an additional six to eight facilities spread over the following two to five years, the details of this plan is still work in progress and will be further examined over the coming 12 months. The elevator project will represent a very considerable investment and the major reasons for this are as follows.
Operating on such a large scale, Black Earth Farming is exposed to inconsistencies in approach when using third party Elevator services. Discrep- ancies may arise between quantities and quality of grains loaded into local Elevators and is what is sub- sequently loaded out. When operating at the scale of Black Earth Farming these numbers can become very significant and the company wants to move towards a situation where it can control storage of its own prod- uct in its own facilities. Having invested very signifi- cant sums in growing high quality crops the last thing Black Earth Farming wants is to lose control of the final product and building own facilities reduces this risk considerably.
The second major reason is that there will be a cost saving when comparing operating costs of a
modern large facility to service charges currently being paid to local Elevator providers. These bene- fits are still being calculated in some detail as Eleva- tor charges vary and the company continues to inves- tigate detailed build costs and options for achieving optimum value for each dollar invested. The third reason for investing such amounts is that in many areas where Black Earth Farming operates there is a shortage of Elevator facilities. Therefore the mar- ket responds at harvest accordingly with particularly low prices during the July/August period. By having own, large scale, very modern efficient facilities an opportunity will present itself for acquiring third party grain and/ or storing it by providing drying and stor- age facilities to large International traders.
Thirdly, and perhaps most importantly – in the cur- rent climate of high volatility on commodity markets – Black Earth Farming sees an important opportunity in being able to hold crop and begin to develop sophis- ticated marketing tools in conjunction with the physi- cal hold of crop that will provide additional margins in the future. Where prices may increase due to shocks in world supply/ demand – the Company needs the ability to hold crop and turn market volatilities into a potential upside.
Finally, these types of “fundamental assets” are in short supply in Russia and actually hold value in the long term. Therefore this investment is in keep- ing with the overall strategy of investing in underly- ing assets that firstly will largely hold their value in the medium term and secondly contribute to capturing further value in the market place and reducing risk stemming from current commodity market volatility.
60,000 tonne capacity Grain Elevator in Lipetsk
7
The Market
2007 has been characterised by steep rises in soft commodity prices both globally and locally in Russia, benefiting agricultural producers such as Black Earth Farming, although input prices have risen as well, especially fertilizers, fuel and transportation costs, driven by increase in oil price. The market for crops is subject to important global and local long term trends as described below. Additionally, the 2007 glo- bal harvest was adversely affected by poor weather conditions, especially in Australia and Argentina, fur- ther putting upward pressure on prices.
Global Grain sector
The global grain market is dominated by producers and traders from the major producing countries, while local operators have a secondary role. The total grain area harvested has been in an increasing trend since the Agricultural year 2002/2003, but still lower than ten years ago, and amounted to 634 million hectares in the Agricultural year 2006/2007. China and India con- tributed the two largest areas, corresponding to 13 percent and 14 percent of the harvested hectares.1)
In recent years, trade volumes have been stable despite growing global consumption. The nations of East Asia, especially China, require more grain for domestic consumption because of growing popula- tions. The next key variable is consumption trends.
Two elements drive changes in this area – urbanisa- tion and increased general prosperity, as inhabitants
grow richer, direct grain consumption decreases and consumption of meat and dairy products increases.
This has large consequences on the demand for feed grains since it takes multiple kilograms of grains to produce a kilogram of meat, exchange factors depending on the type of meat, poultry, pork or beef.
The increasing demand for grains due to increased wealth and thereby shifting food preferences mainly stems from the BRIC countries (Brazil, Russia, India and China) that are experiencing strong economic growth. This while the amount of arable land is fixed or declining. Especially China has growing difficulty in juggling land resources for food with industriali- sation and urbanisation. This is aggravated by ero- sion, pollution, and the large stretches of deserts and mountains. Much of the most productive agriculture is in provinces where industry and urbanisation are strongest. The result is a major contest for land. As arable land falls towards the minimum needed for the 95 per cent food self-sufficiency policy (excluding soybeans), pressure to import more food is growing.
China’s share of global farmland has fallen from 9 to 7 per cent since 2000 while the population is forecast to rise to 1.4 billion by 2025.2) Only Bangladesh and Egypt have lower ratios of arable land-to-population.
These countries already have, or are gradually transforming from exporters to importers. For exam- ple, Chinese corn export has decreased from 7.3 mil- lion tons in the Agricultural year 2000/2001 to 3.7 mil-
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World population estimates Million people
2005 2007E 2009E 2011E 2013E 2015E 2017E 2019E
Source: Census Bureau of the United States Department of Commerce
170 190 210 230 250 270 290 310
170 190 210 230 250 270 290 330 310
180 190 210 220 200 230 240 250 260 270
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40 60 80
6500 7000 7500 8000 0
100 200 300 400 500 600 0 5 10 15 20 25 30
0 50 100 150 200 250 300
Russian income distribution
By average monthly per capita income (RUR)
2002 2005
Source: Rosstat
1) Source: United States Department of Agriculture 2) Source: Population Division of the Department of Economic and Social Affairs of the United Nations
More than 12,000 8,001–12,000 6,001–8,000 4,501–6,000 3,501–4,500 2,501–3,500 1,501–2,500 less than 1,500
8
The Market
lion tons in the Agricultural year 2005/2006 corre- sponding to a decrease of 49 percent. The forecast for the Agricultural year 2007/2008 is a continued decline to 3 million tons.3)
Historically low stock levels for, among other wheat, in 2007 have put strain on demand/supply balance, contributing to the rise in prices for wheat in 2007. This can be adjusted with a good crop year and more land being diverted to produce wheat, why it should be considered a short term factor. However, acknowledg- ing that while increased wheat output for 2007/2008 crop year might push down prices other crops might instead experience deficits and rising prices.
Besides possible positive one time effects from very favorable weather conditions in a specific crop year, there are certain more long term factors driv- ing demand and affecting supply which speak for a sustained general price level taking into account the whole spectrum of crops. These are:
The main drivers for demand on grains are
– World population growth and increased wealth are main drivers for increased general food consumption – Urbanisation and higher disposable incomes lead a
consumption shift to more protein based foods, e.g.
meat and dairy
– Surging usage of biofuels driven by high oil prices and political policies generate additional demand for agricultural produce
The main constraints on the supply side are – Limited and declining amount of arable land – Regional lack of usable water for irrigation
– Climatic change with adverse affect, as seen over last 2 years, especially in Australia
– Historically low stock levels puts further short term strain on demand/supply balance
Improved global productivity would even out the sup- ply/demand balance but such general improvements will take some time while some of the demand factors are ever increasing.
Russian grain sector
In Russia, grain production uses more than 55 per- cent of the total cropped land. Wheat is the predom- inant crop in most grain producing areas. Barley, the second grain in terms of extent of cultivation, is grown mainly for animal feed and beer production in colder regions. Sugar beet production has expanded in recent years and is mainly grown in the Russian part of the Black Earth Region.
Russia is the world’s fifth largest grain producer producing approximately 3.8 percent of the world output. Russia is the fourth largest producer of wheat globally and is also the largest producer of barley in the world. Russia’s total grain production is estimated at 75 million tons for the Agricultural year 2006/2007.
Wheat constitutes the largest part of the Russian grain output, estimated at 44.9 million tons (60 per- cent of Russia’s grain output) for the same period.4)
The number of harvested hectares of grain in Rus- sia has been decreasing steadily. However, this neg- ative trend has been halted in recent years and the number of harvested hectares of grain has stabilised at around 40 million. Between the Agricultural years of 1998/1999 and 2005/2006 the average grain yield increased by 93 percent.5)
Lately, Russian grain exports have risen signifi- cantly. In the Agricultural year 2001/2002, the coun- try became a net exporter of grain and for the Agri- cultural year 2007/2008 the net export is estimated to approximately 12 million tons. Russia mainly exports wheat and barley, while grains such as oat and corn are consumed locally thus creating a partially iso- lated domestic grain market. Russian wheat is pre- dominantly exported to North Africa, and Russian feed barley is mainly delivered to southern Europe and countries in the Middle East.
The main reasons for rises in domestic grain prices in Russia is that this year the domestic prices have been more connected than practically ever before with world prices, and also because of increased
4) Source: United States Department of Agriculture 5) Source: United States Department of Agriculture 3) Source: United States Department of Agriculture
9
The Market
prices of such inputs such as electricity, fuel, and gas for heating. This rise in prices occurs despite the fact that Russia’s total crop output in 2007 was about 5%
larger than last year, which otherwise logically would cause the opposite domestic price trend. Consump- tion has not risen as much as to offset this increase in output, which means that export has increased. There have previously been no government export quotas or taxes, the limitations have consisted of domestic port and elevator capacity, i.e. limits of logistics and infra- structure for export, but no government actions. In 2007 however, the Russian government implemented export taxes for certain crops, not to lower prices but to curb the steep rise in prices. The increased export and closer relationship between domestic and world prices has had the effect that the domestic prices are basically set by the prices at the ports, foremost Novorossisk, which is the main hub for export to the Arabic Countries, China, India, Egypt and Marocco.
Prices further inland have then been derived from the port price with reductions for the potential transport costs to port (i.e. Net Back). The price for wheat at the Novorossisk port was by the end of the year higher than in the US, but lower than in Europe. The reason the prices were higher than in the US is the closer proximity to China and India etc.
Energy crop sector
Energy crop is a blanket term including all crops intended as raw material for extracting energy, for instance in the form of biodiesel and bioethanol.
Biodiesel and bioethanol constitute the two main cat- egories of biofuels used in transportation. Bioethanol can be produced from any feedstock containing high concentrations of sugar, cellulose or starch, whereas biodiesel can be produced from fats or vegetable oils derived from oilseeds.
The European Union is the largest producer of biodiesel in the world. The greatest amount, approx- imately 80 percent, is produced from rapeseed oil whereas the rest is mainly produced from sunflower oil, palm oil and soybean oil.6)
6) Source: United States Department of Agriculture
170 190 210 230 250 270 290 310
170 190 210 230 250 270 290 330 310
180 190 210 220 200 230 240 250 260 270
-20 -15 -10 -5 0 5 10 15 20 25 0 20 40 60 80 100
-20 0 20 40 60 80
5000 5500 6000 6500 7000 7500 8000 0
100 200 300 400 500 600 0 5 10 15 20 25 30
0 50 100 150 200 250 300
Wheat Class 4 prices*
USD/ton
Jun 2007
Source: IDK.ru & Company Estimates
Aug 2007 Oct 2007 Dec 2007
Class 4 (CBER) Class 4 (Novorossisk)
170 190 210 230 250 270 290 310
170 190 210 230 250 270 290 330 310
180 190 210 220 200 230 240 250 260 270
-20 -15 -10 -5 0 5 10 15 20 25 0 20 40 60 80 100
40 60 80
6500 7000 7500 8000 0
100 200 300 400 500 600 0 5 10 15 20 25 30
0 50 100 150 200 250 300
Feed barley prices*
USD/ton
Jun 2007
Source: IDK.ru & Company Estimates
Aug 2007 Oct 2007 Dec 2007
Feed Barley (Novorossisk) Feed Barley (CBER) 170
190 210 230 250 270 290 310
170 190 210 230 250 270 290 330 310
180 190 210 220 200 230 240 250 260 270
-20 -15 -10 -5 0 5 10 15 20 25 0 20 40 60 80 100
-20 0 20 40 60 80
5000 5500 6000 6500 7000 7500 8000 0
100 200 300 400 500 600 0 5 10 15 20 25 30
0 50 100 150 200 250 300
Wheat Class 3 prices*
USD/ton
Jun 2007
Source: IDK.ru & Company Estimates
Aug 2007 Oct 2007 Dec 2007
Class 3 (CBER)
* Prices including 10% VAT tax, original local prices in RUR, exchange rate used for dollar conversion RUR/USD 24.5462.
CBER prices correspond to approximate average price in the Central Black Earth Region, defined as the average for the regions Kursk, Voronezh, Belgorod and Tambov. Novo- rossisk prices correspond to average export price for actual transactions at the Novorossisk Black Sea export hub.
10
The Market
The European Commission had set a goal that by the end of 2005, biofuels should account for 2 per- cent of the energy used in transportation. This target was set to increase by 0.75 percentage points annu- ally to reach 5.75 percent in 2010. However, at the end of 2005, the actual share of biofuels used in transpor- tation was merely 1.4 percent. The European Council has now suggested a new goal of 8 percent by 2015, and is aiming to reach 25 percent biofuels used in transportation in 2030. Currently, less than 2 percent of European farmland is sown with crops for biofuel production. The European Commission has decided that to divert enough of its own land area for produc- ing energy crops to reach the set targets is undesir- able and proposes to produce half the biofuel from domestic crops and import the other half.7)
The demand for rapeseed in the EU-27, has encouraged an expansion of rapeseed cultivation.
In spite of a record harvest of rapeseed during the Agricultural year 2005/2006 explosive growth in Euro- pean Union use of rapeseed and rapeseed oil is fore- cast to exceed domestic production by over a mil- lion tons for the second consecutive year driven by demand from the biodiesel sector. Traditional suppli- ers, Australia and Canada have not been able to keep pace with surging EU demand, particularly this year with drought in Australia.8)
Over the past three years Russia and Ukraine have expanded rapeseed area by 250% and 400%
respectively, because producers have a ready market in the EU with a natural freight and logistically advan- tage. Russia and Ukraine shipped close to 400 thou- sand tons of rapeseed to the EU during 06/07, triple the volume of the previous year, and accounting for 50% of the EU import market, and export to EU is only expected to rise further.9)
Market for Dairy
Besides the dramatic increases for wheat, barley, corn and sunflower seeds, prices for dairy products in Rus- sia have also increases substantially. Changes in glo- bal consumption patterns as discussed above plays an increasingly important role. Especially demand from China for dry milk, which is normally blended into finished dairy products in Russia, have helped drive up prices for the fresh milk. Furthermore, there is today a large deficit in terms of Russian domestic supply capacity and Russia therefore imports about 45% of all its milk.
7) Source: United States Department of Agriculture 8) Source: United States Department of Agriculture 9) Source: United States Department of Agriculture
170 190 210 230 250 270 290 310
170 190 210 230 250 270 290 330 310
180 190 210 220 200 230 240 250 260 270
-20 -15 -10 -5 0 5 10 15 20 25 0 20 40 60 80 100
-20 0 20 40 60 80
5000 5500 6000 6500 7000 7500 8000 0
100 200 300 400 500 600 0 5 10 15 20 25 30
0 50 100 150 200 250 300
EU biodiesel production Million tons
Source: Methanol Institute, International Fuel Quality Center, EurObserv’ER 2007 and Vostok Nafta estimates
170 190 210 230 250 270 290 310
170 190 210 230 250 270 290 330 310
180 190 210 220 200 230 240 250 260 270
-20 -15 -10 -5 0 5 10 15 20 25 0 20 40 60 80 100
-20 0 20 40 60 80
5000 5500 6000 6500 7000 7500 8000 0
100 200 300 400 500 600 0 5 10 15 20 25 30
0 50 100 150 200 250 300
Harvested hectares of rapeseed in Russia 1,000 Ha
Source: United States Department of Agriculture, PSD Online Actual Forecast
1999 2001 2003 2005 2007E 2010E 2020E
19931996/1997 1997/1998 1998/1999 1999/2000 2000/2001 2001/2002 2002/2003 2003/2004 2004/2005 2005/2006 2006/2007E 2007/2008E
1995 1997
11
Black Earth Farming
Background
Black Earth Farming Ltd is a leading farming com- pany operating in Russia. It acquires and cultivates agricultural land assets primarily in the fertile Black Earth Region in Southwest Russia. Black Earth Farm- ing was among the first foreign financed companies to make substantial investments in Russian agricul- tural sector and because of its early establishment, Black Earth Farming has now gained a strong market position in the Kursk, Tambov, Lipetsk, Samara, Vor- onezh and Ryazan areas. On 31 December 2007 the Company controlled over 289,000 hectares of what perhaps is the world’s most fertile soil and this year’s harvest comprised approximately 53,000 hectares.
Founded in 2005 by Michel Orlov, the company has been developed by the listed investment compa- nies Vostok Nafta Investment Ltd and Investment AB Kinnevik, which together still are the principal share- holders in the company.
Organisational structure
The Black Earth Farming Group consists of the Jer- sey parent Company: Black Earth Farming Limited, the wholly owned Cypriot subsidiary: Planalto Enter- prises Limited, and a number of wholly owned Rus- sian subsidiaries under the joint name of Agro-Invest.
As of 31 December 2007 the Group had 1180 full time employees.
The Company’s operations are divided into three divisions – Kursk division, Tambov division and Voro- nezh division. Each division is governed by a regional production director who reports to the Production Director. The Production Director is responsible for the overall operational management such as planning and optimisation of cultivation and agronomic issues, while each regional production director is responsible for the execution of the agricultural operations. Each division holds certain acreage and consists of two to four production clusters, Regarding further land acquisitions, mainly land areas contributing to a con- solidation of the existing production clusters will be considered. The reason is that operational synergies arise as the land area increases, through a more effi- cient usage of the machinery and through, for exam- ple, coordination in agronomical planning and pro- curement. Each cluster has its own crop rotation plan created by a central agronomical committee, based on the soil’s composition, climatic conditions, and other considerations such as infrastructure and dis- tance to customers. In Black Earth Farming’s opinion its operations shall be conducted within a 100-kilom- eter radius from respective cluster centre, where a hub with transportation and storage capacity is erected to obtain maximal synergies. At present, the clusters consist of consolidated land areas of between 3,000 and 58,000 hectares and are divided among the three divisions as follows:
1995/1996 2000/2001 2005/2006 2006/2007E
Russia Argentina USA Ukraine China EU-27 World 0
1 2 3 4 5 6
0 40,000 80,000 120,000 160,000
0 1 2 3 4 5 6 7 8 9
3 4 5 6
Coarse grain yields (ton/ha)
1990/1991
Source: United States Department of Agriculture, PSD Online
12
Black Earth Farming
– Kursk division: the East Cluster and the West Cluster.
– Tambov division: the Kaluga Cluster, the Lipetsk Cluster, the Samara Cluster and the Tambov Cluster.
– Voronezh division: the East Cluster, the North Cluster, the South Cluster and the West Cluster.
Each production cluster is organised in one or more production teams which are all governed by a Chief Agronomist. The production teams consist of an agronomist, a manager, an accountant and several tractor and combine drivers.
The Black Earth Region
In the Black Earth Region, which is Russia’s largest agricultural region, one of the world’s two existing black earth belts is to be found, the other one is situ- ated in Canada. The region has received its name from the black highly fertile soil, commonly referred to as
“chernozem” or black earth. The belt of soil stretches from northeast Ukraine across the Russian Cen- tral Black Earth Region (Voronezh, Tambov, Kursk, Lipetsk and Belgorod Oblasts) and southern Russia across Kazakhstan into Siberia. A special character- istic of the black soil is that it contains a very high percentage of organic matter in the form of humus, ranging from 3 to 15 percent. Further, the earth is rich in phosphorus and some areas have a content
of clay, of up to 40 percent. The black earth layer is usually deep, often more than one meter but occa- sionally up to six meters. Apart from the large quan- tities of naturally present nutrients, the high humus content in black earth gives the soil a structure and moisture-retention capacity that makes it highly suit- able for farming.
Land acquisition
What makes Black Earth Farming relatively unique on the Russian market is its firm commitment to buy land not for speculative purposes, but to put it in pro- duction. The company’s current holdings of agri- cultural land assets consist of both acquired crop- ping rights on land, so called “Pais”, which is com- parable with long term leases, and direct ownership.
Successively over time all the cropping rights are intended to be converted into ownership. The Com- pany has now moved into a second, less aggressive but more refined land acquisition stage where it pri- oritizes land which is geographically close and with sufficient communications to one of the existing pro- duction clusters. Consolidating the Company’s farm locations will increase administrative and logistic effi- ciencies and further support the economies of scale opportunities. Additionally, Black Earth Farming pri- oritizes land with access to elevators, railroad and loading capabilities.
1995/1996 2000/2001 2005/2006 2006/2007E
Russia Argentina USA Ukraine China EU-27 World 0
1 2 3 4 5 6
0 40,000 80,000 120,000 160,000
0 1 2 3 4 5 6 7 8 9
0 1 2 3 4 5 6
Wheat yields (ton/ha)
1990/1991
Source: United States Department of Agriculture, PSD Online
13
