For the wheat industry, China presents one of our most complex trade policy issues. It also presents one of our greatest opportunities. I have been working for months to break down the issue into a quick video update, but I am struggling to do it, it is too complex. So I will attempt to break it down in this blog post. First I will start with background on the China market, discuss two crucial WTO enforcement cases that we recently won, and finally address the Phase 1 agreement that is expected to be signed in early 2020.
China Market Background
China is the largest producer of wheat in the world, they are also the largest consumer of wheat in the world. They have long maintained a stated goal of being 95% self sufficient when it comes to wheat consumption. They currently hold over 50% of the world wheat stocks. For more information on global wheat stocks as well as S&D, US Wheat provides an excellent weekly report – it can be found here.
As China’s population has risen so has their need for wheat stocks. China imported as much as 15 million metric tons (MMT) in the early 1990s before focusing on increasing domestic production. Since that time their imports have dwindled down to around 3 MMT. In order to encourage their own farmers to raise wheat they have provided substantial domestic price support, as well as an unknown amount for input subsidies. I will discuss this issue later when we talk about the WTO cases we brought against China.
China’s domestic market has a mix of state trading enterprises (STEs) which dominate their market as well as private companies. The dominant STEs are COFCO and SINOgrain. They are responsible for most of the grain imports that flow into the country. The private entities are less dominant, however they prefer the quality of wheat we produce here in the US as well as our competitors in Canada and Australia. China domestic production tends to lack the quality of our Hard Red Spring (HRS) crops which leads the private millers to come to us to buy high quality wheat to blend with lower quality domestic wheat. The China market, much like most of the Pacific Rim also demands high quality wheat for noodles. This leads them to purchase our soft white wheat (SWW) as well as HRS.
US led WTO enforcement cases
To understand the two enforcement cases the US brought against China at the WTO we have to go back to 2001 when China acceded to the WTO. As part of their ascension agreement they agreed to several policies that impacted the wheat industry. The first was a wheat tariff rate quota (TRQ). China committed to importing 9.64 MMT under the TRQ at a tariff rate of 1%. Outside of the TRQ the tariff is a staggering 65%. The TRQ is not specific to the US, it is open to any exporting country in the world.
China also committed to “de minimus” support level for their domestic production at 8.5%. This is factored into their Aggregate Measure of Support (AMS). For developing nations, which China is considered a developing nation in the eyes of the WTO, they are allowed up to a 10% de-minimis AMS while developing nations such as the US are allowed 5%. China came in at 8.5%, lower than some developing nations but obviously higher than developed nations such as the U.S., Australia, and Canada. A de-minimis support level is calculated as a percentage of the total value of production. China is allowed to support their domestic producers at 8.5% of the total value of their wheat crop. You can see how we report agriculture support subsidies to the WTO in these Congressional Research Service reports, linked here.
China was given several years to implement these agreed upon changes however they failed to do so. They have routinely failed to import their TRQ, typically fulfilling less than 50% of their quota. Just because a country opens a TRQ for a certain commodity does not necessarily mean they will fill all of it. Quotas can be under-filled if markets dictate that, meaning the domestic price is below the import price. Or domestic supply exceeds demand. But in the case of China their TRQ should always be filled because their domestic price is nearly double the price of importing wheat. They are also free to import beyond the TRQ – Japan often imports over their TRQ for wheat.
Because China’s economy is state based rather than market based they administer their TRQ by assigning roughly 90% of the total TRQ to the state owned enterprises (STEs) and 10% is available for private companies. The private companies always fill their allowed TRQ. In fact they will sometimes overfill it despite the 65% tariff. The STEs never fill their alloted 90%. Their fill rate hovers around 25%.
They have also failed to reform their domestic price supports. In 2014 US Wheat associates commissioned a study by DTB Associates that highlighted the extent to which China is subsidizing their domestic producers. China essentially guarantees their producers a set price per bushel. If they cannot get that price on the private marketplace they can sell their wheat to the STEs for the set price. In 2014 that price was around $10 per bushel. They have lowered it some in recent years, but they are still paying around $8.90 per bushel. The best price we have seen recently in the US markets for hard red winter is around $5.00 (that is a cash price out of Montana). Here is a link to US Wheat’s information on the China cases.
These domestic price supports have distorted domestic production and caused the government to buy incredibly large quantities of grain. This distortion was found to cost US producers $650 to 700 million annually from lost sales as well as a suppression of global prices due to overproduction. This overproduction has led to China holding over 50% of the world wheat stocks and has given the appearance of excessive global wheat stocks.
Once US Wheat had compiled these studies they were taken to USTR and USDA Foreign Ag Services. US Wheat and NAWG worked with these two agencies to encourage them to bring an enforcement case to the WTO for both the domestic price supports and TRQ. The cases were brought in 2016 and included other commodities including corn and rice. We won the cases in early 2019. China agreed to implement changes for both programs without appealing the cases at the WTO.
China Phase 1 and Domestic Support Changes
This essentially brings us up to date and into 2020. China has committed to reforming their domestic price supports as well as fully implementing their TRQ. But how does China Phase 1 agreement factor into this? How do we ensure China complies with the WTO ruling? For the TRQ case it is fairly easy to ensure China complies as well as to track their compliance. The Foreign Ag Service (FAS) publishes reports on the imports and exports of various countries. Here is a recent one on the China market (page 5) as well as other markets impacting the US. As they note, prior to the beginning of the trade war, we often owned as much at 60% of the China import market. That is a sizable market share.
That market does fluctuate substantially based on domestic production as well as production from our top competitors in Canada, Australia and Russia. The trade war caused our market share to plummet to zero for all of 2018. We recovered 1% of the market share in 2019. This has represented a significant blow to US wheat producers, especially in HRS and SWW areas in Montana and the Pacific Northwest. We are hopeful however that we will recover a substantial amount of this market share through the Phase 1 agreement.
There are a lot of details to be released on the Phase 1 agreement, but here’s what we know: it is an 86 page agreement and includes 7 chapters (that is incredibly short for a trade agreement, for comparison USMCA is over 1800 pages and includes 34 chapters). Here is a link to the USTR fact sheet. The deal is being scrubbed by lawyers and is expected to be released and signed in early 2020. There are some small differences between the public statements from the US and China in regard to the total agriculture purchases agreed upon in the deal, but the larger trends are mirrored from both countries. China has committed to increasing their agriculture purchases from a baseline of $24 billion (the value of their 2017 purchases) to $40 billion. There has been a lot of debate about whether or not China can achieve that level of purchases, however JCI – China’s top agriculture consultancy group – has provided compelling data that shows they can achieve that level.
JCI put China’s wheat imports from the US at 5 MMT. This is an eye popping number. It would give us just over 50% of their 9.6 MMT TRQ which is inline with the market share we previously had in the China market but it is well above the estimate of roughly 3.0 MMT that we had hoped to get from China fully implementing their TRQ. So where does 5 MMT put China in terms of US export customers? Easily #1. Historically our top markets have been Mexico and Japan, with the Philippines recently increasing their demand and challenging Mexico for the top destination. These markets import around 3 MMT. The full implementation of their TRQ alone allows for a significant increase in imports which would likely increase the price of wheat worldwide, but it would be a significant development if the TRQ was fully implemented as a result of the WTO case we won and if the Phase 1 deal did give us a market share of over 50%. The combination of a Phase 1 deal as well as our win at the WTO leads us to be optimistic about China’s plans to fully implement their TRQ.
While the implementation of China’s TRQ is a major factor in our export markets we still have to track China’s changes to their domestic price supports. China announced earlier this year that they will be changing their domestic price supports however they did not announce substantial changes. They announced they will continue to provide substantial price supports – maintaining their $8.90 price – but “limiting” the number of bushels they support. But their “limit” is above the level they typically purchase. This leads us to be fairly cautious when it comes to our optimism on their domestic price support reforms.
As an industry we will continue to monitor China’s domestic price supports as well as input subsidies and will encourage the administration to bring future WTO cases if we find they continue to be out of compliance with their WTO commitments. We will also continue to work with Chinese millers and bakers to ensure we can provide them with the high quality wheat their consumers demand. We were encouraged to see a substantial number of Chinese buyers at our recent wheat buyers conference in November 2019.
China is has long been a complex economy and trading partner for the US. We have fundamentally different economies as ours is market based while theirs is reliant on government support. This has made them our greatest challenge as well as our greatest opportunity. Breaking down those opportunities and challenges is certainly not easy. There are a lot of different factors impacting our trade policy opportunities into that market. While we are cautiously optimistic we will be able to increase our exports to China as a result of them implementing their entire TRQ and the Phase 1 deal we are not as optimistic about their domestic price support reforms.