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Pepper Crop Report 2015 Summary of presentations at ASTA and ESA Annual Meeting

with 6 months forward view until February 2016

Since issuing our 2014 crop report pepper prices have shown continued volatility. It probably can be argued that during the last decade pepper price volatility ranged amongst the highest when compared to many other agricultural commodities. Looking at historical data it seems that the current bull market is lasting significantly longer than during the previous cycles. Whereas normally we saw cycles ranging from 7-10 years, the current cycle which started in 2006-2007, is still making new highs. Considering that the downward leg usually extends over a period of 3-4 years we probably are looking at a cycle length of close to 15 years. At least that is assuming that fundamentals will start to do their work, meaning that higher prices will lead to higher plantings followed by bigger crops. One reason for the extended cycle is that global demand has been increasing especially in the developing

economies in Asia. It is estimated that currently some 40-45% of global consumption takes place in Asia. With rising incomes food patterns are changing and meat consumption is increasing and so is also the demand of spices and pepper in particular. For various reasons, which are elaborated on later in this report, the farm community in the producing countries has found little incentive to invest in pepper and to expand the areas under cultivation. So supply has not been able to keep up with this spur in demand. To ration demand and to bring supply and demand in balance prices had to increase. Black pepper prices peaked during June 2015 at an all-time high of $10,900 per ton for ASTA quality. This is 7 times higher when compared to the lowest monthly average recorded in July 2005 at $1,560 per ton.

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Production The 2014 global production is estimated at 409,000 tons, which is expected to increase to approximate 454,000 tons for 2015. During 2014 Vietnam topped the list with a crop of 155,000 tons, 38.6 % share of global production. Playing the market leader‘s role Vietnam set the benchmark for the global pepper price. Due to unfavorable weather during the early growing stages the 2015-2016 output of pepper from Vietnam is forecast lower at 145,000 tons. Indonesia’s 2014 crop of black pepper was disappointingly low at 42,000 tons. With output of

white pepper at 18,000 tons total production did not exceed 60,000 tons. For 2015 we expect a better black pepper crop bringing the aggregate black and white pepper output 2015 crop to around 70,000 tons. India shrugged off a 6 year decline in production bottoming during 2014 at 45,000 tons. For 2015 India’s crop is significantly better at 85,000 ton. Main reason for this is favorable weather conditions rather than expansion of area under cultivation. Brazil’s output has been fairly stable over the last 10 years fluctuating between 30,000-40,000 tons. For 2015 we expect output to be at the higher end of this range.

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The pepper vine is quite sensitive to soil conditions, rainfall and temperature during the various growing stages. In recent years we have heard quite often about the El Niño and the El Niña effect. Recently released climatic studies indicate that there is a fair chance of another El Niño impacting crops in Asia, however to date we have no indication that pepper production is affected. Various reasons can be mentioned why global pepper supply has not been able to keep up with demand. Increase in cost of input materials at the farm level (fertilizer, pesticides, labor, water, etc.), land availability, investments in new gardens only yield returns after 3 years, spread of disease due to minimal crop alternation and high usage on fertilizers, competing crops like coffee and rubber which also yield good returns, yield (kilos/hectare) differences between the producing countries, currency fluctuations, etc.. Urbanization and demographic changes are other elements that influence pepper production. As the younger generation looks for employment in the non-agriculture sector, older farmers, who are generally also smallholder farmers, move to higher incentive crops. Not only does this affect the scarcity of spices, it also negatively affects the environment – high intensive monoculture farm systems cause serious land degradation, pollution and erosion issues. As a consequence, the life span of pepper vines is shortened. This is seen especially in Vietnam, partly due to a lack of experience combined with the prevalence of smallholder farmers. Thus, it can be inferred that the Vietnamese farmers have high, but not sustainable, yield. As a result, although the yield seems impressive, much of this is simply replacing dying and diseased vines; ultimately, the true yield is quite limited.

This whole basket of reasons made that farmers were less inclined to invest in pepper in order to ensure that production could keep pace with the rise in consumption. However, as mentioned in the beginning of this report for 2015 we see higher crops in Indonesia and India, whilst also plantings in Brazil and Vietnam are increasing. Possibly the first signs that farmers find incentive in growing more pepper. Global consumption Global pepper consumption is estimated at around 400,000 tons and has been increasing steadily. Break down between regions is available from the chart. With 1.5-2% per annum the growth in North America and Europe has been limited. Demographic factors are fairly stable and consumption patterns only change slowly. We can clearly see that the growth in consumption is mainly from countries like India and China, which are estimated to consume 59,000mt and 49,000mt in 2014 respectively. Population growth and per capita income has increased triggering a shift in consumption to protein based foods, like meat. Growth rate for Asia and the Middle East is estimated at 3-4%. In a global view consumption growth is 2-3% per annum. Worthy of note is that although China is a producing country their domestic demand has exceeded their production ability during the past ten years; hence, they should be viewed as a net consuming country. India at times needs to import pepper to cover their domestic needs. However, with favorable weather, India can fill local demand and still have surplus to export.

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Stock levels Since 2006 global stock levels have been declining. However for 2015 we forecast that a surplus of supply is likely to be recorded. This is largely due to the increase in production from India and Indonesia. The increase in global stocks did so far not lead to lower prices, on the contrary: 2015 pepper prices saw new highs. Why is this? Global consumption of 400,000 tons per year translates in some 33,000 tons per month. We estimate that current global stock position of 150,000 tons covers 4-4.5 months of consumption. Considering the fact that in order to fill the pipeline between origin and the end consumer some 92,500 tons is needed (for calculation see table “pipeline stocks”), a global stock position of 150,000 tons is still tight.

To be comfortable the world needs 8-10 months of stocks, (about 264,000 - 330,000 tons). So the supply surplus we expect during 2015 of 20,000 tons is marginal in view of what is needed to have a more comfortable supply situation. These low stock levels indicate a continuation of a period during which supply and demand is in a tight equilibrium making the market vulnerable and very much supply driven. We estimate that production cost of pepper is costing the farmers between USD2.5-3.0/kg, but the selling price has been at least 3 times higher than this for many years. Therefore the farmers’ financial position has been strengthening and so has their holding power.

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Furthermore, farmers are using 21st-century technology to carry out business. Price transparency is common in most farm communities. In Vietnam, there are websites created and managed by the farmers themselves to share market information as well as cultivation techniques. Through these means, they are successful at leading the market. At the other end of the scale, fears that the market may rapidly switch from bullish to bearish encouraged industries and other users to maintain a ‘hand-to-mouth’ buying strategy.

So the tight supply and demand situation and empty pipelines makes that famers, because of their stronger holding power, can exercise control over availability of pepper in the world market where spot positions continue to demand a premium over shipment prices. This is a scenario in which it is difficult to expect relaxation in prices even though there is a slight surplus in supply for the first time in 9 years. The above can also be approached by looking at the global stock ratio, which is defined at global stocks divided by global consumption. From the graph “Global Stock Ratio” we can see that this ratio is likely to improve by a few percentage points during 2015. The relationship between price and stock ratio is obvious. A few percentage points increase in the global stock ratio should therefore translate into a minor relaxation of the global pepper price (expressed as average for the year),

but still for now will fall short of triggering a bear market. 6 months forward view until February 2016 We have used our statistical database to forecast the supply and demand situation during the next six months to 1 March 2016, which is more or less when the new crops from Vietnam and India will arrive at the market. From the table below we can read that exports during this period are forecast at 140,000 tons against a consumption requirement of 131,000, suggesting a surplus of some 8,000 tons. This figure is probably somewhat higher as new crop volumes are likely to reach the market before 1 March 2016. Important here is to note that for the similar period last year we were calculating a deficit of 27,000 tons, hence a difference in availability of around 35,000 tons, which may proof to be a significant number. Exports from Vietnam to Europe are declining because of quality issues, which means that off take for Vietnamese pepper is less. Currency depreciation in the Indonesian Rupiah, Indian Rupee and Brazilian Real may improve competitiveness of pepper from those origins undermining Vietnam’s ability to market their pepper. Lastly there is the potential of a good crop in Vietnam for 2016, which normally casts its shadow ahead. These factors can make that the control of the Vietnamese pepper community over the supply will become less and will cause nervousness when holding back supplies from the market. In conclusion we can state that there are reasons to expect pepper supply to improve especially during the coming 6 months and that we may have seen the peak in prices during June of this year. The fundamentals start to work again as the price incentive for farmers is likely to trigger an increase in the cultivation area. However, at the same time we are still confronted with low global stocks and empty pipelines making the market vulnerable to price swings.

min max min max

shipping 4 5 20,018 25,023

clearing 1 2 5,005 10,009

grinder 4 8 20,018 40,036

industry 3 6 15,014 30,027

logistics 1 3 5,005 15,014

13 24 65,059 120,109

average pipeline in weeks 18.5

average pipeline in tons 92,584

Pipeline stocks

weeks tonnage

Period Sep-Feb Scenario 1 BOS (*) Production Domestic Imports Exports YTD Export Export Stock

100% stock for Mar delivery Stock (**) Consumption From harvest to 31 Augavailability Sep-Feb 16 01-Mar-16

Vietnam Mar-15 28,363 139,000 5,810 9,000 107,000 63,553 36000 27,553

Brazil Aug-15 5,761 45,000 6,835 - 4,000 39,926 30000 9,926

Indonesia Jun-15 12,512 70,000 10,391 - 13,500 58,620 40000 18,620

India Jan-15 3,179 85,000 59,329 26,500 14,000 41,350 10000 31,350

Malaysia Apr-15 9,018 24,000 8,179 - 6,200 18,639 6000 12,639

China Apr-15 9,345 38,000 49,137 16,000 1,000 13,207 3000 10,207

Sri Lanka Apr-15 1,534 30,000 3,617 - 10,333 17,583 8000 9,583

Other 8,634 22,000 13,113 - 5,100 12,421 7000 5,421

Total 78,345 453,000 156,413 - 161,133 265,299 140,000 125,299

(*) Beginning of Season Demand non-producing countries 131,879

(**) nett of losses to white conversion Surplus/Deficit 8,121

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