Three Articles from "Agricultural Outlook" Magazine

1. World Agriculture & Trade
2. Biotechnology: U.S. Grain Handlers Look Ahead
3. Biotech Marketing

"Agricultural Outlook" is published by the Economic Research Service of the U.S. Department of Agriculture (USDA). It is the main source for USDA's farm and food price forecasts; short-term outlook for major areas of the agricultural economy; long-term issue analyses of U.S. agricultural policy, trade forecasts, export-market development, food safety, the environment, farm financial institutions.

Complete texts of the April 2000 issue of "Agricultural Outlook" can be found on the Internet at: http://usda.mannlib.cornell.edu/reports/erssor/economics/ao-bb/2000/ao270.asc, or at http://usda.mannlib.cornell.edu/reports/erssor/economics/ao-bb/2000/ao270.pdf.

WORLD AGRICULTURE & TRADE

Biotechnology: Implications for U.S. Corn & Soybean Trade

About the Data: U.S. trade data are from calendar year Foreign Trade of the U.S. (FATUS), ERS/USDA. Other countries' calendar year trade data are from the United Nations FAOSTAT and COMTRADE databases. In this article, use equals supply minus stocks.

The introduction of biotechnology into the U.S. food and fiber system has raised questions about possible effects of the new technology on U.S. agricultural trade and the U.S. agricultural marketing system. Producers of major field crops such as corn (maize) and soybeans have rapidly embraced bioengineered varieties because of their ability to enhance yields and reduce pest-management costs. Nevertheless, these farmers have begun to face uncertainty in marketing bioengineered products abroad, in part because of potential limitations from government policies and the direction and intensity of consumer preferences. Consumer preferences regarding biotech products have been cited as a factor in the performance of U.S. exports.

The Biosafety Protocol, an environmental agreement aimed at protecting biodiversity, was adopted by more than 130 countries on January 29, 2000, in Montreal, but must be ratified by 50 countries before it can go into effect. This process could take 2-3 years. The scope of the Protocol does not cover food safety. To a large extent, the Protocol will not alter the status quo for bulk commodities containing a biotech component. Countries may, as many currently do, require approval of new biotech crop varieties under their national laws and regulations.

The European Union (EU) approval process for imports of bioengineered varieties has been a particular source of consternation for U.S. exporters. Although some bioengineered corn varieties have been approved by the EU, a number of other corn varieties approved and planted in the U.S. have yet to be accepted by the EU, and a de facto moratorium currently exists on EU approvals. To date, however, the one biotech soybean variety commercially grown in the U.S. is approved in the EU market.

While only a small fraction of U.S. corn acreage has been planted to these non-EU-approved corn varieties, fears of having shipments delayed or halted if unapproved varieties are commingled with approved varieties has prompted some U.S. corn exporters to forego the EU market altogether. Meanwhile, a number of countries around the world have announced plans to move forward with labeling requirements for bioengineered foods, generating concern that the U.S. might lose export markets or that U.S. food processors will face significant labeling-related costs.

These circumstances suggest the need to take stock of the potential impact of biotech trade restrictions on U.S. commodity exports and markets. An examination of the global markets for corn and soybeans which are similar but which differ in some significant ways can highlight factors that may be key to assessing the degree and nature of potential effects. Key factors include the importance of trade as a share of demand for U.S. commodities, trading partners' inclination to buy from the U.S. rather than competing suppliers, flexibility in the U.S. marketing system to respond to "differentiating" demands of importers, and regulatory actions taken by governments.

Most U.S. Corn Remains Stateside

In marketing year 1998/99, the domestic corn market claimed more than 80 percent of total corn use (use equals total supply less stocks). With such a large domestic component consisting of feed use (61 percent), food use (8 percent), and ethanol and sweeteners (13 percent) the U.S. corn market should be cushioned significantly from international biotech issues.

The export component of U.S. corn use is 18 percent, with shipments going to countries throughout the world but nearly evenly distributed among four countries or regions: Latin America, Japan, "other East Asia," and Africa and the Middle East. These four markets account for 94 percent of total U.S. corn exports. EU purchases about 300,000 tons in 1998/99 represent less than 1 percent of U.S. corn exports, a drop from 4 percent prior to biotech-related problems. The EU has remained relatively self-sufficient in corn, indicated by the large volume of trade among member countries (intra-EU trade) relative to imports from nonmembers.

The EU represents the one documented loss of U.S. corn exports resulting from issues related to biotech products. The volume of corn exports to the EU fell more than 90 percent in 1998, a decline due largely to delay in the EU regulatory approval process. Moreover, this market represented an import quota to compensate trading partners for the loss of market when Spain and Portugal joined the EU. However, this market opportunity has been virtually eliminated by delays in the EU regulatory process.

Patterns in world trade over time depend on a number of factors, including relative proximity, historical trade ties, and degree of price sensitivity in a market. The biotech issue is another factor that may influence world trade flows. Global commodity markets are composed of many bilateral trade flows linking individual country markets. A high degree of price sensitivity means that small price differentials arising between competing suppliers may generate dramatic changes in trade flows. This is illustrated by examining bilateral flows of corn in the pivotal period between 1995, when U.S. corn exports totaled 60 million tons, and 1998, when corn exports had fallen back to 41 million.

Most of the drop in U.S. corn exports from 1995 to 1998 is attributable to a fall in shipments to "other East Asian countries," including China. U.S. corn exports to this region plunged from 20.4 million tons in 1995 to 8.6 million tons in 1998, largely because of increased global supplies and weak demand when China, a net importer in 1995, became a net exporter in 1998. Fierce price competition among competing suppliers to the East Asian market generally plays a major role in import decisions, causing strong shifts in trade relationships.

Malaysia, which imported most of its corn from the U.S. in 1995, made a dramatic switch away from U.S. corn in 1998, as China, a long-time supplier, once again became the dominant supplier by offering lower prices. Malaysia substitutes corn from China with relative ease because of its historical bilateral ties with China and its relative proximity.

The Malaysian example typifies the general price sensitivity of trade relationships in East and Southeast Asia. Japan, however, stands apart from other East Asian countries with regard to its importing decisions, because of the strong government role in managing food imports. The U.S. has remained the dominant supplier of corn to Japan, and the U.S. share of Japan's imports has been roughly the same over time despite major disruptions in the corn market, because Japan favors a reliable and stable trade relationship.

Mexico provides an example of an importer that has consistently relied on the U.S. as its dominant supplier because of market conditions. This strong bilateral tie is explained by geographic location and shipping logistics, as well as the reluctance to incur large transaction costs of switching to nontraditional suppliers e.g., negotiation of contracts with new suppliers and exposure to risks of an unfamiliar supplier. Mexico's reliance on the U.S. as its sole supplier of corn provides continuity in foreign demand similar to the stable demand from the U.S. domestic market. While total U.S. corn exports fell dramatically from 1995 to 1998, Mexico's imports from the U.S. actually increased 80 percent. Colombia's relatively close proximity to the U.S. also seems to explain its stable trade pattern. More than 60 percent of Colombia's corn imports come from the U.S.

Clearly, U.S. corn suppliers face a diverse foreign market, and competitively priced corn seems to be a larger consideration for some importers than for others. Direct price competition between the U.S. and China will likely continue to be a key factor in U.S. market share in the East Asian market. But proximity and historical trading ties also play a role.

From a global perspective, with the U.S. supplying about two-thirds of total corn trade, importers cannot easily satisfy such large demand with alternative sources. Furthermore, the U.S. does have to its advantage a long history of being a dominant supplier in a number of countries where purchasers would likely be reluctant to incur the costs associated with switching to nontraditional suppliers unless the U.S. were unable to deliver crops that fit their import needs.

Issues stemming from biotech preferences will be a factor to be considered along with other factors in purchasers' import decisions price, proximity, and historical trading relationships. But unlike sudden shocks that the global corn market has historically experienced (e.g., adverse weather or government policy changes), changes stemming from biotech preferences will likely be more gradual, giving producers and grain handlers the opportunity to anticipate and prepare for potential market adjustments.

Stiff Competition In Soybean Market

Exports play a larger role in the market for U.S. soybeans than for corn. Shipments to foreign markets amount to about 42 percent of U.S. soybean use including meal and oil. A symmetry exists in U.S./EU soybean trade i.e., U.S. soybeans make up a large share of EU soybean imports (39 percent), and EU purchases make up a large share of U.S. soybean exports (33 percent). If soybean exports were to fall suddenly, there would be significant impact on the U.S. soybean market unless the U.S. were able to quickly find alternative buyers. However, efforts to replace U.S.-produced soybeans would impose higher prices on foreign consumers at least in the short term. Foreign consumers would also face higher prices as suppliers sought to recoup costs associated with developing separate marketing channels for non-biotech crop varieties.

A dramatic drop in U.S./EU soybean trade is unlikely because of EU reliance on imports from the U.S., and because biotech soybeans commercially grown in the U.S. are EU-approved. However, it is unclear how the EU regulatory regime will evolve, particularly in relation to the potential commercialization and approval of new biotech soybean varieties.

As in the case of corn, the global market for soybeans experienced significant changes in recent years. Between 1997 and 1998, U.S. soybean exports fell from 26 million tons to 20 million, although world trade remained nearly constant. The drop in U.S. exports resulted from price competition that led to expanding foreign sales for every other major soybean exporting country and most importer countries switching some purchases to non-U.S. soybeans. Unlike the corn market, where the decline in demand for U.S. exports was somewhat limited to East Asian countries, the U.S. experienced an across-the-board drop in soybean exports. The U.S. faces direct competition from top soybean exporting countries in nearly all markets, since competitors have established bilateral trade ties in those same markets. The Mexican market, an exception because it has few alternative suppliers, increased its imports of U.S. soybeans.

Traditional competitive forces (primarily prices) appear to be the main driving factors behind the changes in observed bilateral trade patterns for soybeans, and the price-competitive nature of the market has implications for producer decisions to plant bioengineered seed. In order to remain in business, all producers, including those in the U.S., need to remain globally competitive and strive to adopt cost-reducing technologies. Bioengineered seed is one of those technologies. A possible strategy for some producers is to sell in niche markets willing to pay a higher price for differentiated products, including products not derived from bioengineered crops.

Potential Profit & Cost In Differentiated Products

Among buyers in some countries, demand may co-exist for both biotech crops (grown from bioengineered seed) and non-biotech crops (grown from seeds developed with traditional plant breeding techniques). The extent to which demand for one or the other will eventually dominate may vary significantly from country to country. Some exporting countries are likely to produce and export both types of crops, and to develop marketing systems that offer consumers products that are differentiated according to their biotech status.

Such product differentiation is merely an extension of a trend already established for high-value products in grain and oilseed markets. Other differentiated products such as high-oil corn, hard endosperm corn, white corn, waxy corn, nutritionally dense corn, high oleic soybeans, and improved food-quality soybeans are already fixtures in the marketplace.

The Japanese soybean market is one example of how U.S. agriculture may tap into opportunities presented by potential demand for non-biotech commodities, and how new marketing channels emerge to accommodate shifts in demand. In contrast to the EU, a significant amount of soybeans in Japan are consumed by humans. Although Japan continues to import biotech soybeans for use in animal feed, the U.S. has also been successfully exporting both organic and non-biotech soybeans to the Japanese food-use market at a considerable price premium.

U.S. exports of organic and non-biotech soybeans suggest that some U.S. producers and companies have pursued profits from potential foreign demand for non-biotech foods. If there are premiums to be earned for non-biotech commodities (or for any varieties with other specific traits of value to users), then suppliers of marketing services that help producers meet these specific demands are likely to emerge.

For example, in 1999, Clarkson Grain and Nisshin Shokai announced a program, called Fresh Pure Green, to assure buyers (principally Japanese soy food manufacturers) that their soybeans are non-biotech varieties and 99.5-percent free of bioengineered material. The company contracts directly with farmers for specific varieties that are identity-preserved, from planting through harvest, storage, delivery, cleaning, and conditioning. The company relies on an independent certifying agency, the Illinois Crop Improvement Association, to sample and test the soybeans to assure they meet the 99.5-percent standard.

In the long run, consumers around the world will decide what premiums they will pay for non-biotech products, and producers in different countries will consider the relative prices for biotech and non-biotech crops in relation to their local farming conditions when deciding what to plant. Both the magnitude of preferences (demand) and the costs of providing different products (supply) will determine the market outcome.

Regulatory actions of governments around the world will also influence the impact of biotech issues on trade. The EU recently adopted labeling regulations for foods containing a biotech ingredient or containing any ingredient with a biotech content of 1 percent or more. Further, to avoid labeling, if the food contains less than 1 percent biotech material, processors must prove that introduction of the biotech content occurred accidentally. However, it is unclear whether enforcing a 1-percent threshold for food is technically feasible, especially where commingling can occur at many locations in the marketing chain. The EU is currently drafting feed labeling regulations.

Japan is also developing food labeling regulations. In August 1999, the Japanese government announced it would institute mandatory labeling of over 20 foods and food ingredients produced from biotech corn and soybeans, to be effective in April 2001. Last fall, well ahead of scheduled government implementation of labeling requirements, a few tofu manufacturers, brewers, and soy sauce and soy protein food manufacturers announced that they will cease using biotech corn or soybeans in their operations. These companies are apparently seeking to cultivate niche markets for non-biotech foods.

A number of other Asian export markets South Korea, Thailand, Indonesia, and Hong Kong as well as Australia and New Zealand, also have decided to follow suit, drafting labeling regulations they expect to implement soon. Canada recently announced that it intends to encourage voluntary labeling.

Full implementation of labeling regulations, while responding to some consumer concerns, could hinder market adjustment by increasing the costs of market segregation and voluntary labeling that may be naturally occurring in response to differentiating demands. Government labeling policies may specify the set of products requiring labeling and determine the tolerance levels for products. If the tolerance level is unduly low or if the standard exceeds the capabilities of currently available technologies such as diagnostic tests to reliably differentiate products, mandatory labeling could lead to increased costs.

Potential changes in consumer preferences and the likely evolution of technologies to segregate and verify biotech-free products mean that standards need to change over time. Adapting government regulations to these dynamic market conditions requires widespread public and industry discussion.

Prices Capture Biotech Tradeoffs

Not surprisingly, prices summarize all the impacts of biotechnology on both demand and supply for corn and soybeans. On the demand side, consumers must be willing to pay higher prices for non-biotech crops in order to cover higher costs of production and marketing. Consumer preferences may create two potential markets and a choice for producers in the future. Producers may face a trade-off between potentially higher prices for non-biotech crops and lower costs of producing biotech commodities.

Prices play a central role in all types of global market adjustments. In any year, a large number of corn and soybean importing countries switch suppliers readily to obtain the lowest market price, and producers face constant pressures to cut costs in order to remain competitive. The global market impact of a country's preferences regarding biotech products depends on the size of the affected trade flow. EU corn imports represent a small share of global corn trade, but the EU is the world's largest soybean importer. On top of shifts in global markets for biotech crops, consumer willingness to pay for non-biotech foods also creates a new market that U.S. producers and traders have started to supply. To date, evidence shows that the higher price, non-biotech market remains small.

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Market prospects for genetically-modified crops are tinged with uncertainty. U.S. producers have rapidly increased acreage devoted to production of crops developed through biotechnology (biotech), which has the potential to increase yields and reduce pest management costs. However, some consumers in the U.S. and abroad particularly the European Union remain wary of the new technology despite reviews by the U.S. Food and Drug Administration that have determined that biotech foods currently in the market are safe for human consumption. As a result, grain handlers, food manufacturers, and others in the global marketing chain are attempting to balance the issue of divergent consumer demand with producers' desire to capture the cost-saving potential of biotech crops.

Although trade pattern changes arising from shifts in consumers' preferences have been quite modest so far, segregation of grain into biotech and non-biotech may increasingly become a consideration. Questions are being raised about possible adaptations in the marketing system. What are the likely costs of large-scale segregation? How has the U.S. grain marketing system already responded to changing demands? And, how is the system likely to change in the future?

Consumer Preferences & Market Uncertainty

Adoption of biotech varieties has been rapid in the U.S. Since the mid-1990's, U.S. acreage in insect-resistant corn and cotton, and herbicide-tolerant soybeans has increased dramatically. By 1999, nearly 60 percent of soybean-harvested acres in the U.S. was planted to herbicide-resistant soybeans, while nearly 40 percent of corn-harvested acreage and over 60 percent of cotton-harvested acreage was planted to biotech varieties.

Whether U.S. farmers will continue to expand their seeding of biotech crops this spring depends primarily on how they anticipate acceptance of biotech crops in domestic and foreign markets, which rests upon consumers' attitudes toward biotech food and feed products. At present, market demand for non-biotech corn is very limited, accounting for only 1 percent of 1999 U.S. corn production. This demand stems primarily from 1) European Union (EU) imports, where products containing biotech ingredients must be labeled, 2) a few brewers in Japan that accept only non-biotech corn as a grain ingredient, 3) domestic seed use, and 4) a handful of domestic food manufacturers that recently decided to use only non-biotech ingredients.

According to analysis by USDA's Economic Research Service (ERS), market demand for non-biotech soybeans now accounts for about 2 percent of U.S. soybean production and is associated mainly with 1) domestic seed use, 2) food soybeans exported to Japan (about 200,000 tons a year) under identity preservation (IP) marketing for making tofu, soy sauce, and other soy foods, and 3) a few niche markets in the EU. Most EU imports of soybeans and soybean meal (16 million tons of soybeans and 19 million tons of soymeal) are used for animal feed, but a small share (less than 1 million tons) is used for food. Despite the relatively small market shares for non-biotech corn and soybeans, demand for non-biotech commodities is highly fluid and could expand quickly, depending on whether consumers' preferences for non-biotech food products expand, as well as consumer preferences regarding the use of biotech crops in industrial uses and in livestock feed.

During the last 2 years, U.S. corn exports to the EU dropped about $200 million per year, on average, primarily because of declining exports to Spain and Portugal resulting from a moratorium on EU approval of new corn varieties already being grown in the U.S. The share of U.S. corn exports destined for the EU declined from 4.5 percent in fiscal year (FY) 1995/96 to less than 1 percent in FY1997/98 and FY1998/99. U.S. grain processing companies are concerned not only about corn exports, but more importantly, about exports of processed byproducts, such as corn gluten feed and meal. Export sales of U.S. corn byproducts have outpaced corn sales to the EU for a number of years. For example, the value of corn byproducts exported to the EU totaled $403 million in FY1998/99, far exceeding the $22-million export value for corn.

Some large U.S. grain processors e.g., A.E. Staley and Archer Daniels Midland (ADM) announced in April 1999 they would not accept EU-unapproved corn biotech varieties for processing for fear of jeopardizing their byproduct exports to the EU. Last summer, ADM advised producers to segregate biotech crops from non-biotech crops, but reversed this decision in early February 2000 as weak demand for the higher priced non-biotech grain became apparent.

Some countries have begun to require that foods containing biotech ingredients be labeled. The EU recently adopted labeling regulations for foods and is currently drafting feed labeling regulations. Japan, Korea, Australia, and New Zealand are among other countries proposing mandatory labeling policies for bioengineered foods. Potentially widening interest in food labeling regulation could be an impetus for more farmers and grain handlers to assess their ability to segregate or begin to take steps necessary to segregate.

Over the last year, a few food manufacturers decided to end the use of biotech crops in their operations. In July 1999, the Gerber and Heinz companies announced that their baby food processing facilities would immediately stop using biotech inputs. In January 2000, Bestfoods, Inc., decided to end its use of biotech ingredients in manufactured foods destined for the EU, in order to avoid the biotech labeling requirement, and Frito-Lay Inc. announced that it would cease using biotech corn in its snack food manufacturing.

Strategies to Separate Non-biotech Grain

Current demand for non-biotech corn and soybeans is weak, and according to grain trade sources, European consumers appear generally unwilling to pay premiums for bulk shipments of non-biotech commodities. However, if circumstances were to change and demand for non-biotech commodities were to strengthen, it would be necessary to form supply chains on a larger scale that keep the non-biotech product separate from undifferentiated "standard" commodity grain. This could be accomplished by either "crop segregation" or "identity preservation (IP)." These marketing practices to preserve a commodity's unique characteristics are not new, but rather an extension of practices that have heretofore been used to preserve differentiation in markets for value-enhanced commodities such as high-oil corn and STS soybeans (non-biotech, but herbicide-tolerant).

Identity preservation (IP) is the more stringent (and expensive) of the two methods and requires that strict separation typically involving containerized shipping be maintained at all times. IP is often used for marketing commodities like food-grade corn and soybeans. Testing for biotech vs. non-biotech status typically occurs just prior to containerization. IP lessens the need for additional testing as control of the commodity changes hands, and it lowers liability and risk of biotech/non-biotech commingling for growers and handlers.

Crop segregation requires that crops be kept separate to avoid commingling during loading and unloading, storage, and transportation. This supply chain system thus requires cleaning of equipment such as augers, as well as transportation and storage facilities. Such a handling process has been in place for some time for specialty grains (e.g., high-oil corn). But containerization is generally not involved, and testing to check for the presence of biotech content, which occurs at various points in the marketing system (e.g., country elevator, terminal elevator, and final purchaser) is more critical.

Because of limited demand for non-biotech corn and soybeans and the expense of maintaining separate storage facilities, few grain elevators have attempted to segregate and market non-biotech products. Last September, Sparks Companies conducted a survey of 100 mid-western grain elevators and found that 11 percent were differentiating for non-biotech corn and 8 percent for non-biotech soybeans. Of the surveyed elevators, only 1 percent offered premiums for non-biotech corn and 3 percent offered producer premiums for non-biotech soybeans. The premiums varied widely, depending on the elevator's location and the intended consumer market for the product. According to other industry sources, common non-biotech price premiums ranged from $0.05 to $0.10 per bushel for corn and $0.10 to $0.15 per bushel for soybeans. The lower end of the premium range reflects less strict tolerance levels (i.e., more biotech content) and vice versa. In February 2000, the Farm Progress Company's survey of 1,200 U.S. elevators indicated that 24 percent plan to segregate corn and 20 percent plan to segregate soybeans in the fall. Elevators are likely anticipating food labeling regulations in other countries.

Effective segregation or IP which begins at the farm level is particularly difficult if a farmer grows both biotech and non-biotech varieties of a certain crop. Pollen drift is a natural occurrence over which farmers have little control but which can lead to the unintended presence of biotech material in non-biotech crops. Using buffer zones may help minimize biotech commingling from pollen drift, but it remains a serious problem for effective crop segregation or IP. Pollen drift is a less critical issue for a self-pollinated plant like soybeans than for corn.

Not only must farmers keep biotech and non-biotech plots separate, but they must also prevent commingling with biotech varieties during harvest, transport, and storage by cleaning all equipment and on farm storage facilities. Testing methods are sensitive enough to detect very small amounts of biotech material, making it difficult to clean equipment thoroughly enough to meet a very strict standard. A recent straw poll of 400 U.S. farmers conducted by Reuters in January 2000 found that 15 percent of farmers have made or are planning to make the necessary investments to handle or segregate non-biotech crops in the fall.

Elevators must also develop stricter control over handling procedures in order to maintain segregation. A key problem at the elevator stage is that segregation will likely slow the rate of turnover in a high-volume business. The elevator industry operates with very thin margins differences between prices paid to sellers and prices received from purchasers and elevator profits depend on moving large volumes of product quickly. Segregation slows the process because it involves tests to ensure that the grain is truly non-biotech. In addition, farmers must form multiple queues (for biotech and non-biotech) to deliver their grain, unless elevators specify days on which they accept only biotech or non-biotech varieties. Particularly during peak harvest periods, delays can be a serious problem, and the need to segregate aggravates the problem.

Segregation also reduces the volume the elevator can maintain, because with commingling prohibited, some elevator bins will likely remain partially empty. This is referred to as "storing air" and may be a significant expense incurred by elevators when segregating different types of grain. In addition, elevators must clean all their equipment, including augers and bins, to make sure that no commingling occurs beyond the tolerance level. The tolerance level for biotech content in large part determines the degree of difficulty for grain handlers to maintain segregation of non-biotech commodities the stricter the tolerance level, the harder for grain handlers to comply.

The elevator's ability to segregate depends in large part on the size of the operation and the type of facilities at each location. There are currently no official estimates regarding the number of elevators that have the ability to segregate. However, the National Grain and Feed Association estimates that, at a 1-percent or lower tolerance level for biotech content, roughly 5 percent of the nation's elevators can achieve segregation without major new investments. At these elevators, two parallel-track supply chains generally already exist, one for handling standard bulk grains and the other for segregated grains.

Elevators that will be able to segregate most effectively have a large number of bins of varying capacity as well as multiple pits (where grain is dropped before being moved to a storage bin). Multiple pits enable the elevator to dedicate pits for either biotech or non-biotech, reducing the likelihood of commingling. In addition, the size distribution of bins e.g., a large number of small bins vs. a small number of large bins affects the number of commodities an elevator is able to segregate. Elevators located on rivers may be able to segregate at lower cost and with less in-advertent commingling than inland terminals because they can often load grain directly onto vessels, with fewer unloadings and loadings.

Elevators can use a variety of strategies to facilitate segregation. A grain handling firm may commit facilities at certain locations to handling only biotech or non-biotech grains. Specializing in this way will prevent onsite commingling, ensure that elevator services are provided for non-biotech crops, and may preclude the need for additional investments. Another strategy would be for a given elevator to accept non-biotech and biotech crops on different days, enabling the elevator to regularly clean equipment and maintain crop segregation while minimizing elevator queues.

Segregation also poses logistical problems for grain transportation. Currently, grains and oilseeds are commonly transported to export elevators in unit trains of up to 100 cars or by barge. If effectively maintaining crop segregation makes it necessary to shift transportation away from unit trains toward smaller units (such as individual rail cars), transportation costs could increase significantly. According to the North American Grain Exporters Association, setting acceptable biotech content levels at about 5 percent or higher would increase costs only modestly. But if biotech-free thresholds were made increasingly stringent, costs would rise. One industry source suggests that if the threshold for biotech content were as low as 1 percent (a threshold this tight would likely require IP), transportation costs could potentially double.

Non-biotech Marketing Could Mirror Value-Enhanced Grain

The current system of agricultural marketing relies on broad, standardized quality grades to signal value (establish a price scale) through the market, and is based on commingling to achieve a particular quality. As consumers demand agricultural commodities with specific characteristics (such as non-biotech), buyers and sellers will utilize alternative coordination strategies that are likely to resemble those used for marketing value-enhanced products.

The most successful value-enhanced grain crop to date is Optimum high-oil corn (HOC), developed by DuPont using traditional breeding methods (as opposed to biotechnology) and released in the U.S. in 1992. In 1999, U.S. farmers planted about 1 million acres to HOC. Feed from high-oil corn with an oil content of 6-8 percent compared with less than 4 percent for commodity corn provides a significantly higher level of energy than standard corn. The added value from this crop comes from reduced expenditures for fat supplements in the feed ration, improved digestibility, and improved feed efficiency. Since 1998, about 50 percent of the high-oil-corn supply was grown by farmers who fed it directly to their own livestock. The remainder was exported to nations where fat additives are in short supply (for example, Mexico, Japan, and Taiwan).

High-oil corn along with a wide variety of other value-enhanced feed grains and oilseeds is marketed through a business of DuPont, Optimum Quality Grain (OQG), which licenses this technology to more than 80 seed dealers. Given that the value of this product differs between domestic and export markets, OQG has developed a two-tiered marketing approach to capture the crop's value.

Domestic farmers who grow HOC to feed their own livestock purchase the seed (generally at a premium) from licensed technology providers. For HOC exports, OQG contracts with growers and pays a premium for the HOC crop. These contracts involve few management restrictions, but do require the grower to purchase the seed from a licensed dealer who usually charges the grower a technology fee. For the 2000 corn contract, OQG is offering a $0.15-per-bushel premium for HOC at the 7-percent level, and higher as oil content increases. The crop is examined using near-infrared transmittance technology at all elevator transfer points to determine the oil content of the commodity.

The logistics of the export marketing system are managed by OQG and strategic partners ADM, ConAgra, and Consolidated Grain and Barge. A farmer seeking a contract to grow HOC (or any other value-enhanced variety that OQG deals in) can identify interested local elevators through the internet. Optimum Quality Grain ensures that high-oil corn is segregated throughout the supply chain through a network of contracts that coordinates movement of the crop from farm to elevator to barge to ocean freight to consumers who pay a premium for the product.

Other strategies are used to market products with selected characteristics. For example, Japanese consumers have very strict and specific quality requirements for food-grade soybeans. Japanese firms hire brokers who contract with U.S. farmers to produce exactly the type of soybean they require and pay premiums for those characteristics. Specific tolerance levels are indicated in the sales contract, as is often a provision for quality testing. However, testing methods currently available in the market place may not be totally reliable.

The market for non-biotech commodities is not yet well understood. Lack of information about the magnitude of premiums that consumers may be willing to pay for non-biotech crops make near-term decisions difficult for elevators and farmers. Compounding the difficulty is uncertainty about the effectiveness of product quality monitoring and about tests to accurately determine whether a crop meets yet-to-be-determined non-biotech tolerance standards. These problems suggest that non-biotech crops will be marketed in ways that differ from standard commodities, and that at least in the near term they will be sold as niche market products using many of the same marketing techniques currently used for value-enhanced products.

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BIOTECH MARKETING

Segregating Non-biotech Crops: What Could It Cost?

Segregation of non-biotech grains and oilseeds is essentially an extension of the handling process for specialty grains and oilseeds, which has been in place for some time. A University of Illinois study of segregation costs reported by 84 U.S. handlers of specialty grains and oilseeds in the spring of 1998 indicates that separation of specialty corn (high-oil corn or HOC) and specialty soybeans (Synchrony Treated Soybeans or STS a herbicide-tolerant, but not biotech variety) adds, on average, $0.06 per bushel for HOC and $0.18 per bushel for STS soybeans (excluding purchasing premiums) above the customary costs of handling standard bulk commodities at each of those elevators. Segregation costs include the additional costs of storage, handling, risk management (for example, if quality is not as high as specified in the contract), analysis and testing, and marketing (expenses associated with negotiating contract terms). Minimum oil content specified in the contract generally ranges from 6 to 8 percent (7 percent, on average) for high oil corn. In contrast, quality for specialty soybeans is controlled by specifying in the contract that growers plant only the STS variety developed by DuPont. In order to develop a scenario analysis, USDA's Economic Research Service examined each of the cost items in the Illinois study at three points along the marketing chain country elevator, sub-terminal, and export elevator to determine adjustments or modifications needed to estimate approximate segregation costs for non-biotech corn and soybeans. Although the costs of segregation vary significantly among the surveyed elevators, results indicate that, across all elevators surveyed, costs for segregating non-biotech crops could be higher than for specialty crops.

Although the estimated costs are not small, they do not imply that disarray would occur in the grain marketing system if non-biotech crops were handled on a larger scale. If non-biotech crops remain a niche market, many elevators may choose to accept bulk grain and not attempt to distinguish between biotech and non-biotech characteristics. This would be particularly true for those elevators handling the large portion of domestic corn and soybeans destined for feed use.

Not all elevators that choose to distinguish between biotech and non-biotech would bear the costs identically. Some elevators currently handle niche market crops at relatively low cost, particularly if they are equipped with multiple pits and have bin space configured to facilitate segregation. In addition, specialization across elevators (some handling biotech, others non-biotech) would also result in much lower added costs to the handling system. Further, adjustments in the grain marketing system would work to lower costs as economies of scale in handling are realized and new testing procedures are developed.

The ERS estimates, which should be taken as rough ballpark figures given the limited data currently available, indicate that, on average across the 84 surveyed elevators, segregation could add about $0.22/bushel (excluding premium to the producer) to marketing costs of non-biotech corn from country elevator to export elevator. Segregation of non-biotech soybeans at these elevators could add $0.54/bushel, on average, excluding the non-biotech producer premium. These estimates reflect costs at these elevators and may not represent costs incurred by any one elevator or other elevators in general. In addition, it is important to note that these cost estimates do not take into account the costs associated with segregation at the farm level and shipment expenses beyond export elevators to foreign markets.

These cost estimates reflect a scenario analysis under the following assumptions: 1) risk management cost is not greater for non-biotech corn than for HOC (i.e., assuming a high tolerance level for biotech content); 2) two-tier segregation is needed to safeguard against commingling (some elevators have already adopted this practice); and 3) a multiple trait ELISA test kit will be introduced to detect biotech content for Roundup Ready and Liberty Link corn varieties.

In developing this scenario, ERS makes two important adjustments to the Illinois cost estimates. First, the cost estimate for corn at the country elevator is adjusted to reflect a two-tier segregation requirement to segregate biotech from non-biotech varieties, and to separate biotech varieties into those approved for shipment to the European Union from EU-unapproved varieties, because most country elevators lack complete knowledge about the destination of corn shipments. For shipments to domestic markets, two-tier segregation might be necessary because some processors (such as Archer Daniels Midland and A.E. Staley) accept only EU-approved corn varieties. Similarly, for shipments to the EU, no commingling with EU-unapproved varieties is permitted. To the extent that producers channel their corn to market outlets that accept EU-unapproved varieties (such as domestic feedlots), handling costs at local elevators could be lower.

Adjusting for two-tier segregation is estimated to increase handling costs for biotech corn at country elevators to $0.03/bushel higher than the $0.02/bushel reported in the Illinois study. Biotech segregation imposed no additional handling cost above the $0.02/bushel incurred at sub-terminals and export elevators for segregating specialty corn because operators know the destination of their grain shipments at those facilities. No adjustment was necessary to the cost estimate of handling soybeans, at $0.06/bushel, since the biotech soybeans commercially grown in the U.S. are EU-approved.

The adjustment for testing costs reflects the higher cost of testing for biotech content, which is more complicated than testing for physical characteristics such as oil content for high-oil corn. Grains handlers commonly use two testing methods the DNA-based PCR (polymerase chain reaction) and the protein-based ELISA (enzyme-linked immunosorbent assay). PCR takes 2-10 days at a cost of $200-$450 per test higher than most country elevators can afford because of the small volume per truckload. In contrast, an on-site ELISA microwell test takes 2 hours and costs up to $10 per test. A faster and simpler ELISA dipstick test to provide a "yes-no" result takes 5-10 minutes and costs just $3.50 per test. At a 99-percent purity level, a typical ELISA test uses a sample of 50-60 kernels out of close to 1,000 bushels in a truckload. A smaller sample size (40-50 kernels) would be used for testing at a 95-percent purity level.

The additional cost of testing biotech content using ELISA test kits is estimated at $0.01/bushel for one specific new trait (e.g., Bt corn) at country elevators. However, since current ELISA testing methods require a separate test for detection of each unique trait, several tests may be required to determine if a truckload of corn is free of biotech material. The ERS analysis assumes four separate ELISA tests for five biotech corn varieties at country elevators 3 Bt varieties, plus Liberty Link and Roundup Ready. While biotech content in the 3 Bt varieties can be detected technically in one test, multiple tests (usually two) are a common practice adopted by local elevators. This increases the cost of analysis and testing for non-biotech corn to $0.04/bushel from the $0.01/bushel reported in the Illinois study.

At sub-terminals and export elevators, PCR testing is more common than ELISA because it is very sensitive and can be used to detect the presence of several gene modifications in one set of tests. However, PCR tests are generally conducted in commercial labs. In addition, it becomes more economical with the larger volume of grains being handled, remaining just $0.01/bushel as estimated by the Illinois study. The cost of testing soybeans is the same as for corn, at $0.01/bushel. A typical sample size for testing is about 80 pounds of grain in a river sub-terminal, which handles about 50,000-55,000 bushels of grain in a barge.

Risk management costs for segregating grain into biotech and non-biotech conceivably could be greater than for handling high oil corn or STS soybeans, because producers face significantly different risks. For example, a 1-percent lower oil content might reduce price premiums paid to HOC producers. However, a 1-percent biotech content in a grain shipment could cause rejection, which has much more serious consequences for U.S. grain exporters. Because there is no way to quantify this extra cost, ERS assumes the risk management cost is the same as for HOC in the Illinois study, $0.01 per bushel or $0.03 from country elevator to export elevator.

No adjustment was necessary for value-enhanced commodities: marketing costs $0.03 per bushel for corn and $0.06 per bushel for soybeans and storage costs $0.03 per bushel for corn and $0.06 per bushel for soybeans across the three elevator points.

In considering segregation costs from production through marketing, ERS excludes purchasing premiums to producers because the gain to producers offsets the loss to the country elevator. However, the common range for purchasing premiums currently offered by a few elevators to producers for non-biotech grains is $0.05 to $0.10 per bushel for non-biotech corn and $0.10 to $0.15 per bushel for non-biotech soybeans, according to industry sources.

Some U.S. grain handlers are already segregating grain for certain export markets. For example, Cargill is segregating non-biotech corn for Japan, although without guaranteeing a specific tolerance level for biotech material. Patterning corn segregation after handling procedures for HOC methods can usually meet the non-biotech requirements of Japanese buyers. To avoid commingling in shipments, grain handlers may also contract with producers to plant only certain corn varieties (e.g., non-biotech or EU-approved) and require adoption of specific production and harvesting practices.

These cost estimates are meant to indicate general magnitudes and are likely to change as adjustments occur in the marketing system for specialized commodities. For example, segregation costs could be lower if the volume of segregated commodities expands and the grain handling industry realizes economies of size. Handling costs at country elevators could be lower if EU-unapproved corn varieties were channeled by producers only to market outlets that accept them. Development of more cost-effective test kits could also decrease costs. Actual expenses associated with risk management, such as liability and risk of commingling for growers and handlers of non-biotech commodities, could be different from those for specialty grains. Segregation at the farm level and shipments to foreign markets from export elevators, which are not considered in this analysis, could add more to segregation costs.

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