UK Cross Sector Outlook 2022: Rural

1. An Ownership Bias

A lack of investible nature-based offset models is driving new entrants to buy rather than collaborate with existing land managers, although some notable branded partnerships are emerging.

New research suggests that carbon sequestration on farms, in soils, trees and hedges, and in woodlands could be worth as much as £1.25 billion a year in 2050 (based on a carbon price of £50/tCO2e), but the market for formal nature-based offsets from agriculture remains in its infancy. It is also subject to multiple risks for sellers and offsetters, especially the need for governance, and whether the requirements for additionality and permanence can be met.

Land use change (such as from arable to woodland) generates around five times more carbon sequestration than farming can on its own, and with question marks remaining over how a UK Soil Carbon Code would work in practice within farmed soils, de-risking the process through ownership feels sensible for investors.

A 5.2% rise in GB average farmland values in the 12 months to September 2021 shows the impact of this, and most of this growth was in poorer livestock grades – a key target for tree planting. We predict that this demand will continue over the next five years as pressure to decarbonise continues and growing numbers of natural capital buyers enter the farmland market.

2. CONSOLIDATION OF BUSINESS STRUCTURES

Agricultural policy in England at least is signalling a major devolution of responsibility for business viability from central government to farm level. The Common Agricultural Policy was explicitly designed to support farmer incomes, based upon land being used in an environmentally sensitive way. This conditionality is going as the Basic Payment Scheme fades away, with a corresponding need for farmers to work out how to make their businesses viable based on markets, diversifications and a plethora of emerging environmental schemes, or to exit the industry.

We predict that more English land will come to the market as a result, and that further consolidation is likely, especially given the famous reticence of farmers to collaborate with each other.

Farmers in Scotland and Wales may be protected by emerging policy that has stronger social imperatives, but the shift to leverage private investment into natural capital markets is a goal in each. Changes in market demand for the key outputs of upland farms, a general shift of livestock back into lowland arable rotations, and the weight of capital chasing land suitable for afforestation may offer an attractive route out of the industry for some.

Net zero-fuelled land use change is potentially disruptive for rural communities, but having fewer but better-resourced businesses may well improve the bargaining position of agriculture and enable investment in the further professionalisation of farming.

3. FARMING AS A SERVICE

The shift from area-based payments will also change the risk profile of agriculture. At the moment, a lump sum amount received every December will underwrite the financing of next year’s crop. Considering an agricultural input inflation figure of 22% in 2021 (AF AgInflation Index), and the prospect of further climate-disrupted growing seasons, the loss of liquidity could mean many farmers cannot afford to finance the next harvest.

Supply chains cannot ignore this. Furthermore, these corporates and listed businesses will be under increasing pressure to disclose their environmental footprints to their shareholders and financiers, and so they are starting to take a more active interest in how farms are run.

The eternal screw-down on food prices has already shifted this year as a result of the numerous transport and Covid-19 related factors, contributing to 2.1% grocery price inflation in 2021. But further food price rises (as implied in Scotland’s Good Food Nation policy and England’s National Food Strategy, and tacitly approved by the government’s levelling up agenda) feel inevitable.

Over the next five years, farmers will need to be paid for the services they are providing to their supply chains, and supply chains and consumers need to accept the higher cost of securing products that meet overdue environmental and social impact expectations.

LOOKING AHEAD

Against a loosening market where supply may just increase back to average, where more consolidated, more profitable businesses will rise to the fore, and where impatient capital is returning to the land market with a time-constrained net zero ambition, asset value inflation feels inevitable and our five-year outlook highlights this.

These market factors have changed dramatically from 2020, when Covid-19 disruption was rife, the UK-EU trade deal was still an uncertainty, and little detail of emerging schemes across any of the home nations had been provided. Rural assets have never correlated very clearly with agricultural productivity due to the plethora of other ownership motivations, but it’s the relative affordability of rural assets for newly environmentally active investors, and the brand and reputational value created through the management of ‘authentic carbon’, that is driving competition for scarce assets.

How high values could go is unclear, particularly given the scale of structural change that the sector needs to go through following the agricultural transition. We’re not expecting the recent spectacular performance of commercial forestry to be repeated in all land classes, but evidence is mounting for a sustained period of growth.