Harvesting from offshore farms - not for the faint of heart.

Norwegian Gannet

For those who have been following my blog, you’ll know that I have been thinking a lot about offshore farming and the barriers to developing a successful sector to provide the growth the salmon market desperately needs. This post is intended to look at challenges related to operating an offshore farm should current innovation directions and trends continue.

A few notes about markets for farmed salmon.

Although the salmon market is enormous (estimated growth of 7% each year) and chronically undersupplied (production growth has averaged less than 3%), entering the market as a new supplier comes with conditions that make it challenging to navigate, particularly for entrants from remote, logistically challenged regions or for producers with irregular volumes to sell. These challenges include:

1)        The market for farmed salmon is close to 100% fresh with a generally accepted shelf-life of ~14 days (although some producers with excellent cold chain control can achieve significantly longer) and long channels of distribution. The ability of a producer to hold inventory (other than swimming inventory) is limited. The market is driven by daily harvests and constant flows of fish through the value chain. Unlike most other seafood types, there is almost no frozen inventory on hand at any given time.

2)        Frozen products are an option but are normally sold at a significant discount compared to fresh and the entire harvest/sales system is geared towards never having to freeze. From an objective quality perspective, frozen products are often as good in culinary terms, but consumer preferences are hard to overcome. I still wake up in a cold sweat thinking about a foray I made into the world of frozen portions a few years ago.

3)        Most salmon are sold on the spot market. In Europe, producers report contracted volumes in the 25-35% range with 65-75% sold on the spot market. In North America, the number is more like 10% sold through contracts and 90% sold on the spot market. From a producer’s perspective, contracted volumes can be useful for harvest planning as they limit some sales complexity and risk, but in a market where prices generally increase over time, they can tie you to lower earnings. For the most part, farmed salmon is a pure commodity product and both producer and buyer tend to like having the flexibility to shop around for better prices.

4)        During brief periods when supply exceeds demand, as was seen this summer when Norwegian producers were forced to harvest due to sea lice pressures and biomass limits, the spot price for Norwegian salmon fell to 50 Nok/kg for a few days – a drop of 40% compared to average prices and less than half of the high prices from earlier in the year. With the market being almost entirely fresh, the salmon industry has little or no ability to manage volumes to the market through finished product inventory levels. If they are forced to harvest, it needs to be sold more or less immediately at whatever price the market will bear. On the flip side, if there is no urgency to harvest, making the decision to limit harvesting is easy. The fish will continue to grow and you’ll have more biomass at (likely) a higher price.

5)        Expensive logistics are the norm. Norwegian, Scottish and Canadian producers benefit from land transport connections to the European market. Given the short shelf-life, connecting to other markets generally involves air transport. Aside from high costs and carbon footprint issues, air transport systems require complicated support systems to manage daily volumes. It is very difficult to turn these systems on or off if you don’t have regular volumes. Additionally, the airlines assign volumes to their most profitable and consistent customers and extend little supplier credit. It can be hard for irregular suppliers to secure volume when they need it.

The implications for offshore projects

For most of the offshore projects I have reviewed, however, finding a fit with the salmon market will be a challenge. A few key reasons:

Weather – moving offshore takes farmers into a completely different operating environment. While there is no single standard for expected conditions, I think it is fair to say that significant wave heights from 4m to 10m are within the operating ranges being considered. The term “significant wave height” (Hs) describes the average of the largest 30% of waves experienced at a location. For perspective, an average Canadian house is 6 - 8m high - things can get very rough indeed at these farms.

Vessel operations - I stand to be corrected, but I think most vessel operations on an offshore farm (harvesting, feed, fuel deliveries, and crew changes.) would be limited to sea states below 3m Hs (which implies an average wave height of 2m) and will require sophisticated vessels. So, the average wave, measured from top to crest, is taller than a very tall person. On a farm rated as having an Hs of 8m, somewhere around 90% of waves will be over 2m in height and calm conditions will be very rare.

In terms of harvesting, these conditions will have important implications:

1)        The harvest vessel will need to be technologically advanced (dynamic positioning systems, nimble cranes and equipment), large capacity to make the economics work, and extremely seaworthy. Distances will be longer and with less flexibility on timing. Farmers will need to make hay when conditions are good and put up with potentially idle assets when they are not. Very few aquaculture service vessels currently in service will be capable of operating in these conditions.

2)        There will be many days and weeks of the year, particularly during winter months, when accessing an offshore farm will be impossible. With remote feeding and monitoring systems, growing the fish will not be a problem but getting them out will.  It will be a challenge to maintain a regular schedule for harvests during the time of year when prices are normally best. The salmon market has a habit of punishing irregular or unreliable sellers and rewards those who can provide predictable, dependable volumes.

3)        From an animal welfare and harvest quality perspective, even if you can harvest during extreme weather conditions, the fish will likely take a real beating on their way into the processing plant. On truly offshore sites, waves may have long frequencies – a long period between the crest of one wave and the crest of the next - but the journey to shore will likely involve traveling thorough zones were interactions with shorelines, currents, shoals etc. will make waves steeper and more violent. It is hard to understate how much harder these conditions may be on fish, farmers and equipment.

Reinforcing existing industry structures

For regular readers of my blog, you’ll know that I complain a lot about current trends in aquaculture development and how they generally reinforce existing barriers to entry and will lead to further consolidation among the fat and rich.

Current market dynamics and an offshore farm that is essentially a nearshore farm engineered for offshore conditions, will exacerbate this situation. If an offshore farm functions as part of a production unit that includes nearshore farms, there are a couple of ways to manage the unpredictability of open ocean environments. 1) a farmer could stock two identical cohorts of fish, one near shore and then a twin cohort (perhaps larger) in the offshore farm. During winter, if conditions are favorable, harvests can be conducted offshore. During storms, harvests would be drawn from the nearshore farm. Or 2) Fish can be grown offshore until just prior to harvest weight and then transferred when conditions are good, to a nearshore fattening/finishing farm to complete the last few months of grow out and be harvested from that location.

There may be alternatives to these concepts, but I think all will favour a farmer with near-shore production volumes to support the offshore operation. Provided the market for salmon remains 99% fresh and will not allow for finished product accumulation, an offshore farm will always struggle to achieve premium pricing in the market if harvest volumes are unreliable or unpredictable.

So what’s the point of moaning about this?

Shamelessly, a key driver of my desire to write blog entries like this is an attempt to have my voice heard by potential customers, particularly investors interested in the aquaculture space. Over the past couple of years as I’ve engaged with clients and potential investors, I’ve become convinced that the prevailing view of aquaculture is mired in the paradigm of how things are currently done and generally closed when it comes to different operating models. Given how rewarding the current paradigm has been to investors, this is probably understandable, but it may not last forever. Production costs have doubled, prices to consumers have doubled and production has stalled. If current trends in offshore and land-based development continue, salmon production will almost certainly depend on high prices for survival and production costs will continue to increase.

Many of the investors I have spoken to are enthusiastic about the salmon industry but, given the highly consolidated nature of the industry, investing directly in production is only available as a minority shareholder at incredible valuations. Investments in supporting technology and sustaining innovations are a possibility but, ultimately, rely the continued success of an industry that, in turn, relies on extremely high barriers to entry, unmet market demand, and an uncertain ability to stay ahead of fish health, animal welfare and regulatory conditions. Investors need to keep in mind that market prices can fall to unprofitable levels very quickly, high site license fees reflect only bureaucratic intransigence and not a genuine scarcity of potential farming sites, and that the production challenges we continue to see in key production areas are likely to worsen.

If you are an investor and are, incredibly, still reading, my key question to you is how much of your investment thesis is rooted in the status quo of the industry? If you were presented with an investment opportunity that challenged your preconceived notions about how salmon farming is conducted, would you dismiss it immediately or take time to think through the implications?

Thanks for reading. Feedback welcomed via info@AlanWCook.com or LinkedIn.