Ben Aris in Moscow -

Russia and Ukraine have enjoyed their best harvests in over a decade just as global food prices soar to record levels and show little sign of coming down for at least a decade. The world might be engrossed in the international financial brouhaha, but as we come out the other side, "old economy" industries are likely to become fashionable. A growing global population and extra demand from biofuels have combined to give farming an earning power it hasn't enjoyed since Queen Victoria and Tsar Nicholas II were in power.

"New economy" sectors like telecommunications and IT need lots of sophisticated financing, whereas agriculture plods on with solid but unspectacular gains. And in the last 18 months, investors have begun to latch on to soft commodities, quietly pouring money into the farms and fields of Eastern Europe.

Ukraine once dubbed the "bread basket of Europe" is doing best. The record-breaking 47.1m tonnes of grain that had been gathered by October 16 is the best in more than a decade and an increase of over 70% on last year's - albeit bad - harvest. The final tally could be as high as 53m tonnes.

Russian farmers also had an outstanding season. The legendary "black earth" around the city of Voronezh in Central Russia is amongst the most fertile land in the world. This year's grain harvest was up by two-fifths on last year to over 110m tonnes as of the middle of October with almost all the harvest in, against the 88.1m tonnes harvested in 2007.

It is easy to underestimate the growing importance of agriculture in emerging Europe's economies, largely because no one has paid it much attention for over 100 years. But then soaring food prices last September refocused attention on farms by causing an inflation spike that swept through the world. It hit Ukraine harder than most, sending prices up over 25% this year as food makes up over 55% of Ukraine's consumer price index (CPI) basket, against 40% in Russia and between 5% and 15% in Western Europe.

This year's abundant crop in Ukraine has not only helped to bring the rate of inflation down, but it also more than offset a general slowdown in industry caused by the financial crisis and kept the economy growing at an unexpectedly strong 10.9% over the first eight months of this year.

Harvesting the new "super cycle"

Analysts are starting to talk about a new "agricultural super cycle" that will run for the next decade and half, driven by seismic changes in the world's geography.

The first problem is that there are more mouths to feed. The global population was 3bn in 1960. Today it is 6bn and the earth's population will top 7.7bn by 2020, according to the UN Food and Agriculture Organization (FAO). "There are approximately 152 more mouths to feed every minute," said Baring Asset Management when it launched earlier this year its Baring Global Agriculture Fund to take advantage of the huge opportunities it sees in the farming sector.

The second problem is that these people want to eat better food. Until 1991, the world was divided neatly into the haves of the capitalist nations who were used to a high quality of living and the have-nots of communism, who were not.

The Soviet Union guaranteed workers a monthly meat-and-bread ration, but as the roughly 3bn members of the emerging world begin to join the ranks of the middle class, the first thing they want to spend their rising incomes on is better-quality food. That means more calories and more meat. Grain is at the bottom of the food chain and more cows and chickens need more grain to feed them. Moreover, with populations in the West mostly in decline, the majority of the population growth will be in emerging markets, driving demand for agricultural products eastwards even faster.

This super cycle started in 2007 when grain prices rocketed 77% on the Chicago futures market after global demand outstripped supplies, sparking a Malthusian panic. And the prospects for grain prices are for further rises, as the western world hasn't added to its grain production since 1961 and is actually losing land at a steady pace through urbanisation. Grain production and reserves have been sliding for about 10 years as production lagged consumption. As food is a strategic product, governments maintain reserves, but the stock-to-use ratio in the West has been in decline since the last peak in 1998, falling by 262m tonnes to an all-time low of 16% in 2007. "The resultant demand/supply squeeze, which helped grain prices skyrocket in 2007-2008, has also driven up the prices of inputs, including fertilizers and agrochemical products," says Anna Kochkina, an analyst with UniCredit Aton in Moscow.

The razor-thin grain stocks won't improve anytime soon and grain prices are set to stay high for at least the next decade. Even if the grain supply exceeds demand in the next few years, little of this excess will make it to the market, as governments will squirrel away the surpluses to rebuild their depleted reserves. UniCredit estimates it will take 15 years to bring the stock-to-use ratios back to 20% and if there are a few bad harvests during this time, "global undersupply could reach crisis proportions," says Kochkina.

The problem is made worse by the rise of the emerging middle classes in the developing world. Swelling populations will add 1% a year to demand, but changing dietary habits will add another 1.5%, claims UniCredit. The rise of biofuels makes the headache worse, putting a further 0.5% onto annual demand over the next 5-10 years.

Growing room

The appearance of biofuels, which took off in about 2000, is the wild card that could ruin the game. While the growth of crop yields in Western Europe should have kept pace with the growth of demand, the current growth rates are not enough to cover the demand from biofuels as well, argues the FAO.

Authorities worry that the limits on agricultural intensification have already been reached in the industrialised countries, so the modernisation of agriculture in Eastern Europe is not only good business, it's essential if grain supplies are not to fall to crisis levels.

Happily, agriculture in both Russia and Ukraine has lots of growing room. The two countries have already added 2.4m hectares to the total of 33.8m hectares of soil sown with grain in 2007, according to the FAO. This year, Russia added another 2.6m hectares on its own and there is another 13m hectares of arable land lying fallow in the CIS that could be pressed into service.

Rising prices is also supplying plenty of money to improve yields. Grain prices were up by a quarter in the first eight months of this year, which funded a massive 45.3% rise in investment for Ukraine's agricultural sector - more than five times Ukraine's average fixed capital investment rise over the same period. The Russian yield is up to 2.6 tonnes per hectare (t/ha) this year from 2.2 t/ha last year, whereas the Ukrainians have increased their yields to 3.5 t/ha, up by more than half on last year's yields. These yields are still behind the global leader, the EU-27 average of 4.84 t/ha, but are already on a par with the world average of 2.81 t/ha. "The increase in demand for grain is likely to run at 3% a year for at least the next 10 years," says Kochkina. "The increase in arable land will probably add about 1% a year over that time and increasing yields will make up most of the missing 2%, but burden of making these productive gains will fall heavily on the emerging markets."

Send comments to The Editor