Vanilla report 28

Over two years has passed since the turning point in the vanilla market when prices for industrial grade Madagascar vanilla peaked well over $500.00/kg. Today, prices for the same grade vanilla (thankfully the quality is better) start at about one fifteenth of these levels; an incredible drop by any standard! One would assume that given the current scenario of very attractive prices and much improved qualities, the recovery in the vanilla trade would be in full swing. Unfortunately this is not 100% correct. Overall there has been significant improvement in volume exported from origin, especially from Madagascar and Uganda, however, there remains some excess capacity in the vanilla trade. We are still somewhat bearish when it comes to vanilla bean prices in the short term, although pleased at the same time that relative stability has returned to the market. Here are our projections for the principal vanilla growing regions.

Madagascar

Although Madagascar is still by far the most dominant of the vanilla supplying countries, their dominance in the market has been significantly reduced over the past five years.

Nevertheless, when looking for guidance one must start here. Madagascar’s reputation for consistency and quality allows them to command a very significant premium over other origins. To prove this point today, one can purchase first quality extraction grade vanilla for as little as $10.00/kg in PNG and not far from $25.00/kg in Uganda. Prices from Madagascar for first grade industrial vanilla were above the $30.00/kg levels for most of the latter half of 2005 and into 2006.

Production in Madagascar was about 900-1100 mt in 2005 and the consensus for 2006 is about 1400 – 1500 mt. In our opinion, this will shrink the premium in prices between Madagascar and other vanilla producing regions. Although we are not prepared to predict a specific number for Madagascar vanilla prices, we are confident that if conditions remain as they are prices may open at more or less the same levels as we see today but could fall further if consumption does not pick up the extra capacity coming to the market.

Madagascar was able to export an impressive 1800 mt of vanilla in 2005 according to Government statistics and this trend is continuing in 2006. The U.S. accounted for 1127 MT with France talking in 355MT.

We attribute much of this to buyers building up inventories and we question whether this performance will be repeated in 2006 with a large crop looming. Overall, we are cautiously optimistic that the worst may be behind us as far as Madagascar is concerned as long as the recovery in the industrial market continues.

Uganda

Uganda has moved up to become the second most important producer of bourbon vanilla beans worldwide. Production in 2005 was over 180 MT and the number for 2006 should be slightly lower. Uganda like other origins has made very significant improvements in their quality since the end of the crisis. Although flavor and fragrance profiles are typically “Uganda”, vanillin contents have risen dramatically over the last two seasons easily topping any other producer of bourbon vanilla including Madagascar.

Ugandan exporters are less likely to speculate on prices and in a soft market are known to discount their vanilla aggressively to ensure a healthy turnover. Uganda also offers very competitive labor rates, which is critical with vanilla at low prices. We expect the quality of Ugandan vanilla to remain high in 2006 but production may fall to about 150 mt.

As prices in Madagascar continue to fall, the discount for Ugandan vanilla against Madagascar will be less significant in 2006 than it was in 2005. We feel we are already very close to the bottom of the market in Uganda.

Indonesia & Papua New Guinea

Nowhere has the vanilla crisis and subsequent crash in prices brought more changes than in the South East Asian vanilla quarter of Indonesia and Papua-New Guinea. Given their geographical proximity this is not entirely surprising, but many other factors played a role as well.

Indonesian production was already suffering prior to the crisis and when prices shot up the emphasis was placed on producing more of the EP cuts than high quality grades. This in turn removed most of the mid and high grade beans from the market. Today we have seen the return of some mid and high-grade material but overall production remains low. The total for both origins will probably not exceed 300 mt in 2006. Indonesia will have a difficult time competing when vanilla prices are low due to higher labor costs than Madagascar or Uganda.

With PNG emerging as a major producer of vanilla during the crisis it was only a matter of time before growers and exporters from both PNG and Indonesia began cooperating on several levels. Prices in PNG fell much faster than in Indonesia and, as a result, attempts to blend the two origins took place to lower costs. This was not successful and for the most part blending has stopped; however, this often occurs at the farmer level of the vanilla chain and it is very difficult to control.

Indonesia has also suffered somewhat from several occurrences of mercury contamination found in vanilla from the Lampung region. Although we feel that these are isolated incidents, buyers, who have a multitude of choices these days, may want to avoid the risk. We are aware of at least one of these cases of mercury contamination leading to protracted litigation.

Other Origins

Mexico, India, The Comoros Islands, Tonga and French Polynesia will all contribute to the 2006 vanilla crop with varying degrees of production. Combined they may add 250 MT of vanilla beans. We do not feel that any of these regions will challenge the top three producers in the years ahead.

In our opinion, India is the only region capable of consistently producing over 100 mt in the short term, however quality issues remain.

In summary, we feel we are now entering the post crisis period in the vanilla market when we can expect relative stability in prices and qualities hopefully for several years. We believe a case can be made for vanilla prices firming up slightly in 2007, however, again everything will depend on the continued recovery of the industrial sector.

There will be several new initiatives such as new commercial ties and agreements between producers and end-users at origin, manufacturing of extract at origins and of course plenty of self-promotion. This is typical of a soft market for any commodity as purchasers and vendors do whatever is possible to gain a competitive edge in a market with very tight margins. As long as things remain calm in Madagascar and the production of vanilla continues at current levels, we see no clear and present danger that would adversely affect market conditions at least through 2007.

AUST & HACHMANN (CANADA) LTD/LTEE
May 1, 2006