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Photo: NCE Seafood Innovation Cluster

DNB Insight Economic impact of innovation and

digitalization in salmon farming Intrafish/DNB Seafood Summit, London September 2017 Dag Sletmo, DNB Ocean Industries - Seafood

Mob +47 95286134, email: dag.sletmo@dnb.no

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DNB Ocean Industries, Seafood

Innovation will bring

back volume growth

The level of innovation within global salmon

farming is impressive. But innovation is also

necessary as the old approach to farming

has reached the end of the road.

What makes us say that the current farming

regime has reached the end of the road? The

most striking fact is that there has been no

volume growth since 2012. Cost per kg has

skyrocketed the last few years. And we have

seen a decline in production volume per

employee in Norway since 2007. In addition, the

current environmental situation is a strain on the

industry’s relationship with society at large. As a

result governments are hesitant to issue new

licenses.

Stagnant volume since 2012

Source: SSB, DNB

Hefty cost increase

Source: Fiskeridirektoratet, DNB

Declining labor productivity

Source: Fiskeridirektoratet

The common theme behind these challenges is

that the biological capacity of the coastlines is

essentially fully utilized in all major salmon

farming regions globally. The good news is that

this capacity limit is not a fixed number given by

Mother Nature but a function of technology,

farming practices and regulations. Hence

innovation along these three pillars can lift the

biological capacity for salmon production.

The Norwegian development licenses are an

example of a good regulatory innovation. This

regulatory innovation has led to an avalanche of

technological innovation. We don’t know yet if

the solution to the current challenges will be the

sum of many incremental improvements or a

paradigm shift. But the high level of activity and

the strong economic incentive for innovation due

to the high profitability make us optimistic that

volume growth will return to the industry.

The high innovation activity we currently see is

driven by:

High salmon prices

Low oil prices

Digital revolution

The high salmon price is caused by the

challenges mentioned. Zero supply growth in a

market with strong structural growth in demand

will inevitably lead to very high prices. Even if

cost has increased, price has increased a lot

more and led to stellar profitability – which gives

a strong economic incentive to find new

production methods which will increase volumes.

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No growth = high margins = strong

incentive for innovation

Source: DNB

The low oil price has led to significant over

capacity and layoffs in the offshore oil industry in

Norway, which has caused many companies and

skilled engineers to look for new opportunities in

salmon farming.

The digital revolution as such is independent of

these developments. But the adoption of digital

technology will be accelerated by the industry’s

need to solve its challenges and will be enabled

by the industry’s current high profitability and

investment capacity.

Following the announcement of the development

licenses in Norway the rate of technology

development has increased substantially.

Spectacular engineering feats such as Marine

Harvest’s “egg” and Salmar’s offshore farm grab

the headlines. These may allow farming deeper

into the fjords and further offshore and hence

increase the sustainable farming capacity on a

national or global level. Digitalization is also an

important aspect – both independent of the

development licenses and also within them.

Salmar’s offshore rig contains 20,000 sensors for

example.

Salmar offshore rig: 20.000 sensors

Source: Salmar, DNB

Digitalization and new

technology

There is an avalanche of new buzzwords and new

technologies these days – an almost endless

string of so called «Gutenberg moments» (named

after the invention of the printing press which

went on to revolutionize society).

Buzzword fest

Source: DNB

Why do we get so many major new technologies

now, and why do they come simultaneously? MIT

professor Erik Brynjulfsson says it is because

Moore’s law has been at work for so long.

Moore’s law essentially says computing power

doubles every 18 months. Exponential growth is

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very powerful, but in the beginning the impact

can be limited if the starting point is very low. If

something tiny doubles, it is still small. Moore’s

law was coined in 1965 and since then computing

capacity has doubled 35 times. If you fold a piece

of paper a few times not much happens. But if

you fold it 35 times it becomes almost as thick as

the distance from New York to Los Angeles. A

handful more times and it would reach to the

moon. That is why “suddenly” artificial

intelligence, big data, cheap robots, self-driving

cars, 3D printing etcetera all came into existence

at the same time.

Moore’s law on a big base is powerful

Source: Intel

The three most relevant new technologies for

salmon farming are probably the following:

Internet of Things (IoT)

Sky computing & big data

Artificial intelligence.

These will help collect data from physical

operations, store the data in the sky where the

big data can be analyzed using raw computer

power, and artificial intelligence. This will help

optimize operations but more importantly it will

help us understand the fish and the environment

much better – and the interaction between the

two. The outcome of this should be improved

biological and environmental performance. A

prime example is the “AquaCloud” which we will

get back to later.

This doesn’t mean that other digital technologies

will not be important. Blockchain could be one

example. Most people associate blockchain

technology with the digital currency called

bitcoins. But it can also be used in optimizing and

documenting long supply chains, something

shipping company Maersk is working on. This

could also have potential for salmon feed’s long

supply chains which stretch from South America

to Norway. In addition to streamlining and

reducing cost related to the actual movement of

goods, blockchain could potentially be used to

document the origin of ingredients from a

sustainable sourcing and food safety perspective.

Advanced processing robotics can improve

quality and yield and cut cost. Such technology

has already enabled Norway Seafoods to export

cod processed in Scandinavia to Chinese

consumers, breaking the pattern of sending fish

from Europe to China for processing and re-

export to Europe. Electronic systems can replace

the old fashioned telephone based sales process

– the way electronic trading replaced most of the

old fashioned stock brokers years ago. And so

on.

Digitalization trends in

salmon farming

We see two major current digitalization trends in

salmon farming:

Increased instrumentation and data

collection

Increased biological focus

Increased digitalization focuses on

measurements of temperature, oxygen, salinity,

algae, etc. At the same time a candy box full of

exciting new tools such as ROVs, robots,

ultrasound, IoT, etc is available. The aim of the

increased instrumentation and data collection is

to improve specific operations. But over time the

consequences can be radical as improved

knowledge accumulates and data collection turns

into big data which can feed artificial intelligence

algorithms.

The driving force behind this instrumentation and

data collection trend is more mature technology

but also a more mature salmon farming industry

which is more willing to look at new solutions.

The main value driver in salmon farming is the

biology. Biology is complex with many

parameters. Big data and artificial intelligence

can contribute significantly to improving our

understanding of these issues. Examples can be

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the interaction between the fish, the environment

and feeding. Or how to breed a fish with high

resistance to sea lice. Maybe it can tell you which

combination of fish stock, vaccine and feed to

use for a specific region if a customer has

ordered a certain volume of a given quality for

delivery at some given point in the future.

This trend within digitalization of increasing

biological focus is driven by a need to better

understand the fish. A lot of the technological

development has been focused on engineering

rather than the fish as such. The influx of

engineers from the petroleum sector is very

advantageous for the farming industry in general

– but oil people are not used to working with

living creatures. And cost trends in recent years

have clearly shown that the dominant factor

driving production cost is biological performance

– not tweaking smaller cost items here and there

the way it is in many other industries.

A lot of the creativity within salmon farming

digitalization is driven by small start-ups. But we

also see big players getting more involved. The

NCE Seafood Innovation Cluster and DNVGL are

active in big data. We see IBM Watson and

Telenor in artificial intelligence. Public institutions

like SINTEF, Institute of Marine research and

Norwegian Veterinary Institute act as opinion

leaders. And leading companies within digital

manufacturing such as ABB and Siemens are

getting involved.

The AquaCloud project led by the NCE Seafood

Innovation cluster is a poster child example for

digitalization within salmon farming. The project

collects large amounts of data from farming sites

every day which is sent to the cloud. IBM Watson

analyzes the data and generates predictions and

strategies for sea lice treatments using artificial

intelligence. Data is provided by Lerøy, Marine

Harvest, Grieg Seafood, SalmoNor, Bremnes

Seashore and The Institute of Marine Research.

This project is built on the three key

technological elements we mentioned;

sensors/IoT, sky computing & big data, and

artificial intelligence.

The AquaCloud

Source: NCE Seafood Innovation Cluster

OptimeeringAqua is a small startup using big

data and artificial intelligence to make plans for

optimizing production. The company believes it

can boost production per license by as much as

10 percent, which would obviously be of

tremendous value. The people behind the

company used to make production plans for

hydropower companies and are now applying

that methodology to salmon farming instead. So

far they have partnered with Grieg Seafood and

Cermaq.

Optimeering’s license utilization vs manual approach

Source: OptimeeringAqua

Telenor has made a powerful IoT solution for

farmer Midt-Norsk Havbruk transferring data and

live video from the fish pens to a control room on

land. The company can then operate several sites

from one location where three people can do the

job which earlier required six.

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Full page newspaper ad for Telenor farming IoT

Source: Finansavisen, DNB

Startup company Sea Smart has developed a

drone which moves inside the pen without any

cables and collects relevant data on the

environment and fish welfare. The data transfer

to the net is wireless, and the data helps the

farmer make better operational decisions.

The SeaSmart drone

Source: SeaSmart

Former Tomra employees have started a

company called BioSort. They are working with

Cermaq on a concept called iFarm which can

identify each individual fish in the pen through

3D scanning and recognition technology. This will

allow individual treatment of each fish instead of

the current group treatment.

iFarm – treating each fish as an individual

Source: BioSmart

Digitalization is improving the genetic tool kit and

radically reducing the cost of analysis. The

improvement in such cost has even outpaced

Moore’s law.

Genetic revolution

Source: National Human Genome Research Institute

New gen editing techniques such as CRISPR

could have a major impact on improving

resistance to disease and parasites and also on

improving other key biological parameters. Such

methods can be controversial however even if,

unlike with gen modification, gene material is not

moved from one organism to another. But better

genetic insight could also improve traditional

breeding by enabling more precise selection of

which fish to breed and also help in the

development of vaccines and medicines.

Over time the most radical impact from

digitalization in aquaculture is likely to be related

to better understanding of the fish and its

interaction with the environment rather than the

optimization of single elements in the value

chain. In other words: doing the right things will

have a larger impact than doing things right.

Salmon farming executives sometimes sound like

the former US Defense Secretary Donald

Rumsfeld who spoke about “known unknowns”

and “unknown unknowns”. There is an increasing

consensus within salmon farming that there is a

lot we don’t know about certain issues – the

“known unknowns”. And also that as one

problem after another is fixed, new problems will

emerge – “the unknown unknowns”.

Digital technology increases speed and fluidity in

markets which means that most companies must

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become less hierarchical and delegate more

decision making further down in the organization.

Salmon farming may not fit this pattern and

actually see the opposite effect. A key value

driver in farming is decisions and actions which

happen at the actual site. These decisions must

be taken at the site in real-time, not delayed and

forwarded to headquarters. The fact that

Norwegian workers are generally able to make

independent decisions with little supervision has

been a cultural competitive advantage for

Norway. Most cultures are more hierarchical and

command based.

Digital technology could lead to knowledge

becoming less based on individual employees.

Remote real-time monitoring will reinforce this. It

is very difficult to replicate the craft of a master

salmon feeder for example. But if an algorithm

can learn the tricks the game will change and

operations can also be performed remotely.

Disruptive technology

New technology is exciting and positive for the

economy overall. But it is not beneficial for

everybody, there will also be losers. Digital

technology generally has more disruptive power

than other technology and consequently can

create more losers.

A McKinsey study states that the global gross

economic impact of disruptive technology will be

$30 trillion the next 10 years (double the current

US GDP). But the net will be “only” $10 trillion.

The reason is that there will be $10 trillion in new

value creation (captured largely by new players)

but also $10 trillion in destroyed value creation

(the hit taken by established players). Essentially

the gain of the new players is the loss of the old

ones. The reason the net gain is positive and not

zero is that the consumer will receive free or very

cheap services representing a value to them

equivalent to $10 trillion.

Disruption = creation & destruction of value

Source: McKinsey, TRK Group

Already back in 1992 Bill Gates famously said

“Banking is necessary, banks are not..». This is

keenly felt by many bankers today as new digital

players attack the traditional banking value

chain. Salmon farming is different however, and

salmon farmers will remain necessary.

One key reason is that salmon farming is a

biological production, not an abstract and

information based production like banking which

can easily be digitalized.

Another reason is that the product satisfies the

end demand. Unlike salmon many products are

intermediate and not the goal in itself. The

consumer never demanded newsprint as such –

the demand was for information. When

newspapers went online, the demand for

newsprint collapsed. The sharing economy is a

threat to many physical products we will continue

to demand such as vacation homes and cars.

Peer-to-peer sharing services like Airbnb and

Nabobil increase capacity utilization dramatically

and hence reduce demand in terms of number of

units which need to be produced each year. But

unlike your vacation home or your car, your

salmon dinner doesn’t spend 95% of its time

being unused. You will not want to share it.

Is there no black swan risk in salmon farming?

By definition we don’t know. But we can say that

the black swan risk should be lower than in many

other industries. One “outlandish” potential risk

is “cultured meat”. Researchers at Maastricht

University have made a 250 thousand euro

hamburger grown in the lab. The burger was

made from 20,000 muscle fibers from a small

cow stem cells sample. The cow lived happily on

after the sample was taken, and animal welfare

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considerations were what motivated Google co-

founder Sergey Brin to pay for it.

Bill Gates, Richard Branson and Cargill have

recently invested in a San Francisco start up,

Memphis Meat, which is working on producing

meat based on similar technology.

Cultured meat grown from stem cells

Source: Memphis Meats

Given consumer resistance to technologies which

are much less radical than cultured meat (and

much cheaper!) it is difficult to see this

technology becoming main stream in the coming

decades.

Anthony Scaramucci, who was the White House

communications director for 10 days, introduced

a new expression to the English language; “front

stabber”. A front stabber is someone who will

stab you in the front, i.e. you will see him coming

- as supposed to a backstabber. If the salmon

industry is hit by radical technological disruption,

we believe it would likely come from the front,

meaning the industry should be able to see it

before it is hit.

Spotting black swans in advance

Source: Anthony Scaramucci, Fox News, DNB

Why growth at all?

In this note we focus on how innovation may

bring back volume growth. A devil’s advocate

might have asked why we are so concerned

about restoring volume growth in the first place.

From a financial perspective sea lice and the

resulting the lack of growth since 2012 has been

a blessing in disguise for many farmers. The lack

of growth has pushed prices to new highs and

pulled profitability along with it even if cost also

has increased.

Zero volume growth has been profitable so far..

Source: Oslo Børs

Many salmon farmers would find that argument

offensive, even if that dynamic has helped make

them rich. Growth is part of their DNA.

But there is also a financial argument for growth.

A key factor behind the salmon success story is

the strong underlying demand. But demand does

not develop in a vacuum independently of

supply. A key demand driver is the growing

middle class in emerging markets. But if these

new potential customers are never introduced to

the product, they will not demand it – and hence

not be part of the global pricing equation. The

“demand destruction” many commentators fear

when prices are high, is a bit misplaced we

believe. The real danger is not that the shelf

space in European discount retailers contracts.

That is not destroyed demand, that is just a

movement along an unchanged demand curve.

At a high price demand is lower than at a lower

price even if demand as such is unchanged.

When the price comes back down, the shelf

space expands back to its original size. But if a

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lack of product means that new markets are not

developed, that is “destroyed” demand in the

sense that it won’t get developed. And it won’t

impact prices. The standard analyst assumption

that underlying demand grows by some 7% per

year would break down.

There is also the sustainability aspect. If a

natural resources industry generates obvious

super profits over time it is more likely to be hit

with resource rent taxes. And the industry is also

more likely to have problems gaining sympathy

for its cause from society at large. Hence it could

be better to make high profits on a higher

volume, even if return on capital employed would

be somewhat lower. And a larger invested base

means that the total economic value added could

be higher even if the return on capital was lower.

Economic implications of

digitalization

Digitalization of salmon farming will be good for

the world and the consumer. But will it also be a

good thing for the industry? It depends on how

you look at it. And it also depends on whether

you are a farmer or a supplier. For farmers

margin is the key value driver, for suppliers it is

volume. Digitalization and innovation should help

lift volumes, which is good for suppliers. For

farmers it is a trade-off between the positive

impact of higher value vs the negative effect of

lower prices.

One way to approach the issue of how

digitalization and innovation will impact the

industry is to ask ourselves these three key

questions:

1. What happens to cost per kg?

2. What happens to sustainability & “license

to operate”?

3. What happens to entry barriers?

Cost should drop

Digitalization should help reduce cost as it does

in all industries. It can simplify processes, reduce

the need for manpower, improve data quality and

volume, enable real time monitoring, and lead to

better decisions and better asset utilization. The

largest impact of digitalization is likely to come

from better biological insight which can lead to

better biological performance. Doing the right

things will likely be more of a cost driver than

doing things right.

Sustainability should improve

A better biological and genetic understanding of

the fish along with better understanding of the

interaction with the external environment should

allow for more sustainable farming and more

targeted regulations. This improved

understanding could also strengthen the insight

into how disease and parasites move with the

water streams and from site to site. This should

help reduce disease and reduce the

environmental footprint as sustainable production

capacity is a function of technology, farming

practices and regulations – not just the natural

environment. Good sustainability equals “license

to operate” (and license to grow).

Sustainability is not optional

Source: The New Yorker

Entry barriers should decline

While improvements in unit cost and

sustainability are positive for farmers, lower

entry barriers are not. Lice and sustainability

problems created an effective entry barrier.

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Market structure drives profitability

Source: DNB

A lifting of the sustainable biological production

capacity will lower this barrier again. An entry

barrier should give lower margins but on higher

volume. The net effect is not clear for the

farmers. For support industries that depend on

volume as their key value driver lower barriers to

entry in salmon farming should be positive. It will

likely be positive for the farmers also as a lack of

supply growth will impact long term demand

growth.

In business exit barriers are discussed a lot less

than entry barriers but they are still important.

Exit barriers are about how easy it is for capacity

to leave an industry. In hotels, shipping and

airlines the exit barriers are high. If capacity is

too high and prices drop companies may go

bankrupt – but the assets keep living for another

20-30 years under new ownership. New owners

got in at a bargain price and can hence live with

lower market prices, and the market can remain

weak for many years.

In salmon farming the exit barrier is very low.

This is why the down cycles in salmon farming

historically has been two years instead of the

10+ observed in many industries with high exit

barriers. If the salmon price is too low farmers

put fewer juveniles into the water, supply then

drops some 18 months down the road and the

market balance is reestablished. If large capital

intensive structures such as land based facilities

or offshore rigs become a substantial part of the

salmon farming market, a similar dynamic to that

of airlines or shipping could manifest itself in

salmon farming at some distant point in the

future. This would not be related to digitalization

as such however.

In the first half of 2017 the average EBIT/kg

margin for Norwegian farmers was some NOK 25.

With no entry barrier whatsoever, the margin

would have been some NOK 4. That would give a

normal return on the capital invested in biomass

and equipment but not on the licenses. Licenses

would have no value in such a scenario. We

believe the probability of such a scenario to be

extremely low however. Our assumption is that a

normal cross-cycle margin should be around

NOK/kg 10.

Conclusion & summary

The high level of innovation in the salmon

farming industry should help solve the current

challenges and bring back volume growth.

Digitalization will be a key factor behind this

improvement, initially through improved existing

operations but over time primarily through

improved biological performance. This will be

driven by big data and artificial intelligence. This

could help reverse the negative cost trends and

restore society’s faith in the industry and hence

the robustness of the “license to operate”. Entry

barriers will be reduced. This will have a negative

impact on farming margins but higher volumes

would compensate partially or fully. The net

effect could even be positive as over the long run

supply growth will impact demand growth.

Without growth in volume, new markets will not

be developed, and will hence not be part of the

global pricing of the product.

We believe the long term outlook for the salmon

farming industry is very strong. Very few, if any,

industries surf on such a high number of

megatrends. Demand can continue to grow at a

high annual rate for the rest of our lifetimes

fueled by these trends – an increasing and richer

world population being the most obvious ones,

but there are many others in addition. The main

challenge for the industry is to meet and develop

that demand. The high level of innovation we

currently see makes us optimistic that the

industry will be up for this challenge.

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The force is with us!

Source: DNB