You know commodity prices are
obscenely high when you breathe a sigh of relief seeing corn
futures dip below $6 per bushel (mid-August), and you utter
gratitude that crude oil slid back to around $113 per barrel.
Even as commodity prices lose
some of their extraordinary steam, analysts are in the midst of
trying to figure out exactly why they got so out of hand so
quickly. Demand running ahead of supply, federal policies
subsidizing a food and feed product for fuel use and the anemic
U.S. dollar are all favorite targets.
Looking at the situation through
the lens of escalating food prices, according to a recent study
conducted by three Purdue University economists for the Farm
Foundation, the run-up has to do with a plethora of
interdependent variables.
“We made no attempt to calculate
what percentage of price changes are attributable to the many
disparate causes and, in fact, think it is impossible to do so,”
says Wallace Tyner, the lead author of the report. “But
examining the interplay of the forces driving food prices gives
a clearer picture of what has been happening.” Tyner is an
energy and policy economist, most recently specializing in
bio-fuels policies.
Tyner was joined in the study by
Christopher Hurt, who works in analysis of commodity markets and
Philip Abbott, who works in international trade and macro
factors. They reviewed current reports and studies, considering
the findings of that literature as they did their own analysis
of the situation. Here are some key findings:
- Rapid economic growth in
developing countries has led to growing food demand and
dietary transition from cereals toward more animal protein.
As a result, global consumption of agricultural commodities
has been growing rapidly. While many studies focus attention
on China and India, neither country is a major trader of
most agricultural commodities. However, China’s rapidly
growing oil imports have had an indirect effect on food
prices by impacting world prices for crude oil.
-
Demand for agricultural commodities has increased, while
growth in agricultural productivity has slowed. Over the
past four to eight years, depending on the commodity, this
combination has resulted in a change from a surplus to a
shortage era, setting the stage for commodity price
increases. When weather and crop disease problems occurred
in 2006 and 2007, stocks of many agricultural commodities
were already low, exacerbating the impact on prices. Policy
actions by some countries to isolate their domestic markets
through export restraints made the situation even worse,
particularly for rice. Increased investment in agricultural
research is important, but not a short-term solution.
-
The effects of supply and demand on commodity prices are
clear. Less clear are the effects of changes in the
structure of commodity markets, particularly speculative
activity. There is no doubt that the amount of hedge fund
and other new monies in the commodity markets has
mushroomed. Price volatility has increased, partly due to
increased trading volumes. Based on existing research, it is
impossible to say if price levels have been influenced by
speculative activities.
-
Most commodities, including crude oil and grains, are priced
in U.S. dollars, but are purchased in the local currency.
When the dollar falls, as it has over the past six years,
there is a link with rising commodity prices. The link
between the U.S. dollar exchange rate and commodity prices
is strong and more important than many other studies imply.
The decline of the dollar is linked not only to higher
demand for U.S. agricultural commodity exports, but also to
higher oil prices.
-
Some studies conclude that oil prices and rising production
and transportation costs have helped drive current commodity
price increases. But many of these impacts occur with a
significant lag. Higher crude oil prices have pushed up the
cost of producing agricultural commodities through increases
in the price of inputs, such as fertilizer and diesel, but
the long-term impact of these increases has yet to be felt.
-
Crude oil’s strongest and most direct impact on food prices
has been through its effect on the demand for bio-fuels. In
the United States and the European Union, public policies,
such as subsidies and mandates, led to the development of
the bio-fuels industry and its growing demand for corn and
vegetable oils. In the last four years, most of the growing
global demand for corn has come from its increased use for
ethanol production. Ethanol blender credits, tariffs and the
Renewable Fuel Standard are factors causing increased corn
prices, but quantitatively, most of that price increase is
driven by high oil prices.
-
Agricultural commodity price increases have a much greater
impact on low-income consumers, especially in developing
countries, because food is a larger fraction of total
expenditures and commodities are a larger share of their
food consumption. One side of higher commodity prices that
has gotten little attention is the potential for farmers in
developing countries to increase production and
productivity. Higher prices could induce these farmers to
purchase and use such inputs as improved seeds and
fertilizer, leading to substantial increases in productivity
and economic gains. For this to happen, governments would
have to permit higher prices to be transmitted to farmers.
“Today’s food price levels are the result of complex
interactions among multiple factors. However, one simple fact
stands out: economic growth and rising human aspirations are
putting greater pressure on the global resource base,” says
Neilson Conklin, Farm Foundation president. “The difficult
challenge for public and private leaders is to identify policy
choices that help the world deal with the very real problems
created by today’s rising food prices without jeopardizing
aspirations for the future.”
Farm
Foundation’s mission is to work as a catalyst for sound public
policy by providing objective information to foster deeper
understanding of the complex issues before the food system
today.
“We
commissioned this report to provide a comprehensive, objective
assessment of the forces driving food prices,” Conklin explains.
“It is the intent of Farm Foundation that the information will
help all stakeholders meet the challenge to address one of the
most critical public policy issues facing the world today.”
Fact
is the bloom appears to have faded from the commodity rose in
recent weeks as it seems more of the speculative money in those
markets have bailed out for Wall Street and other investments.
Just as that money added to volatility, and arguably the high
prices themselves on the way up—an overcorrection beyond market
reality—prices on the way down will likely do the same. That
doesn’t mean a return to the inexpensive commodity prices the
cattle industry enjoyed for the better part of five decades. It
does mean, the market should become a more reliable indicator of
reality.
Further Contraction Without Incentive
“If beef demand—especially export demand—does not increase
enough to boost beef and cattle prices high enough to offset the
rise in production costs, the industry will shrink in size to
the point that fewer pounds of beef are marketed to U.S. and
international consumers,” says James Mintert, agricultural
economist with Kansas State University. “The rising costs of
production have largely been absorbed by livestock producers so
far, but that cannot continue indefinitely. Ultimately, higher
prices throughout the marketing chain will be required to offset
the large increase in production costs.”
As it
is, the July 25 mid-year Cattle Inventory report from the
National Agricultural Statistics Service (NASS) indicates beef
cow numbers are 1% lower than a year ago (33.2 million) and beef
replacement heifers are 2% fewer (4.6 million head). The
inventory of all cattle and calves July 1 is estimated at 104.3
million head, down slightly from a year earlier—milk cow
inventory is 1% higher—and 1% fewer than 2006.
Further reflection of the lack of economic incentive to retain
replacement heifers could be found in the monthly Cattle on Feed
(COF) report issued that same day. Looking at the percentage of
heifers and heifer calves on feed for slaughter, as a percentage
of all steers, heifers and heifer calves, 37.3% of the COF
inventory July 1 was heifers and heifer calves; it was 36.8% at
the same time last year and 34.3% in 2006.
Sluggish to anemic fed cattle sales continue to keep a cap on
calf and feeder prices that might otherwise surge ahead given
the decrease in corn prices the past month.
“Feed
is the largest single cost item for livestock and poultry
production - accounting for 60 to 70 percent of the total cost
in most years,” says Mintert. “Although energy, labor and other
inputs have increased over the last two years, feed costs have
jumped 40 to 60 percent, depending on whether a producer is
feeding swine, cattle or poultry.”
Reflecting upon record high economic losses in cattle feeding,
and the growing negative margins in the cow-calf sector, Mintert
points out, “…the losses experienced in the cattle sector were
not associated with large cattle price declines. In fact, prices
for market-ready cattle in Kansas were record-high in 2007,
averaging $93 per hundredweight or 8 percent higher than in
2006. So, the reduced profitability was directly attributable to
rising costs, especially feed costs.”
That’s
why increased demand is key to maintaining or growing the
industry. “Consumers´ disposable income is a major determinant
of their demand for beef. Slow or even negative growth in the
U.S. economy during 2008 and 2009 will mean little likelihood in
the short run for an increase in domestic beef demand,” says
Mintert. “Looking ahead, the U.S. beef industry could be facing
several more years of herd reduction before prices rise
sufficiently to offset the new production cost regime.”
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