farmgate: Commodity, Food, Fuel Prices: What Goes Up Must Come Down, But, Really Now, Why Is That?
The rise in commodity price from 2007 into the spring and summer of 2008 sent food prices upward to the point of consumer complaints and finger shaking at farmers, farm policy, bio-fuels and anything they could imagine that might be to blame. Since that time commodity prices have retreated 50% or more, but food prices have fallen very little. We’ll put those commodity and food prices under the microscope to see what dynamics are or are not at work.
Thanks to the Farm Foundation, which sponsors analysis of agricultural issues for the benefit of Congress and the public, Purdue economists Chris Hurt, Wally Tyner, and Phil Abbott recently updated their 2008 study to find out why economic forces at work last year reversed course and what the results were. The March Update followed last year’s findings that said food prices were driven upward by global consumption outpacing production, the low value of the dollar, and the linkage between energy and agricultural markets. All contributed to tighter stocks of grain and oilseeds.
The 180 degree turnaround was the result of many factors, and not the least was supply and utilization. Low prices caused production declines and stocks diminished, resulting in some price rationing going into 2008. The higher prices spurred more production globally, and in the past 8 months production grew, consumption declined and ending stocks doubled for corn and wheat. While early 2008 production challenges did not seem to hamper crop yield, they caused markets to peak early as perceived shortages were resolved. The economists say higher production last year was an important factor in increasing stocks, particularly for wheat and soybeans.
The impact of price was felt after May 2008, say the Purdue researchers. First was the upward surge from perceived crop shortages, then growing conditions improved about the time the dollar was rising in value, and finally prices fell from declining demand for food and fuel. They say, “The financial crisis further reduced demand for grains and oilseeds for both food and energy uses as world income growth eroded.” They say USDA’s Supply/Demand report for May 2008 forecast an average $5.50 corn price based on a 6% stocks to use ratio, but by January 2009, stocks had climbed to 15% and prices had fallen to $3.90 per bushel of corn. The economists say with lower market prices now, and higher production costs, the low margin awaiting producers will result in reduced production.
The rising commodity and food prices in 2008 was also the result of the declining value of the US dollar which made our commodities less expensive to foreign buyers and that cut the inventory available to the US consumer. The lower dollar caused higher oil prices, which are quoted in dollars. The Purdue economists also report that global growth, the recession, and the financial crisis were responsible for not only the rise in commodity prices into last summer, but the dramatic decreases in commodity prices since then. While the dollar was falling, then rising, it was engaging in a volatile dance with other world currencies, even to the point of helping the balance of payments and reducing the trade deficit.
The economists say, “The recession, which is now expected to be longer and more severe than recent recessions, coupled with the financial crisis that has also spread across the globe, led to much weaker demand for energy and strengthening of the dollar.” Consequently, that weakened demand for agricultural commodities beginning at mid-summer 2008.
The bio-fuel demand served to drive corn, and to some extent soybean, prices, which were linked to the market for crude oil. Since ethanol is a substitute for gasoline, the price of gasoline will drive the price of ethanol, and subsequently the price of corn. But when crude oil rose to $140, taking ethanol and corn up with it, then fell to $40, the demand for corn to make a low margin ethanol quickly diminished. Many ethanol plants were either halted or production slowed because, “The price relationship between ethanol and corn became very important as plants opened or closed depending on margins driven mainly by these two prices.”
Significant to the discussion about the impact of ethanol on commodity prices are the federal policy issues of tariffs on imported ethanol, the blenders’ credit, and the 10% blending wall, which puts a 12 billion gallon upper limit on production. All have a potential impact on ethanol supply and demand.
The Purdue economists attribute the commodity price rise and fall to macroeconomic forces and say the depth and length of the recession will play a key role in how long food and crude oil prices stay where they are. They believe the inflation anticipated with a recovery will influence commodity prices, and the price of oil (along with ethanol and corn) will be linked to the exchange rate. They wonder aloud about the movement of crude oil and how that integrates with the renewable fuels mandate, the blending wall, and other policy issues. But they believe the big question is whether and when supply will catch up with increasing demand for food and fuel and where commodity prices will settle.
Summary:
The rapid rise in commodity prices in 2007 and early 2008 is attributed to several macro-economic forces including low stocks, increasing demand because of exchange rates, and the growth in the connection between food and fuel markets. But the collapse of commodity prices resulted from an unwinding of those forces, exacerbated by a global recession that diminished demand for both food and energy commodities. The gradual return to normalcy expected within a year will create a likelihood for some inflation and whether commodity supplies will be sufficient to meet the demand growth.
Posted by Stu Ellis on March 18, 2009 12:54 AM to farmgate