There are enough number of reasons why we should be ready for a secular rise in food prices in the near term. I shall go into what in my opinion are the main drivers of this process.
Low stocks of food products are a significant contributor to this rise in prices. Lester Brown of the earth Policy institute has said that the per capita stock availability /inventory of food are at the lowest level since 1972. When stocks are low, prices go up significantly at the slightest unanticipated event/s that can reduce production which replenish those stocks. These events could be geopolitical, weather related or something else.
The other main driver of rising prices for food is the move towards bio-fuels in the US and Europe. President Bush famously said in his state of the union address in 2006 that the US is addicted to oil. Hence the US is now resorting to making ethanol. This ethanol is then blended into gasoline/petrol. It is estimated that the ethanol production capacity is set to double in the next 18 months from the current 5.6 billion gallons (as of February 2007). The feedstock for this in the US is corn, unlike in Brazil where it is sugarcane. The amount of corn required as feedstock for this quantity of ethanol production is estimated to be 40% of US production.
We live in a world where markets are increasingly interdependent. Prices in one geography/ market get reflected almost instantaneously elsewhere. The US is the world’s largest producer (40% of global production) and exporter (60% of global exports) of corn. This diversion of corn to ethanol production has been reflected in the price of corn, which is currently at about $4 compared to the usual range of $2-3 a bushel. The upper limit of the price is anybody’s guess. In today’s prices about $12 of plastics can be made from a bushel of corn.
Such a diversion affects not only the price of corn. Corn acreage is at a 63 year high in the US. Some of this increased acreage has come at the expense of other food crops. Acreage devoted to soy is expected to be down 11% in 2007 from last year. Wheat acreage is also less. What follows is less production and hence exportable surplus of multiple food crops for the rest of the world. Consider this – corn is a more fertilizer intensive crop than soy. Fertilizer prices have an extremely high correlation to natural gas prices – and that is not coming down anytime soon.
Add to this, the fact that corn has many uses. As a sweetening agent in aerated drinks to chickenfeed, there are a number of other uses including as a feed to dairy animals. Now one need not wonder why milk prices are going up! Point is, this rise in the price of corn will feed other price increases.
Add to this the situation in India. 2006 saw significant rises in food prices. This is again due to the declining per capita production levels. Subhash Narayan of The Economic Times had this to day recently on the issue.
According to estimates prepared by the Planning Commission, the annual per capita production of cereals has declined from 192 kg during 1991-95 to 174 kg during 2004-07. Similarly, per capita production of pulses has also dropped from a high of 19 kg during 1971-75 to just 12 kg during 2004-07.
One such unanticipated event that is now unfolding is climate change. How this will play out is not yet clear. It is a given though that from the US to Europe to Australia warmer weather is having an impact on food output. Larger acreage will be able to make a dent on this problem to a certain extent.
Fertilizer requirement, natural gas reqments, urea wildcard .