Sunday, March 6, 2011

Grain$ of truth

Updated (8/3/11) news links at end.

Early Warning had a post recently decrying the proposed emergency policy of the Spanish Govt. to increase the biofuel content in their petrol.  One follow up post  then used US data for ethanol production to extrapolate the impact of US production to global food prices.  Thus linking the unrest in North Africa and around the gulf states with the increased cost of food due to biofuels (as indicated by corn ethanol).  But root causes of the increased cost of food are more complex than that.

Stuarts prime beef seems to be with the corn to ethanol conversion: many authors have argued that the conversion efficiency is poor - but it is probably the final act of a greater tragedy. Outside of the Americas, is corn a primary human staple? Even within the US its prime function seems to be as energy source for feed lot produced beef and a major ingredient in the US staple of fast foods (including supermarket ready meals).

While I agree that biofuels may be problematic, lumping all cereal crops together and then assuming that because 40% of US CORN production is going to ethanol that that is the cause of the rise in food prices seems to overly and dramatically simplify the issue.

Various international agencies have pointed out that the rise in GLOBAL food prices is a complex issue, with different causes in different regions.

The Overseas Development Institute has a report out that says (my emphasis added):

Rising food prices: Cause for concern

Policy conclusions
Food prices have been rising since the early 2000s • but spiked in early 2008. Even if they start to decline later this year, the next ten years will see food prices at levels above those seen in the early 2000s, thanks to higher energy costs, demand for biofuels, growing demands for staples as populations grow, and for higher value foods, such as livestock products, as incomes rise.

• Prompt assistance is needed for countries facing surging food and energy import bills and for low-income households

• Low stocks threaten the functioning of agencies such as the WFP and prompt calls for land to be switched back into food production, from biofuels throughout the OECD, and from “set-aside” in the EU.

• In the medium term, economic and agricultural growth can offset the damage, but this will require more determined efforts to boost food production.

• Beyond action, a better understanding is needed of the 2008 price spike, to ensure that such events are rare. Increased variability of weather from climate change makes future price spikes more likely. If more can be learned from the current shock, then dealing with future ones may be easier.

Why have food prices risen so much in recent years?
The prices of staple foods on world markets have fallen substantially in real terms over the last 50 years, with wheat in 1999 at less than a quarter of its 1950 price. Since the early 2000s, however, food prices have been rising. Within the 12 months up to early 2008, the FAO food price index rose by 57%. The causes of these price rises are both short- and long-term.
The former include, above all, low harvests in some exporting countries — notably Australia where drought has hit wheat production — against already low world cereal stocks. Speculation in commodity prices by investors looking for a better option than stocks and shares may also have contributed. Some countries, alarmed by mounting prices, have imposed taxes, minimum prices, quotas and outright bans on exports of staples that have exacerbated world price rises.

The oil price rise also feeds through to the demand side: once oil prices rise above US$60 a barrel – it is currently well over $100 – most forms of biofuel compete with oil and gas, so that foods may be diverted to energy production. This is reinforced by targets in both USA and the EU, and by subsidies to refiners in the USA.

The main effects will of course be on the poor (US not included) where 1/3rd to 1/2 of household income may be spent on food. However the higher food prices may also stimulate reinvestment in farm production, which in lower income countries is labour intensive, thus partially offsetting the effects through increased employment. Thus this report suggests that, yes, biofuels have an impact, but that low harvests, speculation and “panic” (ie restricting exports) all played a part. The politically motivated farm subsidies of the US are a particular problem.

Offering partial support for the corn to ethanol effect on raising prices, a Congressional Research Report on primarily the US food price situation back in 2008 noted:

Food Price Inflation: Causes and Impacts


U.S. food prices rose 4% in 2007 and are expected to gain 3.5% to 4.5% in 2008.
Higher farm commodity prices and energy costs are the leading factors behind higher food prices. Farm commodity prices have surged because (1) demand for corn for ethanol is competing with food and feed for acreage; (2) global food grain and oilseed supplies are low due to poor harvests; (3) the weak dollar has increased U.S. exports; (4) rising incomes in large, rapidly emerging economies have changed eating habits; and (5) input costs have increased. Higher energy costs increase transportation, processing, and retail costs.

Although the cost of commodities such as corn or wheat are a small part of the final retail price of most food products, they have risen enough to have an impact on retail prices. Generally, price changes at the farm level have a diminished impact on retail prices, especially for highly processed products. The impact of higher food prices on U.S. households varies according to income.

Lower-income households spend a greater portion of their income on food and feel price hikes more acutely than high-income families. Higher food costs impact domestic food assistance efforts in numerous ways depending on whether benefits are indexed, enrollments are limited, or additional funds are made available. Higher food and transportation costs also reduce the impact of U.S. contributions of food aid under current budget constraints.

From this we should remember that generally “commodities such as corn or wheat are a small part of the final retail price of most food products”. Note also the effect attributed to the currency situation in the US – the effect of the deflating dollar.

In 2008 the OECD put out a note on the same issue:


• Recent steep price increases of major crops (cereals, oilseeds) were triggered by a combination of production remaining somewhat below trend and strong growth of demand.

• A low and declining level of stocks has added to the price rise, as has probably a significant increase in investments in agricultural derivative markets.

• The OECD-FAO Agricultural Outlook expects prices to come down again, but not to their historical levels. On average over the coming ten year period, prices in real terms of cereals, rice and oilseeds are projected to be 10% to 35% higher than in the past decade.

• The acute price hike adds to inflationary pressures in developed countries. Poor consumers in developing countries, and food importing developing countries overall, will have to spend an even higher share of their limited income on food.


The causes of this price spike are complex and due to a combination of mutually reinforcing factors, including droughts in key grain-producing regions, low stocks for cereals and oilseeds, increased feedstock use in the production of biofuels, rapidly rising oil prices and a continuing devaluation of the US dollar, the currency in which indicator prices for these commodities are typically quoted. This turmoil in commodity markets has occurred against the backdrop of an unsettled global economy, which in turn appears to have contributed to a substantial increase in speculative interest in agricultural futures markets.

Tight market conditions for essential agricultural commodities pose policy challenges for national governments as well as for international organisations. In order to take the right policy decisions, we need to understand what caused the current price spike, what the implications may be for prices and price volatility in the future, and how various countries and members of society may be affected. This note aims to improve this understanding and thereby to contribute to sound policy formulation.

So, its complicated, but it’s not all down to biofuels.

Other sources about the more recent price rises also note that speculation has been a significant factor in the increases.

Speculation behind global commodity price rise different version at Speculation behind global commodity price rise

Food Price Spiral: Causes and Consequences

High food prices: Cause and Result

Finally, I just want to point out that many of the countries in the Arab World experiencing turmoil (partially) as a result of these increased prices have one other thing in common. They all have currencies that are either:

  1. directly pegged (or nearly so) to the US dollar,
  2. are neighbors or close trading partners with countries with fixed dollar exchanges, or
  3. have currencies that are not traded.

The following have (had?) a direct peg; Eritrea, Lebanon, Qatar, UAE, Suadi Arabia, Jordan, Bahrain. Egypt had periodic revaluations along with Oman, Kuwait and Tunisia had rigid currency controls. That a large number of countries in the region have a pegged or fixed exchange rate to the $US and the major commodity of the region is traded in $US means that other commodities will be more expensive to import in these countries.

So, if you need to buy grain valued in falling US dollars and your currency is pegged to (or otherwise controlled by) that currency, or your own currency is also falling OR you can’t easily convert your currency to buy US dollars AND speculators are playing the market…  What then for local food prices?

On the other hand, if your currency was not affected in this way, and appreciated against the $US, then food from the US would have become cheaper.

Which could explain the US sourced apples and oranges in the supermarkets of the provincial Indonesian city in which I currently reside!

However the cost of rice has increased, not becuase of corn feed cows or biofuels, but for the simple reason that the heavy rain (and flooding) in Indonesia has cut production.

Climate change, biofuels threaten food security-FAO (Reuters)

MILAN/ROME, March 7 (Reuters) - Climate change bringing floods and drought, growing biofuel demand and national policies to protect domestic markets could drive up global food prices and threaten long-term food security, the United Nations said.

High and volatile food prices are a growing global concern, partly fuelling the protests that toppled the rulers of Tunisia and Egypt this year. The aftershocks have been seen across North Africa and the Middle East from Algeria to Yemen.

Periods of price volatility are not new to agriculture, but recent price shocks triggered by extreme weather and increasing use of grains to produce energy have caused great concern, the U.N.'s Food and Agriculture Organisation said.

The growing influence of commodities markets and "counter-productive 'beggar-thy-neighbour' policy responses (to high prices)...may exacerbate international market volatility and jeopardise global food security," it said.

FAO warns on oil as world food prices hit record (Vanguard)

Global food prices hit a record high in February, the United Nations said on Thursday, warning that surprise oil price spikes induced by Middle East unrest would impact already volatile cereal markets.

David Hallam, Director of FAO’s Trade and Market Division said further jumps in the oil price could have an impact on food markets, which have seen benchmark U.S. wheat prices surge 60 percent in the year to March.

“Unexpected oil price spikes could further exacerbate an already precarious situation in food markets,” Hallam, said in a statement. Oil prices recently hit 2-1/2 year highs, nearing records set in 2008, with markets spooked on concern that North African and Middle East unrest would choke key supplies.

Food, food, everywhere and not enough to eat (Malaysian Star)

In 2008, surging food costs sparked protests and riots in more than 30 countries; this year, many commentators believe this has aggravated the political turmoil in Tunisia and Egypt.

Many media reports have blamed food price hikes on climate change and Asia’s increasing wealth.

It is true that severe droughts in Russia and China and floods in Australia, Europe, India, and Pakistan have affected crops.

And yes, the other reason touted – often by the Western world – for rising food costs, Asia’s increasing wealth, might be borne out by the fact that increasingly affluent consumers in China and India are eating more meat; 7kg of grain are fed to cows to produce 1kg of beef for human consumption, thus diverting supplies of corn and wheat from feeding people to feeding livestock.

But climate havoc and meat-eating are just part of the explanation. Olivier de Schutter, the United Nations Special Rapporteur on the Right to Food, underlined at a media briefing in September that while the “initial sparks” of food price hikes may have been caused by such issues of supply and demand, the deeper reason is speculation on food commodities by powerful investors, such as hedge funds and investment banks.

For instance, he noted that in July 2010, Armajaro, a London-based hedge fund, purchased US$1bil (RM3.06bil) worth of futures contracts for 241,000 tonnes of cocoa, equivalent to almost all the cocoa in Europe’s warehouses!

“That such hoarding is permitted in this day and age stretches belief,” said De Schutter.

The article explained that, following heavy lobbying by banks, hedge funds, and free market politicians in America and Britain, regulations on commodity markets have been steadily abolished in the past decade. Contracts to buy and sell food items were turned into “derivatives” that could be bought and sold among traders who have nothing to do with agriculture. In 2006, driven by the US sub-prime mortgage banking disaster, banks and traders around the globe stampeded to move billions of dollars into “safe commodities” such as food.

While Prof Fatimah agrees that such speculators are one cause of price hikes, she points out that there is another cause: the diversion of over 100 million tonnes of corn (one-third of the entire US crop!) from satisfying human hunger “to satisfying the thirst for fuel” for vehicles in developed economies (corn is used to make ethanol, a biofuel).

According to Prof Fatimah, this demand for biofuel was “politically created” worldwide through government subsidies.


Greg said...

> lumping all cereal crops together and then assuming that because 40% of US CORN production is going to ethanol that that is the cause of the rise in food prices seems to overly and dramatically simplify the issue.

Dramatically, yes. Overly, no.

There are incremental impovements in per-hectare maize productivity. But the figures Stuart used, from the US Biofuels Association, show that the 1997 to 2010 *trend* growth in ethanol is over 20% per year. I don't think that even the most optimistic boosters of GM maize claim they can match that, year after year.

Maize production can only grow more than 3% per year by using more land to grow maize. Land that, in the US, is now used to grow wheat.

Growers will grow whatever they make the most money from. In the US at present, that is increasingly maize, because of the subsidy.

So consumption of the US maize crop for ethanol does affect the wheat price, by reducing the amount of wheat grown. Rice, not so much -- so far. Note that the price of rice has not (yet) risen nearly as much as that of maize or wheat. Growing wheat in preference to rice is a second-round effect that will play out in Asia.

Droughts are over-emphasized IMO. There has always been weather. The same applies to currency fluctuations. The new factor, the thing that hasn't always been there, is exponential growth in the quantity of maize used to produce ethanol -- now up to 36% of the US maize crop, and growing at 20% compounding per year.

SP said...

So far, all the figures have been in percents of corn production going to ethanol. What about the acerages?

You might know better than I (and you imply as much above), but by area, although near record levels the plantings are not hugely different to historical levels - granted wheat area is down.

Only 12% of corn goes directly (corn chips etc) or indirectly (HFCS) to humans. The rest goes to feed lots (slightly more indirect) and factories. So the immediate food being affected should be US sweeteners and beef... not wheat.

So where the article states:

"given inelastic demand for food (food is a necessity),"

this is true and less true not all foods have the same level of necessity. The US (and other western nations) could eat a lot less meat thus freeing up industrial corn production for ethanol production.

Whether or not this mitigates the environmental damage of corn production is a different question. It would however produce less methane.

RE your comment about weather.
This seems a bit simplistic. Reductions in Australian, Chinese, Russian or Canadian wheat has a major effect on wheat price. Thus if the weather in Oz (etc) becomes more variable, for example cycling between severe drought followed by flooding (repeat) production is going to be more uncertain and this will be seen as a higher price.

When you say;
"There has always been weather"
yes... well there has always been death. It's a bad argument to make.
It's the timing and predictability of it that counts.

Your comment about fluctuating currencies is also naive. How long is "always"?. The modern era of freely traded floating fiat currencies and the of uninterested parties being able to speculate on the food commodities market is not as "always" as you seem to assume.

Yes biofuels (ethanol in the US) are a factor... but not the sole dominating factor. It may impact the price of junk food and beef in the US, but outside of that? Don't extrapolate the US to the world.

A partial solution seems simple though. Scrap the subsidies.

Please don't take this comment or the article as a blanket defense of biofuels.

Greg said...

I am not sure where I saw it, now, but I recall seeing a chart showing that the percentage variations in global harvests over the last decade were smaller than in previous decades. This suggests that weather can't have been a factor in the rising trend in food prices since 2000.

Yes, last northern-hemisphere summer was exceptional (by recent standards) for crop loss. But that doesn't explain the trend. I don't think prices in 2008 were anticipating the 2010 harvest.

Weather is the reason why our main calorie crops are grains, which can be stored for several years, rather than potatoes, which have much higher yield. Grains provide a buffer. Our food production system is designed to tolerate weather-driven variation from year to year. But it's not designed to cope with an exponentially increasing demand.

On exchange rates: grains were being traded internationally in Adam Smith's time, and well before that -- the Romans, the Macedonians, ... Exchange rates have always fluctuated. Traders are aware of this fact. The difference now is that they can hedge -- buy insurance against currency changes. And they do.

I'll follow Paul Krugman in being sceptical of speculation. For real speculation, there must be hoarding. And there are no reports of that. Oh, and speculation has been going on for as long as there has been trade.

In my first comment I explained one of the mechanisms by which grains are fungible. There are others; for example the concept of "inferior goods" in economics: the price of meat rises, so people eat less meat and more wheat. (I myself have been doing exactly this over the last three years.) This is another way in which what happens with maize in the US affects the demand for wheat, and so its price, elsewhere in the world.

Some friendly advice: I found the tone of your reply to my comment to be argumentative. If you don't want comments, that's fine. If you do want comments, it's not a good idea to apply labels to other people's words, as in "It's a bad argument to make".

SP said...

Well I am sorry to argue with you, but your comment did not convince me.

I offer these comments in reply.

That US wheat acreage, by area the third largest crop in the US, has declined by ~5% (the figure in one of my links) does not to me seem sufficiently large enough in the global context (China, Russia, Canada, Australia, India, Brazil).

While you support the argument that the increase in biofuel production (US corn to ethanol) is the cause of global food price increases, other sources suggest that other factors may be just, or more, important.

In the same time frame, biofuel (ethanol) production is not the only change. Whether production goes to corn chips, cows or ethanol depends in part on the price of oil in US dollars.
The value of the US dollar against the euro declined until 2008, recovered, declined, recovered and is declining again. Against the Swiss its just a decline, Against the UK and Russian currencies decline to 2008 recovery then decline again. Yen - decline, Renmembi - decline. Thus globally traded food prices measured in US dollars have increased - regardless of whether traders insured themselves against the currency fluctuations.

A similar pattern is evident in oil price. Which is cause and which is effect - that's another argument.

In the longer term, increasing use of 'food crops' (this needs to be clearly defined I think) to biofuels will become a more important factor in food prices.

I took issue with your throw away line about the weather because it seemed dismissive of an important factor in crop production. And droughts are certainly no small matter in Australia.

Comments at this blog are welcome... and I hope so too is friendly 'argument'.


SP said...

Greg, updated the post.
This quote interested me...

"The article explained that, following heavy lobbying by banks, hedge funds, and free market politicians in America and Britain, regulations on commodity markets have been steadily abolished in the past decade. Contracts to buy and sell food items were turned into “derivatives” that could be bought and sold among traders who have nothing to do with agriculture. In 2006, driven by the US sub-prime mortgage banking disaster, banks and traders around the globe stampeded to move billions of dollars into “safe commodities” such as food."