Biofuels impact on food prices is challenged

Great bounce debate

25 February 2009 00:00  [Source: ICB]

Will the debate between biofuel supporters and food advocates finally cool down?

THE DEBATE between biofuel supporters and food advocates over pricing issues appears to have taken a sharp turn as food prices remain high despite falling energy and commodity prices.

"I think the inflation pressure from both oil and corn prices has abated substantially in the second half of 2008, and that is pretty well expected to continue into 2009. I expect the debate to be a little cooler during this year," says Scott Richman, senior vice president, commercial consulting lead, for Informa Economics, a commodity market analysis and management consulting firm based in the US.

"We haven't seen a change in food prices even though commodity and energy prices have dropped by half since their summer highs. In fact, one food manufacturer recently announced its profits rose during this time of economic turmoil due to price hikes on some of its most popular items," says Jin Chon, spokesperson for Growth Energy, a coalition of American ethanol producers.

"The scenario is certainly changing, and we don't know quite how yet. But certainly the whole ecomonic environment has changed," says Keith Wiebe, deputy director, agricultural development economics division, of the Food and Agriculture Organization (FAO) of the United Nations.

A general consensus has arisen that biofuel production, namely ethanol, drove up food prices last year. Although biofuel production may have had an impact on food prices, a number of other factors have been just as significant, if not more significant.

"There are numerous global factors behind food inflation, including energy prices, increasing demand for food from a growing global population, regional droughts and commodity speculators. These are far bigger factors in increased grain prices than biofuels, which uses only 4% of world grain and has a minimal impact on food prices," says Chon.

Last year, food prices in general were very high, and there was clear concern that biofuels were one of the factors driving these high prices.

"Most studies found around 30-40% of the grain price increase between 2006 and 2008 was attributable to biofuels. Some of those grain prices even tripled. We believe it was related to the expansion of biofuels, but biofuel expansion was only one of a number of factors going on," says Wiebe.

Other factors that influenced grain prices were oil prices, trade restrictions and poor harvests in several key countries.

"I think first of all, there have been a lot of things going on at the same time that have contributed to what has happened with food prices," says Richman.

In fall 2006, grain prices started to take off, and oil prices had been rising steadily for a few years before that. During 2006 and following through to 2007, Australia was hit with a draught that destroyed its wheat crop.

"What happened this time last year is that oil prices were going up over $100/bbl at the same time that there were shortages in some agricultural commodities, like rice and Australian wheat. Given all these things, food prices went up in the first half of 2008," says Richman.

Other events such as floods and extremely wet weather in the US Midwest delayed planting until past optimal times. Meanwhile, at that time crude oil prices were continuing to spike, reaching record levels in July. Concurrently, corn prices reached record levels the month before, Richman explains.

"After that, a succession of things happened. First of all, the US was able to get its crops planted, namely corn, and it was the second largest crop ever. There was also a bumper wheat crop in the summer/autumn of 2008 because of higher plantings around the world after the Australian draught in 2006. During the same time, oil prices began to fall because of the economic situation," says Richman.

All these events happening together created a frenzy in the commodities markets, as well as in the debate over biofuels' impact on food prices.

"The Consumer Price Index (CPI) went up 5.8% in 2008, which was substantially above general economic inflation," notes Richman.

Some of this gain was due to higher commodity prices and some due to higher oil prices, he adds.

"If you look at what happened, the compound annual rate of the CPI as reported by the Bureau of Labor Statistics in the last three months of 2008 was 1.7%, which is very consistent with historical inflation rates for food. It had just been during that period of peak frenzy that food prices went up substantially," says Richman.

In April 2008, a period when Growth Energry notes there was "rampant commodity inflation," a Texas A&M university study found important food items with high prices that were largely unrelated to ethanol or corn prices. Rather, these prices corresponded to fundamental supply and demand relationships in the world.

"Further, the study went on to state, 'the underlying force driving changes in the agricultural industry, along with the economy as a whole, is overall higher energy costs, evidenced by $100/bbl oil.' Additionally, a US Department of Agriculture (USDA) study found that labor costs account for 38 cents of every dollar a consumer spends on food. Farm value accounts for roughly half of that, or 19 cents of the consumer food dollar," says Chon.

To date, ethanol production has had a very small impact on food prices, and this impact won't grow in the future, according to Growth Energy.

Between 1970 and 2005, corn yields increased by 90%. This was the result of increased corn productivity through better seed variety, better farming practices, and other agricultural measures.

The 2004-2008 five-year average crop size was 11.7bn bushels, compared to the 1999-2004 average crop size of 9.6bn bushels, according to Growth Energy.

"In the US, we're producing more than 150 bushels of corn per acre, far ahead of other parts of the world. China produced 90 bushels per acre in 2008, which was higher than the 82 bushels per acre it produced in 2007. Brazil produced 60 bushels per acre last year." says Chon.

Pricing trends between between food, commodities and fuel have separated as prices of the latter two declined and prices of the former stayed up.

"Now, of course, you're getting the opposite argument, where people are saying the commodities prices and oil prices came down substantially, therefore shouldn't the food prices come down too? There hasn't been massive reversal of food price increases," says Richman.

"Commodity prices and biofuel prices moved up together over the past four years, but that relationship has turned the corner since last summer," Wiebe adds.

"Oil was up at roughly $140/barrel and corn was up over $7/bushel last summer. Now oil is down 60-70% to roughly $40/barrel and corn is down to under $4/bushel," he notes.

"I think a part of that is if you look at food prices and the way costs go through the system, as you get closer to the consumer, there's a lot of hesitancy to pass on higher prices. But there's also higher hesitancy to change food prices around rapidly and dramatically," Informa's Richman explains.

What tends to happen when prices first start to rise is that they are generally absorbed into the system. Margins at the time usually allow food processors and, in some cases, food retailers to do that.

"I think that food manufacturers and retailers felt they were at a critical point last summer and felt like they had pricing power, so they went ahead and started raising prices significantly. It was generally thought that these trends of higher oil, commodity and food prices were going to be set in place for awhile. What they did not expect was the severe reversal in commodity and oil prices," he explains.

Growth Energy asserts that erroneous claims around food and fuel were perpetuated last year by ethanol opponents. "The smear campaign won believers until the prices of commodities dropped, exposing the truth: food costs were high because oil costs were high, among other reasons."

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