27 June 2008
Economists Cite Six Factors for Oil, Food Price Hikes
Six factors create a “perfect storm,” which brings higher prices
Washington -- World prices for oil and food commodities are closely linked, and six key factors are creating a “perfect storm” of conditions that are boosting prices worldwide, a group of U.S. Department of Agriculture (USDA) economists said June 23.
Members of the group who spoke to America.gov, include Michael J. Dwyer, director and chief economist for the Foreign Agricultural Service; Daniel B. Whitley, deputy director of that office; and Hui Jiang, a USDA agricultural economist.
Normally, Dwyer said, the international system is dynamic enough to handle one or two simultaneous shocks, but the number of factors in play today “pretty much overwhelms the system’s ability to deal with it, and prices are spiking sharply higher.”
He and his colleagues outlined six factors.
First, higher energy prices have led to higher input costs for pesticides, fertilizers and herbicides (many of which are petroleum-based), higher processing costs and higher costs for transportation -- which directly affects the cost of food being shipped overseas.
“Right now, to ship a ton of corn out of New Orleans to Asia [costs] about $130,” a dramatic increase from not long ago. “When farmers have to pay more for their fertilizers and other inputs,” Dwyer said, “it means these higher food prices are not all pure profit to a producer because their costs are up as well.”
Dwyer said it is incorrect to single out the current U.S. biofuels policy, which promotes the conversion of some corn into biofuels, for driving up prices.
“A lot of the world press is covering this issue right now, and it is probably the number one issue in the newspapers around the world. Unfortunately, a lot of the newspapers have unfairly scapegoated the U.S biofuels policy as the driver behind why corn prices and commodity prices in general have spiked sharply higher in the last 18 months.
“We don’t dispute that ethanol has had a role,” he said. “What we are saying is that it is a little more complex than that.” U.S. ethanol production is booming, he said, with one-third of the U.S. corn crop expected to be milled for ethanol this year. “We don’t deny that it is having an impact.”
The second factor is the growing demand for food, particularly emanating from China, India and Southeast Asia, Latin America, Africa and the Middle East. “As the middle classes are growing in these regions, they want to eat more food and are all entering the international market at the same time,” Dwyer said. “When the new middle class gets new income, they want to spend it on food in much of the developing world, so the demand-side growth for food is on a rapid growth curve right now.”
Third, the dollar is at a 30-year low in real terms. “Any time the dollar goes down in value, any dollar-denominated commodity tends to go up in price,” Dwyer said. Like oil, most major food commodities worldwide are traded in dollars, and a weak dollar contributes to upward pricing pressure.
Fourth, bad weather has reduced global food supplies, particularly wheat out of Australia. The European Union, Canada and Eastern Europe also had shortfalls in the last two years. “What happens is that you get this strong demand growth, coupled with a supply shock, and you draw your stocks or inventory down to make up the gap. Anytime your inventory is at a very, very low level the price shoots up at a corresponding rate.”
The fifth factor is action by a number of countries that have either restricted or completely shut off exports, particularly of rice, to keep domestic prices low. The USDA estimates there is enough rice in the world to handle demand. Unfortunately, Dwyer said, rice-export bans prompted logistical problems and pricing scares. “The people who had it basically did not want to sell it to the people who needed it -- they got ‘freaked out’ and bid the price sky-high.” Dwyer stressed that the United States has not shut off any of its food exports.
The final factor cited is increased interest from investors in oil and commodities. In the oil markets alone, up to 70 percent of the futures contracts are being held by investors with no intention of taking delivery, up from 30 percent historically, he said. “We do not have comparable numbers for agricultural commodities, but anecdotally, a lot of these index funds go out and buy all of these commodities. Investors are playing a much, much bigger role in the commodity markets. So the concern is that investors may be having an undue influence on prices,” by heavily moving into these markets, he said.
Supply and demand fundamentals indicate that prices needed to be higher than they were, Dwyer said. The question is whether they need to be $15 a bushel for soybeans versus the historic price of $6. It is the same story with wheat and corn, he said.
Whitley added that large-scale agriculture operations -- which contribute much of the crops sold on the world markets -- are “heavily dependent” on energy, both in petroleum-based products fueling the tractors and equipment in the fields and petroleum-based fertilizers and herbicides.
Adding to that, Jiang said, emerging economies simultaneously are increasing their demand for oil, gas and electricity.
As stated at the recent United Nations food summit in Rome, Whitley said, the United States is working on a three-pronged approach to help stem the food crisis worldwide. The first step is to provide immediate, short-term and long-term humanitarian assistance for those hungry due to higher food prices.
Second, the United States will continue to pursue the successful completion of the Doha round of trade talks in the World Trade Organization. The talks seek to establish rules covering export restrictions on food as well as lower tariff on agricultural products, allowing producers to access more markets.
Third, the United States will continue its technical-assistance efforts in the developing world and promote technologies that safely increase agricultural production.
