Record grain prices provide food for thought

Food prices are rising. Rice is just the latest staple to soar through record levels as increasing demand and lagging supply on global markets prompt exporters to restrict their sales to quell food price inflation at home.

Similar moves by major wheat and soyabean exporters announced earlier this year have helped keep prices near record levels, while record corn prices continue to be underpinned by rising demand from China and from the biofuels industry.

Are staple foods poised to reach luxury prices, or is the current surge in agricultural commodities a bubble waiting to burst?

Abah Ofon, agricultural commodities strategist at Standard Chartered, answers your questions below.

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The recent spike in grains prices is a correction in the world economy. Earlier farm prices were too low. Do you agree?
Syed Ali Asfar, Bangladesh

AO: Nominal food prices have risen, certainly when one looks at measures like the Commodity Research Bureau (CRB) Softs Index which is up over 150 per cent from its levels in September 1993. The current spike in grains prices does have an element of cyclicality in it. There have been historic spikes in food prices, notably in 1974, 1977, 1980, 1986, 1994 and most recently in 1998. Food prices tended to trend lower after these spikes, particularly during the period from 1986-1993, and again between the periods from 1998-2002. So to an extent the current move higher can be viewed as a correction for dollar-denominated soft commodities especially given the 40 per cent drop in the broad US dollar index since 2002. In most cases, low farm prices have been a consequence of high supply vs lower demand/exports, as experienced in 1999/2000 by US soybean farmers. However, given that a large proportion of people in developing countries spend between 50-75 per cent of their income on food, opinion that prices are currently high could be a more convincing argument.

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With fertilizer costs increasing 40 per cent or so each year recently, when will organic farming become a cost effective alternative, not just a natural food alternative?
Eric Everett, UK

AO: There is room to believe that higher fertiliser costs could narrow the differential between “conventional” and organic farming costs. However the ability for costs in both sectors to converge will be limited by the labour intensity of organic farming methods.

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Could you please give your short, medium and lond term price perspectives for the soya in international market?
Emanuel Cabral, UK

AO: The sharp rally in the soy complex at the start of March appeared overdone and markets have since corrected. Given that short term supply concerns seem to have eased somewhat further drops in prices are likely. Nevertheless, we expect dips to be short-lived. Longer term price risks are to the upside given burgeoning global demand. For example, Indian vegetable oil demand should rise as incomes increase (same is true for China). There is also evidence to suggest that soybeans planted area in the US has peaked – which will put a strain on supplies. We also expect demand for soybeans to remain robust with global trade in the commodity rising by around 3.5 per cent annually over the next decade with most of the demand coming from China. Additionally, bio-diesel targets in some countries will support prices.

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Is the considerable rise in wheat prices likely to be sustained around the current level due to rising demand or will it fall back once the next harvest is underway assuming no new weather issues? I understand a lot more wheat has been planted in the USA and Australia has had rain unlike last year.
Lord Carnarvon, Highclere Estate Nr Newbury

AO: It is true that wheat output over the next season should be much higher on increased plantings and higher output from key exporting countries like the US and Canada. In fact Canada expects its wheat output for 2008/09 to increase to around 25m tons from around 13m tons in 2007/08. In the US, plantings (wheat acreage) are expected to rise by around 6 per cent. The increase in supply should dampen the surge in prices and already the near wheat future is down around 40 per cent from the high it reached this year (although still up more than 90 per cent year-on-year). The panic buying that drove the market higher is easing as the market focuses on the new crop (season generally begins in October). We are looking for prices to moderate over the course of the year and into next year.

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Is there not now a moral case to remove food and water stocks from the worlds stock markets? Ie that the costs of speculation outweigh the efficiencies of the market?
Amos Levin, South Africa

AO: It is a concern when markets are excessively volatile. This is an issue which has now been taken up by the Commodity Futures Trading Commission (CFTC ) which is organising a roundtable discussion next week (April 22nd) to gather information on whether the agricultural futures markets are properly performing their risk management and price discovery roles after some agricultural industry members complained about the futures markets. Some grain elevators have reportedly stopped offering some forward contracts for farmers because of high margin calls.

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What are your thoughts on GM consumption crops? Do you feel that expanding GM programs will alleviate the rise in costs or will they allow those companies with the patents to control pricing?
Chivon Reyes, New York

AO: The debate on GM crops is important as there are diverse issues which affect different regions in different ways. What is viewed as optimal policy with regards to GM crops will therefore vary from country to country.

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Is there a real shortage of food? How did this happen?
Chuen-Wai Poon, Malaysia

AO: Global stocks for a number of grains like rice and wheat are low compared to historical levels. In the case of wheat, stocks have fallen due to poor harvests in the current season as a result of bad weather across a number of major exporters. Unlike wheat, rice output has not fallen this season (it has actually risen marginally) but supplies have been pressured by an increase in demand, partly emanating from the shortfall in traditionally consumed wheat supplies.

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How much of the rise in food prices is tied to the rise in the price of oil? And if there is any significant tie-in, how can food prices stabilize if energy prices continue to rise?
Bill Goedecke, San Francisco

AO: There are two aspects to this issue. Energy prices and their impact on farm costs, as well as their impact on biofuel demand. It is estimated that fuel and fertiliser costs make up around 25-30 per cent of farming costs. Rising fuel and fertiliser prices (as a result of rising oil prices) will put additional pressure on food costs. Secondly, rising fossil fuel prices is increasing the need of policymakers to find alternative sources of energy and leading to the increase in global mandates for biofuel blends.

Given that the feedstock for biofuels is mainly corn/sugar or edible oils, this is reducing supplies available for food. However, price rises can be dampened by further technological advances that improve yield.

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Has there been such increase in food prices before? If so, what were the reasons then? And are they similar to current factors?
CK Ching, Malaysia

Which historic period of time (1970s?) would you compare the current commodities inflation phenomenon to? Given that, what would be the main differences?
Terence Choy, Vancouver

AO: The shape and scale of the rise is reminiscent of the late 1970s when food prices rose sharply peaking in 1980 due to a drop in global stocks which was compounded by fiscal reform in a number of developing countries.

However, over the next 12 months following that peak, food prices dropped equally sharply as supplies returned to normal levels. We expect supplies for key cereals such as wheat to improve significantly over the next season but there is also a structural change in the industry which should keep average prices for grains much higher than historical averages.

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Which African and Asian countries would see their political stability most closely and directly compromised by further rises in rice prices in 2008-09 and how likely are such Haiti-type scenarios to be realised in these economies?
Rosario Ingles

AO: The risks of social tensions emanating from high food prices is real, particularly if food price increases are sustained beyond the current season. In general, low income, import dependent countries will be particularly vulnerable, more so given that they will be less able to absorb the additional fiscal commitment employed by other importing countries (e.g. subsidies) as a short term measure to combat food price inflation

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The Club of Rome, under The Limits of Growth, among others, anticipated a somewhat similar situation. With increased demand,rising costs, lower supplies, it would appear that the situation may well continue; this is the case at least with oil prices, a factor in food price increases. What is the solution, rather than the explanation to the impending crisis that has already resulted in riots in many parts of the globe?
Ian Cairncross, Canada

AO: One way of solving this issue would be to increase output where this is possible, either through increased plantings or new technologies that improve yield. Some regions do not lack the resources (land or labour) but the political and economic infrastructure is weak and this is exacerbating the supply problem. These issues need to be looked at, including an emphasis on making capital available through microfinance initiatives for rural/poorer populations for example. This should go some way towards improving farming productivity and incomes.

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Rising demand from the biofuels industry is considered one of the main factors behind food price rises, just how much is the biofuels boom contributing to the food crisis?
Henry Huttinger, Washington DC

AO: Bio-fuel targets in some countries is contributing to some extent to the increase in the price of food as planted areas are switched from other crops into biofuel crops. However, with regards to sugar(which is the main feedstock for ethanol in most countries apart from the US), the industry is fundamentally oversupplied. Still, sugar futures have been trending up since December 2007 on account of other reasons (e.g fund/spec buying). Biofuel demand has contributed to rising food prices, but there are other elements which include supply shocks for specific products, persistent food demand growth, changing tastes with rising incomes as well as high energy and fertiliser costs.

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Increasing food prices should be beneficial for the farmers who constitute the majority in China and India. Why, then, are their governments crying hoarse in the name of inflation?
Sushil Pawa, New Delhi

AO: Logically, high food prices should lead to high incomes for farmers but this is not always the case in developing countries. In India for example, although over 50 per cent of the workforce is employed in agriculture only a few own land while others may be field hands or migrant workers.

There is also a lot of underemployment or disguised employement in the sector which keeps wages low. It is estimated that around 70 per cent of India’s population live on less than 20 rupees a day. This makes inflation of significant concern as it erodes already meagre incomes. Additionally, external control of commodity value chains tends to erode the share of the final product price that goes to producers in some countries.

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It has been speculated that in an attempt to stem the tide of ever increasing crop production for biofuels, governments might regulate the amount that could be dedicated for such purpose. Would this have any effect on prices? Furthermore, since agriculture is so heavily subsidized in the U.S., is such regulation an implied athority.
Charles Kreidl, Chicago

AO: The use of grains/edible oils as a feedstock for biofuels has contributed to an extent to the rise in food prices. Regulating crop use for biofuels could potentially limit further rises in food prices as it could dampen market speculation as well as free up acreage for other non-biofuel crops. However, like I have mentioned, there are other elements which have contributed to an increase in global prices.

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Which Funds are most likely to benefit from agricultural commodities in the medium term?
Peter Mortimer, Hampshire

AO: In general, funds that had decent agricultural commodity allocations prior to the recent rally have been early winners. Given that we are still bullish agriculture, funds which are able to ride out current market volatility may also benefit. Unfortunately we are unable to recommend specific funds.