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Stephanie Cohen

New Atlantis blogger Stephanie Cohen is a journalist who covers energy and environmental issues for a wide range of print and online publications. She can be reached at scohen@thenewatlantis.com.
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Power Politics

Monday, June 2, 2008

What’s behind the food price hikes? 

International agencies say biofuels a “significant factor”; ethanol makers respond

  

The Organization for Economic Cooperation and Development (OECD) and the Food and Agriculture Organization (FAO) of the United Nations recently released a report on the world’s agricultural outlook from now through 2012. The report, prepared jointly by the two groups, tries to sort out the factors driving up food prices. The release of the report was timed to coincide with the UN conference on food security and climate change in Rome on June 2-5.

The report (a summary of which can be found here in PDF format) begins with some background:

This year’s Outlook is set against a backdrop of exceptional increases in prices for many agricultural commodities, and this has posed a considerable challenge in preparing the projections and assessing the “durability” of the various influences shaping these prices. That is, which of the factors that are driving up prices are temporary and which will prove to be more permanent influences? How will they individually and collectively affect price levels, price trends and price volatility in the future? How will markets react to currently high prices and a more uncertain price outlook? What are the appropriate policy responses? This report comes at a very timely moment and provides important information, with a view to enlightening the discussion on food-price increases, their causes and their likely consequences for agricultural markets as well as for the policy formulation process.

Biofuel production is mentioned as a “strong driver” on the demand side, though it is understood to be just one among many causes. The report lists the following factors as drivers of higher commodity prices: droughts in key grain-producing regions; sharply increased biofuel demand for food commodities; rising oil prices; and a continuing devaluation of the U.S. dollar, the currency in which indicator prices for the commodities of interest are typically quoted. The report also notes that “Critically, these supply and demand developments occurred after there had already been a run-down in stocks, which under more normal circumstances could have dampened price movements.” And “finally, the turmoil in commodity markets has occurred against the backdrop of a severe world financial crisis that is widely believed to have sparked a substantial increase in speculative interest in agricultural futures markets.”

Some of the key findings of the report (quoted from the document; emphases added):

  • World reference prices in nominal terms for almost all agricultural commodities covered in this report are at or above previous record levels (see Fig. 2.1). This will not last and prices will gradually come down because of the transitory nature of some of the factors that are behind the recent hikes.
  • But there is strong reason to believe that there are now also permanent factors underpinning prices that will work to keep them both at higher average levels than in the past and reduce the long-term decline in real terms.
  • The dramatic increase in [food] prices since 2005/06 is partly the result of adverse weather conditions in major grain-producing regions in the world, with spill-over effects on crops and livestock that compete for the same land. In a context of low global stocks, these developments alone would have triggered strong price reactions.
  • On the demand side, changing diets, urbanisation, economic growth and expanding populations are driving food and feed demand in developing countries.
  • When the average for 2008 to 2017 is compared with that over 1998 to 2007, beef and pork prices may be some 20% higher; raw and white sugar around 30%; wheat, maize and skim milk powder 40 to 60%; butter and oilseeds more than 60% and vegetable oils over 80%. Over the Outlook period, prices will resume their decline in real terms, albeit at a slower rate. However, the impact of various supply and ... demand factors on prices will differ across commodities.

Biofuel

  • But stacked on top of this is now the fast-growing demand for feedstock to fuel a growing bioenergy sector. While smaller than the increase in food and feed use, biofuel demand is the largest source of new demand in decades and a strong factor underpinning the upward shift in agricultural commodity prices.
  • Policy support, as well as oil-price developments, will strongly influence the evolution of future demand from biofuel for agricultural commodity feedstocks.
  • Once they have fallen from their current peaks, however, prices will remain at higher average levels over the medium term than in the past decade. But the underlying forces that drive agricultural product supply (by and large productivity gains) will eventually outweigh the forces that determine stronger demand, both for food and feed as well as for industrial demand, most notably for biofuel production. Consequently, prices will resume their decline in real terms, though possibly not by quite as much as in the past.
  • On the demand side, use of food grains to be processed into biofuels stands out as an important component of demand growth between marketing years 2005 and 2007. Wheat and coarse grain use overall increased by about 80 Mt, or 5%. Within this aggregate, biofuel use doubled, rising by 47 Mt, thus accounting for over half the increase in world grain use. The U.S. biofuel use of grains alone explains the vast majority of this change, up by 41 Mt even after adjusting for distillers grains co-produced with ethanol and added to feed use. But these data also show that an attribution of all the grain price increases to ethanol would be incorrect. Despite a doubling of some grain prices and broad increases overall, global food and feed use per capita were sustained, implying that the generally strong economic performance of the last two years has been manifested in outward shifts of demand that – in combination with relatively inelastic demand in the short term – has offset the impact of higher prices on quantities demanded.
  • Available data suggest that somewhat more than half of the increase in the quantity of demand for grains and vegetable oils between 2005 and 2007 was due to biofuels. Based on Outlook assumptions of further modest increases in the price of oil, continuation of policies that support for biofuel production and use and no dramatic technology change, feedstock demand for biofuel production appears to represent a permanent factor.
  • While biofuel use of grains and vegetable oils is anticipated to represent a falling share of the overall increase in demand for these food commodities, it is nevertheless a new source of demand which is seen as one of the factors lifting prices to higher average levels in the future.
  • Demand for these grains to be used as feedstocks in biofuel production is not expected to continue to expand at the rate of the last two years.3 However, cereal use for biofuel production is projected nearly to double from 2007 to 2017, though its share of the overall increase in quantities of wheat and coarse grains used is expected to fall from about 60% to just over 40%. The U.S. is likely to continue to be the centre of grain-based ethanol production, assuming no new technologies displace current practices, but use in the EU is likely to expand, too.

Vegetable Oil

  • World vegetable oil use increased faster between marketing years 2005 and 2007 than production (Table 2.5). Of the demand increase, biofuel use of oils accounted for over half.
  • Biofuel use of vegetable oils accounts for more than a third of the growth in vegetable oil use from 2005 to 2017. This is very strong growth in percentage terms, as world biofuel use increases more than five-fold from the very small base in 2005. But the growth in other uses amounts to an increase of about 33% over this period as well.

Crude Oil

  • The oil price, and energy prices more generally, are important contributing factors to the recent increase in agricultural commodity prices.... The Outlook assumptions reflect the widely held belief that the oil price increases are permanent and that further gradual increases are likely. Higher oil prices result in a structural increase in agricultural production costs and contribute to lifting future prices to higher average levels.

When the report looks specifically at biofuels it finds that conditions (namely, high oil prices and public support for alternative energy sources) remain favorable enough to make further growth in biofuel production likely. Assessing the global biofuels picture, the report notes that while the U.S. and Brazil remain key players in the ethanol market, they are not the only actors on the world biofuel stage:

Production and use of both ethanol and biodiesel have increased significantly in recent years. Production of fuel ethanol tripled between 2000 and 2007, with the U.S. and Brazil accounting for the majority of this growth. However, a large number of other countries either commenced renewable energy programmes or increased fuel ethanol production in this period as well. Biodiesel output witnessed an even more pronounced expansion over the same period, having grown from less than one billion litres to almost 11 billion litres. Initially the EU accounted for more than 90% of global biodiesel production, but with increased biodiesel output in many other countries, in particular the U.S., its share has declined to less than 60% in 2007.

The report also notes that “near-record prices for maize, wheat and vegetable oils” have reduced the economic viability of biofuel production in many countries, despite strong public support and increasing fossil fuel prices.” But in Brazil, where sugar cane is used for ethanol production, “lower world sugar prices associated with a large global surplus have improved the economic viability and profitability of ethanol production in Brazil, which remains competitive with gasoline at a crude oil price of around $35 per barrel.” That’s about $100 cheaper than crude oil at today’s prices.

The report predicts global ethanol production will increase “rapidly and to reach some 125 billion litres in 2017, twice the quantity produced in 2007.... Following increased mandates, international trade in ethanol is expected to grow rapidly to reach 6 billion litres in 2010 and almost 10 billion litres by 2017, despite continuing trade protection. Most of this trade will originate in Brazil, and will be destined for markets in the EU and the US.”

It is worth noting that U.S. and Canadian biofuel industry leaders sent a letter to FAO Director-General Dr. Jacques Diouf refuting the report, arguing that it includes “a number of questionable and/or confusing assumptions that call into question the validity of the findings.”

posted by Stephanie Cohen | 5:14 pm
File As: Biofuels, Gas and Oil Prices