WHAT IS NEXT FOR COMMODITY AND FOOD PRICES ?

Alex F. McCalla,

Professor Emeritus, UC Davis

U of A International Week

Edmonton, February 5, 2009

Why Are We Talking about This Question ? Because of What has Happened to Ag.

Commodity Prices over the Past 3 Years;

First They Sky Rocketed Up; Now They are Crashing Down; Because of Food Price Inflation; Because of Food Riots in 30+ Poor

Countries; First Let’s Look at What Happened- And Then Try to Put it in Historical Context Then Turn to The Question

Wheat: Near Future- July 2005 – Jan 2009 CBOT

5 min 15 min

30 min

60 min

Daily Weekly

Monthly

Corn: Near Future -July 2005 – January 2009 CBOT

5 min 15 min

30 min

60 min

Daily Weekly

Monthly

Rough Rice: Near Future-July 2005- January 2009 CBOT

5 min 15 min

30 min

60 min

Daily Weekly

Monthly

Soybeans: Near Future-July 2005 – January 2009

5 min 15 min 30 min 60 min DailyWeekl

yMonthl

y

Light Crude Oil-Near Future July 2005 –January 2009 CBOT

5 min 15 min 30 min 60 min DailyWeekl

yMonthl

y

                                                                                           

The Historical Context

• Since 1870’s LR real grain prices have been declining except for periodic price spikes.

• What do the dates 1910-14, 1972-74 and 1995-96 have in common?

• They were price spikes after which real prices returned to the previous downward trend.

• Therefore one basic question is- when this spike is over will the LR trend revert or be higher?

• Will Show You 4 Pictures

Index of real corn and wheat prices, 1866-2008

0

50

100

150

200

250

18

66

18

76

18

86

18

96

19

06

19

16

19

26

19

36

19

46

19

56

19

66

19

76

19

86

19

96

20

06

19

48

=1

00

Corn Wheat

Sources: Carter, et al. editors (2006), USDA NASS Agricultural Prices, USDA WASDE and BLS “CPI- All Urban Consumers. Quoted in Sumner (2008)

Real U.S. Prices of Maize, Soybeans, and Wheat, 1924-2008

Index of Real Corn and Wheat Prices and Long term Trend -1948-2008 (from Sumner 2008)

Declining Real Prices of Grains and Soybeans (2000 US$) 1960-2008 USDA deflated prices from Meyers & Meyer, Dec 2008

Short Answer the Question –Nobody Knows for Sure- But We Can Identify Critical Factors

Outline Of Where We Are Going: What Prices and Markets are we talking

about? Will Set Global Context; but Will Focus on Basic Food Products esp Grains;

A Look at Market structure Is There a Consensus on What Caused the Price

Spike? No What are the Candidates?

Is There a Consensus on Where Prices Will Go in the Future? No- What are the Possibilities?

Why is it so Complicated and When Will We Know what will be the Future of Food Prices?

What Prices and Markets are we talking about?

Agricultural Products Can Be Grouped into 3 Parts Livestock & Livestock Products-

Milk & Milk Products- butter, cheese, powder; Meat – beef, pork, sheep, poultry; Fiber- wool

Annual/ Field Crops- Fiber- cotton, flax; Cereals- Big 3-- rice, wheat, maize—also coarse grains Vegetables; Oilseeds- soya, canola

Perennial Crops- Oil Trees- palm, coconut Beverages- coffee, tea, cocoa Fruits

What Prices and Markets are we talking about? -2

Markets However Are Not All The Same- They differ by what share of global

production enters international markets –share traded;

If Small Share is Traded, Markets are “thin” Whether Major Producers are the Same as

Major Traders? Degree of Concentration: Among Exporters?

Among Importers? The Nature of Trade and Production Policies

Applied by Major Players

WORLD COMMODITY MARKETS -- A TAXONOMY

LIVESTOCK & LIVESTOCK PRODUCTS CROPSANNUAL PERENNIAL

DAIRY MEAT FIBER FIBERS CEREALS VEGETABLES OILSEEDS OIL TREES BEVERAGES FRUITS

BUTTER BEEF WOOL COTTON WHEAT SOYA PALM COFFEE FRESHPOWDER PORK FLAX RICE CANOLA COCONUT TEA PROCESSEDCHEESE POULTRY CORN SAFFLOWER COCOA

COARSEWORLD DAIRY WORLD WORLD FIBER GRAINS WORLD VEGETABLE WORLD BEVERAGEMARKET MEAT MARKET WORLD OIL MARKET MARKETS

MARKETS GRAINSMARKETS

vegetables fruit< 5 % < 5%

Palm 74%< 5 % 10% > 50 % 12% WHEAT 18-20% Soya 36% Coffee 73%

wool cotton RICE 6% Canola 18% Tea 50%% of Production Traded: MAIZE 14% Cocoa 77%> 50%20 - 50%

10 - 20 %< 6 %

What Prices and Markets are we talking about? -3 Share Traded-

high for tropical products – palm oil 74%,coffee 73%, cocoa 77%,tea 50% -also about 50% for wool;

20 – 50 % - vegetable oils- soy & canola; 10 – 20% - wheat(18), cotton (12), meat (10); < 10 % -rice (6), milk products, fresh

vegetables and fruits < 5%; Not traded –roots and tubers, pulses

Where Share is High, Big Producers are Big Traders too- not Necessarily True in Thinner Markets

Therefore Market Structure Matters.

Focus Will be on Grains & Oilseeds

Not Time to Talk of All Markets so Will Focus on Grains & Oilseeds Given Where we are-

Specifically on Wheat, Rice, Maize/corn and Oilseeds;

Will be Looking at Market Structure and International Price Behavior;

Will Make Occasional Comparison to Coffee Market

World Market Structure – Milled Rice

China 130.2 India 96.4 Indonesia 35.8 Bangladesh 28.8 Vietnam

24.4=73% USA 6.3 WORLD 431.3

Thailand 10.0 Vietnam 4.6 USA 3.5 Pakistan 3.0 India 2.9 =82%(top 5 importers 28.2%) WORLD 29.2 6.8% of Pdn Traded

Major Producers mmt 2007/08

Major Exporters mmt 2007/08

World Market Structure-Maize/Corn

USA 331.2 China 152.3 Brazil 58.6 EU 47.7 Mexico

22.4=83% WORLD 791.5

USA 60.8 Argentina 15.6= 80% Brazil 7.9 Ukraine 2.1 S. Africa 1.1= 91%(top 5 importers 56%) WORLD 96.0

%12 of pdn traded

Major Producers mmt 2007/08

Major Exporters mmt 2007/08

World Market Structure -Wheat

EU 119.4 China 109.2 India 75.8 USA 55.8 Russia 49.4 =

67% Pakistan 23.3 Canada 20.1 WORLD 610.2

USA 34.5 Canada 16.6 EU 12.2 Russia 12.2 Argentina 10.2 =74%(top 5 importers 29%) WORLD 115.5

18.7% of Pdn Traded

Major Producers MMT-2007/08

Major Exporters MMT- 2007/08

World Market Structure- Soybeans

USA 72.9 Brazil 61.0 Argentina 46.2 China 14.0 India

9.3=92% WORLD 220.9

USA 31.6 Brazil 25.4 Argentina 13.8 Paraquay 5.1 Canada 1.8=98%(top 5 importers 80%) WORLD 79.536% of Pdn is traded

Major Producers mmt 2007/08

Major Exporters mmt 2007/08

For Comparison-Coffee Market

Brazil 37.6 Vietnam 18.3 Colombia 12.4 Indonesia 6.7 Ethiopia

5.0=66% WORLD 120.9

Brazil 23.8 Vietnam 16.0 Colombia 10.9 Indonesia 4.6 Guatemala 3.8=66%(top 5 Importers 86%) WORLD 89.074% of pdn is

traded

Major Producers- m. 60kg bags 2007/08

Green Coffee Beans

Major Exporters m 60kg bags 2007/08Green Coffee Beans

What Should We Learn From Market Structure ?

1. Markets are very different- Rice- very thin market (6% traded);smallest top 5 producer

is only one in top 5 traders; exporters & producers highly concentrated, importers not so; two countries produce ½ of world’s rice;

Corn- only 12% traded(thin),largest producer is also largest trader(US);production and trade highly concentrated –pdn top 2=61%-trade top 2=80%.

Wheat- higher share traded; concentration in pdn & trade lower; importer concentration low and same as rice.

Soybeans-over 1/3 of pdn traded; production and exports highly concentrated in same three countries; importer concentration also high.

Coffee-3/4 of production is traded therefore top producers are also top exporters; 2 importers import 55% of coffee imports; is a highly concentrated market with trade dominating.

What Should We Learn From Market Structure ? -2

The size of larger producers and traders matters because big players can influence world prices by both domestic and trade policies

If big producers and big traders are the same and the market is concentrated would tend to be more stable unless there was a price war;

Thin markets where big producers are not big traders means changes in domestic policy can have big consequences for world markets. These markets are inherently more unstable;

Individual markets are not necessarily homogenous-japonica, indica and basmati are all called rice but are very different; hard red spring wheat is not a substitute for soft white winter wheat.

Yellow maize is predominantly animal feed ,white maize is human food, underlining differing demands for same commodity

The bottom line is that one might expect these markets to behave very differently.

But Markets are Linked in Many Ways

Yet in a broader sense individual agricultural commodity markets are linked in many ways; Substitution in consumption: wheat for rice and

maize; wheat for animal feed if feed grain prices rise relative to wheat prices but it is asymmetrical; among vegetable oils and meals.

Competition/substitution in production: along a continuum there is substitution between corn and soybeans, corn and wheat, canola, wheat and coarse grains-etc.etc. 12 mil acres shifted from soybeans to corn in US in 2007/08

Demand for all commodities is driven by population and income growth.

And domestic and trade policies often treat groups of commodities as one.

Commodity Markets in the Broader Context

Agricultural commodity markets are parts of a broader set of primary products markets-petroleum, metals, minerals and forest products. These all may be influenced exchange rate changes, inflation, recession etc

Ag. Commodities are also real assets whose value as a store of wealth changes with the impacts of inflation/deflation on monetary assets. They have become part of index and hedge funds.

Finally globalization with closer and faster linkages between real and financial markets world wide means ag commodity markets exist in a complex maze of inter-related and often conflicting forces.

What Caused the Spike? There are at least 4 competing stories floating

around: Macro story-It is a commodity spike –oil, minerals

(including gold), ag commodities prices skyrocket together and fell together- therefore must be macro explanation; Declining $US pushes up global commodity P.’s which are

denominated in $- When US$ appreciated in last ½ of 2008 commodity prices collapsed. Low real interest rates reduced costs of storage therefore investors shift into real commodities.

Speculator story- in periods of uncertainty/decline, investors shift to real assets –rapid rise in hedge and particularly index fund investments in commodities, fund investors are very long in commodity markets. But as futures and hedge fund contracts expired investors sold heavily driving prices.This might help explain the magnitude of the volatility of the spike but not sustained price increases

Changes in Futures Market Players

29

Source: Corn Futures Net Positions from CFCT (COT) reports; Quoted in Carter et al. 2008

What Caused the Spike?-2

– Shocks story- three years of drought in Australia, poor crops in Europe, Canada and US in 2007 drew down stocks below critical levels. The explosion of Biofuels demand coupled with reduced supply caused big Price increases.

Structural Change/Shock story- this is the one most ag commentators have focused on. Fast income growth India, China etc driving demand growth faster and supply growth slowing.

Common to first three is –P increases temp. then back to normal. Fourth involved permanent changes and was the popular story among ag. Economists-but prices came back down

Structural Change plus Shocks

An Amazing # of analysts who identified a similar set of causes, differed only on relative impacts.

IFPRI, WB, IMF, USDA/ERS, FAO, OECD, Govt. of Australia, WSJ, NY Times, ad infinitum all see structural change in S & D which are pushing ag. Commodity prices up.

When perturbed by shocks or rapid shifts in parameters, price increases are magnified.

Implication --real prices after the blip should be permanently higher.

Structural Change plus Shocks-2

IFPRI is representative of an great consistency among Agricultural Economic analysts:

Demand side factors; Rapid growth & rising incomes in emerging

developing countries e.g. India and China has increased the rate of demand expansion;

Bio-fuel demand came on fast and hard pushing the D curve out even faster;

Urbanization and globally rising incomes mean demand for more and different mix of food.

Shares in Growth of Grain Consumption 2005/06-2007/08 from Meyers & Meyer,2008

Source: Calculated from PSD database, USDA.

Source: Global Subsidies Source: Global Subsidies Initiative 2007Initiative 2007

BioFuels BoomEthanol production 1975 - 2007 Ethanol production 1975 - 2007 (billion liters)(billion liters)

BiodieselBiodiesel production production 1991 - 2007 (billion liters)1991 - 2007 (billion liters)

EthanolEthanol > 90% of > 90% of biofuel production; biofuel production; Brazil and US Brazil and US dominate the marketdominate the market

Biodiesel:Biodiesel: EU is the EU is the largest producer and largest producer and

consumerconsumer

Structural Change plus Shocks-3

Supply Side factors- Rate of increase in supply has slowed in last

decade because of slower productivity growth and increased competition for land and water;

Rising petroleum prices have irreversibly increased cost of production.

The result has been global consumption exceeding global production in 7 of the last 8 years.

Global stocks have fallen to the lowest level since early 1970’s.

IFPRI has an interesting set of slides on these factors.

0

1

2

3

4

5

6

1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003

Ave

rage

ann

ual g

row

th r

ate

(%)

maize

rice

wheat

Productivity growth is declining

Source: World Development Report 2008.Source: World Development Report 2008.

DAP, US Gulf

World Fertilizer Prices, 2000-2008, US$/mt

Urea, Arab Gulf, prilledMOP, Vancouver

Higher input costs: Global fertilizer prices tripled in 2007

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

100

200

300

400

500

600

700

800

0

Source: IFDC 2008.Source: IFDC 2008.

World Grain Ending Stocks from Meyers and Meyer , 2008

Which Causes Were More Important?

Despite all the “analysis” there have been precious few empirical estimates as how much each cause contributed. Re Biofuel impacts- wide range: IFPRI -30% of

past increases , 18-25% more by 2020 if demand continues to increase; Andy Stoeckel (Australia) argues diversion of 38% of US corn crop to ethanol has significant price impact (no number) but US Ag Sec says ethanol demand only contributed 3% to overall 42% anticipated food price increase.

Re Increased costs of petroleum based inputs-+ 15% says World Bank.

Which Causes Were More Important? 2

Decreased investment in Agricultural R&D and general neglect of agricultural development over the past two decades no doubt slowed up productivity growth.

Stock to use ratios falling below 0.15 have in the past been associated with price spikes e.g. 72-74.

The consensus appears to be that entry of new players such as index funds will have little long run effect.

• Without question bad policies have exacerbated the price spike- Export embargoes, increased export taxes and attempting to build stocks.

The Stocks / Shock Story

The Fact that Grain Consumption Exceeded Production 6 out of 8 years after 2000 drew down stocks sharply to levels below 1972-73.

At a critical point as stocks fall, players in the market change behavior and hold or acquire stocks, the result given highly inelastic demand in the SR drives prices up rapidly ( Brian Wright) may explain run up but not the down.

• But question was what would happen to prices after the bubble broke?

• Most projections forecast higher Real Price after the peak- a sampling here- OECD and FAPRI.

• IFPRI and the World Bank had similar projections.

• But Current prices are already below their projections

Expected world commodity prices for the coming decade- OECD

Source: OECD-FAO (2008).

OECD-FAO Projections: Wheatfrom Meyers and Meyer

OECD-FAO Agricultural Outlook, 2008-2017

FAPRI Projections of US Crop Prices from JanPrices from January 2008

Actual wheat prices were 2008 US$ 12.4 per Bushel in March and less than US$ 5 per Bushel in early Dec. 2008

Consequences: Depends On-

Before looking at future let’s look at impacts of price spike. If Country -depends on:

- exporter or importer; - high or low income; - degree of dependence on world markets; - degree of P pass through to Prod &/or Con. - worst case- low income, high dependency, high grain

consumption - North Africa and Middle East.

If Person -depends on: Consumer or producer ? Of grains or livestock? High pass thru -bad for consumers, good for grain

producers Low pass thru –bad for government fiscal and foreign Ex

budgets

Consequences: An Example

High Income Low IncomeBase Case:Income/yr $40,000 $800% spent on food $4000(10%) $400 (50%)Staples as% of food 20%-$800 70%-$28050 % inc. in staple p:New staples cost $1200 $420New Total food costs $4400 $540

New % Spent on Food 11% 67.5%

Impacts on Food Prices& Inflation

Therefore impacts on food prices depends on: Share of commodity price in final product- e.g. wheat

cost < 10% cost of bread, polished rice =50%; Whether commodity is an input into another food

product- grain into dairy and meat production; Share of income spent on food; if high food price

increases reduce real income- in example the poor consumer has $140 less to spend on other things;

Re Inflation –share of food & ag industry in GDP

What Were the Consequences

The consequences for poor net importing developing countries are severe. Rising foreign exchange costs for imports,

particularly bad if not an oil exporter; e.g Tunisia, Jordan,Yemen –respectively import 53, 65 & 76% of their cereals;

Rising fiscal costs of domestic feeding programs- for Tunisia estimated increase $200 Mil. to $1 Bil.;

Countries pushing back towards inefficient self-sufficiency because don’t trust world markets;

World Bank estimates pushed 100 mil people into poverty;

Created political and social unrest.Plus side if prices passed to poor farmers, good

for food security and poverty reduction.

Food price related protests 2007-2008

1 Argentina2 Bangladesh3 Burkina Faso4 Cameroon5 China6 Cote d'Ivoire7 Egypt8 Ethiopia9 Guniea10 Haiti11 Honduras11 India12 Indonesia13 Italy

14 Jordan15 Madagascar16 Malaysia17 Mauritania18 Mexico19 Morocco20 Mozambique21 Pakistan21 Philippines22 Senegal23 United Kingdom24 Uzbekistan25 Yemen

What Has Happened Since Bubble Broke? Wheat- 2008/09 record crop 683 mmt +12%:

Record yields and + 3% Acreage; Stocks up from record low of119.4mt to 148.4 mt

Rice- 2008/09 record crop 439 mmt ,stocks up 2%: India and Egypt continue export bans:

Coarse grains -3% increase in production EU wheat production up 30mmt, coarse grain

production up 24 mmt; There has been a supply response except in

Australia.

What Has Happened Since Bubble Broke? -2.

Most countries have reversed restrictive policies –not India or Egypt;

WTO trade talks revived but still unfinished; Renewed rhetoric about turning around

decline in investment in ag. research and rural development- e.g. double CGIAR budget-;

But will it translate into action now prices down;

Growing recognition of potential impact of global warming –mainly negative for developing countries

What Has Happened Since Bubble Broke?- 3

Over Shadowed by Global Economic Collapse: Oil prices have plunged as have commodity

prices; Severe contraction in demand for all products

but food less as is basic; people feel worse off; Rising lay-offs and unemployment globally; Collapse of credit and housing markets; Should reduce rate of growth in demand –

upwards price pressure less; Reduces incentives for supply response-

opposite effect.

So What Might Happen Next

But Basic Structural Parameters are Still in Place; World population will rise to near 9 bil in 2050; Incomes still rising rapidly in large middle income

developing countries like India, China and Brazil-increased demands for higher value foods –e.g.meat;

World markets will continue to be price sensitive to cumulative shocks which will occur randomly;

Growing urbanization with alter needed food supply chains and increase competition for water and land.

Therefore repeat scenarios will surely occur but when??

So What Can We Say?

There will be a supply response; Stocks will rebuild but probably slowly; Global warming portends increased frequency

and magnitude of negative weather events; Therefore will be perhaps larger and more

frequent cumulative production dips as in 2005/07;

The best we can say about future markets is that there likely to be greater annual instability and an possibly increased frequency of spikes.

What Others Are Saying.

Willi Meyers and Seth Meyer U of Missouri; “…the two most important drivers of this near-

term outlook are the level of petroleum price and supply response that has been generated by high prices and favorable weather so far this year.”

Ulrich Koester University of Kiel, Germany: “Uncertainty about future prices is extremely

high; It is likely that prices in the short and medium

term will not be significantly higher than US$ 150 to 200 per MT in real terms and likely lower than 2006 in national currencies;

Long-term price projection are very uncertain, however, unlikely that prices will be above US$ 200MT if prices of oil developed as projected.”