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What’s Driving Food Prices in 2011?

Demand shocks help drive 2011 commodity, food price increases

July 19, 2011:  A new report from Farm Foundation, NFP finds that while some of the same factors that drove commodity and food price increases in 2008 are at work today, new and very different factors have also emerged. The report, What’s Driving Food Prices in 2011?, cites the role of two persistent demand shocks—corn for biofuels production and soybeans for China—in the mix of factors pushing commodity price increases in recent months. Other factors include weather-related production shortfalls, changes in cropping patterns and a weak and volatile U.S. dollar.

Farm Foundation, NFP commissioned the report from three economists: Philip Abbott, who works in international trade and macro factors; Christopher Hurt, who works in analysis of commodity markets; and Wallace Tyner, an energy and policy economist most recently specializing in biofuels policies. All three are on the faculty at Purdue University. The report builds on similar reports written by the authors for Farm Foundation in 2008 and 2009.

“Now, as in 2008, the full story behind rapid increases in agricultural commodity and food prices is not a simple one. In today’s environment of higher and more volatile prices—as well as budget constraints—policy makers and society are faced with difficult choices about fundamental elements of food, agricultural and energy policies,” says Farm Foundation, NFP President Neilson Conklin.  “The focus of this report is to broaden understanding of the nature and interactions of the respective factors, the implications for public policy, and whether circumstances have created a new era that will shift U.S. food and agricultural policy to one of shortages from one of abundance.”

The authors identified five key factors in shaping today’s price story:

Persistent demand shocks—specifically demands of the biofuels industry, particularly for corn, and China’s decision to import huge quantities of soybeans due to income growth and stocks-building.

• Biofuels policy mandates and blending limitations have generated a large, persistent and non-price responsive demand for corn. It took 27% of the 2010-11 crop to meet the demand for corn to produce ethanol, compared to 10% of the 2005-2006 crop. Corn-based ethanol has nearly reached the maximum mandated level, so while this demand will persist, it will expand much more slowly in the next few years.
• While income growth and dietary improvements are drivers of rapid growth in Chinese soybean imports, a policy of stocks-building accounted for nearly 40% of the increase in Chinese soybean imports between 2008 and 2011. Given China’s current level of stocks—estimated at a 23% stocks-to-use ratio—future import and demand increases are expected to follow income growth, as was the case prior to 2008.

Market inelasticity—a reduction in the responsiveness of prices to demand and supply forces—is one of the key mechanisms in today’s commodity markets.

• Land adjustments highlight the impact of the two demand shocks. In 2005, 16.1 million acres of land in the United States were required to meet the demand for biofuels production and U.S. soybean exports to China. In 2010, it took 46.5 million acres—an increase of 189%—to satisfy these demands, or 29% of total U.S. corn and soybean harvested acreage. Globally, 70% of the expanded acres used to grow high-demand crops were new land being brought into production; 30% resulted from shifting acres out of other crops. In the United States, where land area has been fairly stable, the new demands caused land to be reallocated from other crops.
• U.S. subsidies and the Renewable Fuels Standard (RFS) mandate encourage domestic biofuels production, though the RFS is currently more important than the subsidy. Changing either policy would have little near-term impact if oil prices remain high—production capacity already exists, and companies could continue to produce without the subsidy. However, if oil prices were lower, the impacts of subsidy and RFS changes would be significant.
• Low stocks are an important contributor to market inelasticity. When stocks are abundant, much of the adjustment to supply or demand shocks is through changes in expected carry-over stocks. If stocks are low, this adjustment mechanism is no longer available, contributing to inelasticity and higher prices.
• Since 2008, higher feed prices have caused livestock producers and market prices for all livestock products—meat, dairy, eggs—to adjust, making them better able to weather current feed price increases. That means fewer livestock production capacity adjustments would be expected now, yielding a more inelastic demand for animal feed components.
• As world prices increased in 2007 and 2008, countries altered trade policies to isolate and partially stabilize their domestic markets from the effects of high prices. Trade policy responses are thought to be less important today than in 2007-08. Some of the extreme trade policy measures of 2007-08 have not yet been repeated in the current environment of higher prices; however, international agricultural markets remain thin and volatile.

Weather and grain stocks: Weather is more important in 2011 than in 2008. Wheat and barley suffered weather-related production setbacks, but large stocks tempered price increases. Corn stocks were drawn down when U.S. yields dropped in 2010. Soybean stocks have remained tight as Chinese demand has surged. With adequate stocks, rice prices have not increased.

• Normal 2011-12 corn and soybean crop yields would barely allow the world to continue to meet trend consumption. Tight world stocks for corn and soybeans cannot be overcome in one year of normal yields. High prices will exist for two crop years or longer, before moderating to levels lower than 2011 peaks but higher than historic norms.
• Slower demand growth from biofuels and China would give world supply a chance to catch up, but other events—new demand growth, the degree of supply response, or macroeconomic variables—will also be important in how this supply/price cycle plays out.

Chinese Policies: China has been a major holder of agricultural commodities but the stocks-to-use ratio of each commodity has varied considerably over the past decade. The policy to accumulate substantial soybeans stocks through imports is one example of the impact on world markets.

Macroeconomics: A weaker U.S. dollar contributed to a commodity boom between 2002 and 2008. Today, changes are not as dramatic, but the dollar exchange rate remains weak and volatile.

“As with the earlier work, this report does not attempt to attribute the proportion of the price increases among the different drivers,” noted Foundation President Conklin. “Our goal with this report is to provide public and private decision makers with an objective assessment of the forces driving commodity prices, and offer some insights into the implications for policy options.”