Brad Pyles
The Big Picture

Inside Increasing Global Grain Prices

By, 02/23/2011

With agricultural prices rebounding back up to their 2007 highs, concern over the impact of their record prices have surfaced globally. To put higher food prices in perspective, we examine factors affecting the agricultural industry and prices of agricultural goods.

First, when looking at food prices, it's important to differentiate between global agricultural commodity prices and US retail food prices. Particularly in the developed world, most of the cost of food purchased at the local grocery is tied to transportation, processing, packaging, and marketing. The US Department of Agriculture (USDA) estimates only roughly 1/5th of every dollar spent on food in the US is attributed to the actual cost of the food—sometimes it's much less. In fact, corn likely accounts for less than a nickel of the cost of a box of corn flakes.

When looking at global agricultural commodity prices, the most impactful driver on a yearly basis is typically weather. This has been demonstrated most recently with the impact of the drought in Russia, or India's 2009 drought and its subsequent food inflation. Energy costs also have significant impact—both from transportation (getting inputs such as fertilizer to the farm and carrying food away) and nitrogen fertilizer costs. (Nitrogen fertilizers are typically manufactured using natural gas.)

Another newer, significant driver is a structural increase in food demand from Emerging Markets. Rising populations combined with increasing per capita wealth in emerging economies is contributing to increased meat consumption. Since it takes roughly three to seven pounds of grain to produce one pound of meat (about three for chicken and seven for beef), increased meat consumption has an exponential affect on grain demand. Exhibit 1 shows global total meat consumption has clearly changed its growth trend line since the Emerging Markets began industrializing in the mid- to late 1980s.

Exhibit 1: Global Meat Consumption

Source: World Resource Institute Data is based on UN surveys aggregated every 10 years; therefore, the most recent data is through 2002.

More specifically, Exhibit 2 shows the trend in meat consumption per capita in some of the larger Emerging Markets compared to the US. From 1980 through 2002, Brazil's meat consumption rose 259%, China's 98%, Indonesia's 84%, and India's 41%, while the US saw just a 15% increase.

Exhibit 2: Meat Consumption Per Capita of Selected Countries

Source: World Resource Institute Data is based on UN surveys aggregated every 10 years; therefore, the most recent data is through 2002.

Emerging Markets' increased demand for food has particularly impacted fertilizer consumption. For example, since 1990, China, India, and Brazil have cumulatively increased fertilizer consumption by over 95% while US consumption has been relatively flat (1990–2008). This can be seen in Exhibit 3, which shows fertilizer consumption for the 10 largest fertilizer consumers, with the rest aggregated into "other."

Exhibit 3: Global Fertilizer Usage by Country

Source: International Fertilizer Association.

An additional driver for global food prices and the agricultural industry has been increasing bio-fuel demand. For example, in 2008 the OECD estimated "current biofuel support measures alone are estimated to increase average wheat prices by about 5 percent, maize by around 7 percent and vegetable oil by about 19 percent over the next 10 years."

Ethanol processes the starch component of corn (typically around two-thirds of a corn) and leaves behind the protein rich center, which can be used for animal feed. However, that doesn't change the fact US corn demand has increased significantly in line with the increase in US ethanol mandates and subsidies. (Ethanol receives a $0.45 cent per gallon tax credit, down from $0.51 prior to 2009, and a $0.54 per gallon tariff on ethanol imports to keep out ethanol-based sugar cane from Brazil.) (See Exhibit 4.)

Exhibit 4: Consumption of US Corn Production

Source: USDA.

Of course, pricing is about more than demand. Supply is the other half of the pricing equation. The large increase in demand has so far been partially mitigated by increases in supply through improved crop yields. (See Exhibit 5.) Part of the increase in corn supply is from an increase in acreage planted—the USDA estimates 2010 was the second largest planting since the mid-1940s. While this increases corn supplies, it also decreases the acreage planted of other crops, pushing up their prices (all else equal). However, the greater contributor to increasing supply has clearly been improving yields. This has been greatly assisted by the use of genetically modified seeds in recent years, but continued improvements in farming techniques, machinery, and economies of scale through consolidation have also contributed.

Exhibit 5: US Corn Production vs. Acreage

Source: USDA.

Future pricing appears likely to continue to be determined by the relative impact of these factors, combined with global population growth. However, population growth is typically a longer-term trend that has little impact on a 12-month basis. Overall, the world is far from being unable to grow enough crops to feed itself, but that doesn't mean prices won't occasionally rise due to weather problems, the unintended consequences of government subsidies, and demand-side changes in preference.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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