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Language: english
Created: Thu May 22 21:26:36 2008

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American Farm Bureau Federation
Backgrounder on Food Prices
May 22, 2008

World Food Price Issues
What is causing all of the concern about world food prices?
The causes of the world food price situation should be viewed as a set of short and long-
term issues because there are legitimate concerns one should have about global food
supplies that are displaying themselves in the short-term.

The Food and Agricultural Organization (FAO) of the United Nations recently released a
report titled "Growing Demand on Agriculture and Rising Prices of Commodities."
Excerpts from the FAO report include:
� Weather Related Production Shortfalls. Output in eight major exporting
countries dropped by 4 and 7 percent [in 2005 and 2006]. However, there was a
major increase in output in 2007...This quick supply response for cereals...came
at the expense of reducing...output of oilseeds."
� Stock Levels. Since 1995...global stock levels have on average declined by 3.4
percent per year...By the close of the 2008 season, world cereal stocks are
expected to decline a further 5 percent, reaching the lowest level since 1982.
� Increased Fuel Costs. Freight rates have...doubled, mainly within a one-year
period beginning February 2006.
� Changing Structure of Demand. Economic development and income growth in
important emerging countries have been gradually changing the structure of
demand for food commodities. In China, per capita meat consumption has
increased from 20kg (44lbs.) in 1980 to 50kg (110lbs.) now.
� Biofuels and Agricultural Commodities. The emerging biofuels market is a new
and significant source of demand for some agricultural commodities such as
sugar, maize, cassava, oilseeds and palm oil.
� Operations of Financial Markets. Market-oriented policies are gradually making
agricultural markets more transparent. This influx of liquidity is likely to
influence the underlying spot markets.

Additional World Food Price Comments
In affecting the short-term, some traditional exporting countries are deciding whether to
limit or even curtail delivery of rice and other products into the world market. Striking
farmers in Argentina are another example of supply disruptions affecting world
commodity availability. Once a hoarding mentality sets in, it can create irrational
behavior.

Longer term, the answer has to be the adoption of more productive approaches to
agriculture around the world. Deciding to forgo technologies that can significantly

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improve yields, reduce pesticide needs and provide for better output traits, as Europe,
Japan and some other countries have elected to do, places a major cost on developing and
other economies.

This was a warning issued more than 10 years ago, but that was ignored or even scoffed
at, at the time.

Further, other countries need to put policies in place that will open their economies to
market signals. Farmers and consumers need to be able to see the true value and cost of
their food.

Some other issues affecting world food supplies:

� China has experienced a harsh winter in the south and a spring drought in the north.
There is concern that this could further exacerbate food shortages/demand in China.
China has curbed exports of grain through quotas and taxes. China has been stockpiling
grain, but as population grows and that nation's arable land shrinks, there is concern
that China is reaching the red line of grain security with about 121.8 million hectares
available (estimates are that China needs a minimum of 120 million hectares for grain
security).

� China and India are consuming more grain and meat as incomes increase. Consumption
of meat has increased demand for grains for animal feeding purposes. Per capita
consumption of meat in China doubled between 1990 and 2005 and is still growing.
This is leading to a rapid increase in the demand for feed.

� For some crops, notably rice in East Asia, the amount of good, productive land is
falling, buried under concrete of expanding cities. Additionally, worldwide investment
in agricultural research has dropped as spending on farming as a share of total spending
in developing countries fell by a half between 1980 and 2004. Rice research has slowed
significantly. Wheat yields also have reached a plateau due to lack of research.

� Rice availability is an issue even in normal times. Worldwide, little rice is actually
exported: more than 90 percent of what is grown is consumed in countries where it is
grown. In the last quarter century, rice consumption outpaced production, with global
reserves plunging by half since 2000.

� A plant disease has hurt harvests in Vietnam reducing supply and leading to the
hoarding of rice as speculators and investors see it as lucrative. Thailand has also
tightened exports, as has India. Senegal and Haiti import 80 percent of their rice.

� Australia, one of the world largest wheat producers, has experienced a drought since
2002. Due to a six-year drought, Australia rice production is down 98 percent. The
largest rice mill in the Southern Hemisphere, located in Australia, previously processed
grain to meet the needs of 20 million people around the world. It closed in December
2007 due to the reduction in rice production.

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� Floods and a devastating cyclone also affected Bangladesh's ability to produce crops.

� Due to population growth and the loss of farmland, the average farm size in China and
Bangladesh has fallen from about 1.5 hectares in the 1970s to 0.5 hectares now. In
Ethiopia and Malawi, it fell from 1.2 hectares to about 0.8 hectares in the 1990s.

� In Africa, Kenyan and Ethiopia, farmers are planting less due to fuel and fertilizer costs
and the inability of farmers to secure credit to their finance purchases. Growing
political violence also has reduced plantings in Africa.

� Of the 58 countries tracked by the World Bank, 48 have imposed price controls,
consumer subsidies, export restrictions or lower tariffs. China, Russia, Cambodia,
Kazakhstan, Argentina, Brazil, Ukraine, Indonesia, India and others have export bans
while others have restricted flow.

Wheat Markets
Wheat is one commodity area that has drawn attention in stories regarding food prices.
After three consecutive years of weather-related production problems, world wheat
production appears poised to set a new record, up 7 percent from last year and 3 percent
above the 2004/05 record, according to the International Grains Council. Production is
expected to exceed consumption for the first time in four years. U.S. wheat production is
expected to increase about 13 percent in 2008.

Wheat futures prices topped out in late-February/early March of this year at around
$12.50 per bushel and have subsequently declined $4-5 per bushel. (See Chart)

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Rice Markets
Rice is referred to as a "thin" market, meaning that the amount that actually shows up in
world trade is very small compared to the amount consumed in the countries where it is
produced. With global rice consumption at 424 million metric tons this year, roughly 93
percent of rice is consumed in the country in which it is produced, leaving only 6-7
percent (27 million metric tons) to actually trade in global markets. Yet it is this traded
quantity that determines the world price for rice. It takes only small disruptions in this
portion of the world's rice production for prices to move sharply.

Reports of rice shortages come in the face of three consecutive years of slowly growing
world rice production. Production for the coming year is expected to rise by 1.8 percent.
Also estimated world ending stocks of rice have been essentially unchanged over that
period of time.

To the extent there are actual rice shortages in some areas of the world, they have been
caused by countries hoarding supplies and withholding traditional exports to try to
mitigate domestic inflationary pressures. Among the major rice exporters restricting
exports are countries like India and Vietnam. But the effects on the overall trade
numbers for rice have been relatively small, as shown in the graphic below.

World Rice Trade

India Pakistan Thailand Vietnam Other United States

30
Million Metric Tons

0
2005/06 2006/07 2007/08
Crop Year

This small decline in trade, coming at the same time as these announcements regarding
trade restrictions, has caused considerable distress in specific markets sufficient to drive
prices sharply higher.

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Domestic Food Price Issues
What is really happening to food expenditures?
USDA has observed that the Consumer Price Index for food and beverages increased by
4 percent for 2007. Expectations are that the increase will come in between 3.5 percent
and 4.5 percent for 2008. The graphic below shows the monthly changes in the food CPI
back to January 1990. Several things show up. First, this is not the first time we have
had a rapid run-up in the food CPI, nor have we come close to hitting some of the degree
of changes observed back in the early 1990s. Also note that the food CPI already has
started to grow at a somewhat less torrid pace than occurred at the end of last year. In
other words, like wheat prices, the food CPI may well be at the peak in this cycle.

Year-over-Year % Change in CPI for Food

% Change Year over Year
7%
6%
5%
4%
3%
2%
1%
0%
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
90 92 94 96 98 00 02 04 06 08
Month

To put this in a different perspective, U.S. consumers spend approximately $1.1 trillion
per year for food and beverages. The core inflation rate is about 2.5 percent per year, as
had been the average increase in food prices prior to 2007. The annualized food price
inflation rate was 5 percent in the first quarter of 2008. Taking the $1.1 trillion food and
beverage expenditures, this suggests annual growth in food outlays of $50 billion, up
from the historical average of $25-30 billion.

Through all of this, it is important to recognize that farmers receive 19 cents from every
dollar consumers spend for food, according to the latest USDA Economic Research
Service report. From March 2007 to March 2008 the Producer Price Index (PPI) for
intermediate foods and feeds rose 11 percent. The largest single share of the food dollar,

5
39 cents, is for labor (Assumed to be up 3.5 percent, consistent with labor cost changes
for 2007 reported by Bureau of Labor and Statistics; however, the minimum wage rate
rose 13 percent in 2007 and an additional 12 percent in 2008). Energy-intensive activities
such as transportation, fuels and electricity contribute a 16 percent share (the PPI for
finished energy goods was up 20 percent March over March). "Other" marketing costs
account for 22 cents, and slightly less than 5 cents is for corporate profits before taxes.

Overall, USDA expects the CPI for food to rise by 4.5 percent to 5 percent this year.
Using the relative price changes of the various components over the last 12 months, that
translates to the shares shown below for the shifts in domestic food costs:

Components of 2007/2008 Food Price Increase
8%
29%

44%

19%

Farm Gate Labor Energy Other

How are food prices changing relative to the rest of the economy?
The Commodity Research Bureau Foodstuffs index, an index based on the prices of hogs,
steers, lard, butter, soybean oil, cocoa, corn, Kansas City wheat, Minneapolis wheat and
sugar, at the end of March 2008, was up 24 percent from March 2007 levels. At the same
time, the overall CRB Continuous Commodity Index (including energy, precious metals
and other broad components) was up 27 percent from year earlier levels. It is also
instructive to compare these two indexes over longer periods. Between March 1990 and
March 2008 the foodstuffs index rose 71 percent. The metals index on the other hand is
up 198 percent and the energy index is up a 393 percent. Food commodity prices have
increased over that period of time, but far, far less than many other input sectors. In fact,
the foodstuff index in January 2007 was actually lower than the nominal value of the
same index in September through November of 1980. (See Chart)

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CRB Foodstuffs Sub-Index (1967=100)
(monthly close) January 1947 - March 2008 m odity Research Bureau
� Com

Index Value

450
350
250
150
50
1947 1955 1963 1971 1979 1987 1995 2003

Clearly there has been a rise in the foodstuffs index in the last few months, but again,
there have been several causes for that rise, and the trend also began as far back as early
2000, about the same time global wheat stocks hit their last peak. Anytime products as
basic as foodstuffs are held at constant nominal prices for several years in a row �
decades in this case � eventually, inflationary pressures will need to be taken into
consideration.

Is ethanol driving up food prices?
While ethanol has certainly become the whipping boy, there are many causes lifting
commodity prices this spring. Several independent think tanks place biofuels'
contribution to the food cost increase on a global basis at somewhere between 10 and 30
percent. A study completed at University of Wisconsin by Fortenbery and Park suggests
ethanol demand has increased corn prices by only 41 cents per bushel over levels that
would have otherwise existed. As it is, corn prices have actually increased by $1.22 over
the same period studied by the Wisconsin researchers, suggesting other factors are
contributing to higher commodity prices. Exports also have increased corn prices, but the
Wisconsin researchers suggest a significant effect coming from speculative trading by
outside investors.

Would suspending the RFS lower corn prices?
Very little, and in the short term, it is unlikely that waiving the renewable fuel standard
(RFS) requirements would cause any reduction in corn prices, let alone working all the
way through to food costs. Following are points to keep in mind:

� Corn exports have increased significantly, despite the corn price increase.

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� The U.S. dollar has weakened sufficiently to keep corn exports flowing.

� This provides ample reason to believe a good portion of the corn freed up by an
RFS waiver � a fourth to a third of the crop � would likely be snapped up by the
export markets. The price response would probably be limited to 10 to 20 cents
per bushel.

� Corn prices mainly affect consumer prices through livestock production, and price
effects would take several months, even years, to work their way through to the
consumer.

Is it true ethanol raises gasoline prices?
Actually just the opposite. Ethanol is serving to limit the run-up in gasoline prices.
Multiple studies show that oil and gasoline prices would be as much as 10-15 percent
higher if biofuel producers were not increasing their output. Without the expansion of
biofuel production and use in the U.S., Brazil and elsewhere, world oil demand would
increase and so would the price. Taking the 10 percent figure as a conservative estimate
and a national average gasoline price of $3.50 per bushel on the roughly 145 billion
bushels of gasoline consumed in the United States every year, ethanol is saving the
consumer more than $50 billion in lower fuel costs.

Does ethanol use more energy than it creates?
No. USDA reports that, taking into account all of the energy used to produce and process
corn into ethanol, including the energy used from the production of the fertilizer used to
feed the corn crop all the way through the energy used to produce the stainless steel tanks
to process the corn into ethanol, the renewable fuel has a positive energy balance of 67
percent. In other words, taking everything into account, ethanol provides 67 percent more
energy than it takes to produce it.

Further, according to a recent report from Argonne National Lab, American ethanol
facilities are using less water and less energy than five years ago while producing more
ethanol.
� Water consumption -- down 26.6 percent
� Grid electricity use -- down 15.7 percent
� Total energy use -- down 21.8 percent

What has ethanol done for the economy and rural America?
Ethanol has brought about rural revitalization. The annual local economic impact of an
ethanol plant, using a 40-million-gallon-per-year plant, is as follows:
� Economic base expansion = $110.2 million
� Additional household income = $19.6 million
� Jobs created = 694 permanent new jobs throughout the entire economy
� New tax revenues = $1.2 million

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What about tariffs?
Aren't tariffs protecting U.S. agriculture, keeping ethanol prices high and costing U.S.
consumers? The fact is that ethanol is being imported today directly from countries like
Brazil, but also from other countries in the Caribbean. These Caribbean countries actually
have duty-free access to the United States, but are not filling their allowed levels because
ethanol prices are higher in other markets. The fact remains that historically high crude
oil prices are far more responsible for high gasoline prices than are existing trade laws.

Eliminating the tariff would result in U.S. taxpayers essentially subsidizing Brazilian
ethanol.

More Information?
For more information regarding this topic:
� Regarding economic aspects, contact AFBF Chief Economist Bob Young.
� Regarding policy aspects, contact AFBF Director of Congressional Relations
Anne Steckel.

(END)