THE HUNGER FOR NEW SOLUTIONS Understanding world food markets
Increased demand and insufficient supply are causing food prices to rise and reshaping how we think about agricultural markets. By David Hale International Economist and President of Hale Advisers, LLC
The impact of rising food prices is of global concern. The United Nations considers "food insecurity" to be a major emerging risk of the 21st century. According to the World Economic Forum's Global Risks 2008: A Global Risk Network Report, food prices in 2007 increased 17 percent in China, 4.7 percent in the United Kingdom and 4.4 percent in the United States. The core of the solution is to grow more food.
Supply and demand issues have affected the markets as long as markets have existed. What is noteworthy now is that traditional supply issues are the most severe they have been in some time, while, simultaneously, demand is increasing. The result is a one-two punch for prices.
Supply and demand in the grain markets The worldwide grain trade represents a classic example of how supply and demand shape markets. Fundamental supply issues, including weather - witness the recent catastrophic flooding in Iowa and other Midwestern states - and export policies are pushing up prices. At the same time, increased demand is coming from emerging markets, with more corn diverted to the creation of biofuels and fewer soybeans planted as farmers turn to corn as the grain of choice. Also helping push up prices is the declining dollar, which makes dollar-denominated products look like attractive buys, and fuel prices, which are running up the cost of fertilizer and distribution.
The result? Global grain stocks are declining, placing greater pressure on prices. According to the International Food Policy Research Institute's 2007 report, The World Food Situation: New Driving Forces and Required Actions, wheat and corn production decreased 12 to 16 percent in the United States and United Kingdom between 2004 and 2006. Cereal stocks in China, which constitute approximately 40 percent of total stocks, declined significantly from 2000 to 2004 and had yet to recover in 2007. For most observers of the grain and oilseed markets, climate is among the biggest factors causing declining global stocks of grain. For example, due to drought, the Australian wheat crop produced only 12.7 million tons in 2007-2008 and 9.7 million tons in 2006-2007, compared with 25 million tons in 2005-2006, according to the Australian Government's Department of Agriculture, Fisheries and Forestry.
Some crop experts also cite "carbon fertilization," the idea that plants grow faster and larger as they absorb the atmosphere's increased levels of carbon dioxide. This can result in higher production for crops such as rice and soybeans, but not necessarily for corn, sugarcane and other crops because of temperature and other factors.
On the other side of the supply-and-demand equation, food demand is rising as incomes increase in emerging economies including the fast-developing BRIC nations - Brazil, Russia, India and China - especially in cities where people now can afford a diet richer in calories and protein. In India, meat consumption has grown 40 percent over the last five years. Demand is rising for pork in Russia, beef in Indonesia and dairy products in Mexico. Higher meat consumption creates greater demand for grains to feed cows, pigs and chickens.
Further competition now exists between food and fuel. U.S. legislation is fostering demand for ethanol, a renewable gas that burns cleaner than petroleum gas and is domestically produced from corn. Biofuels are expected to consume up to 30 percent of the U.S. corn crop by 2010, according to the World Economic Forum's Global Risks 2008: A Global Risk Network Report. Ironically, U.S. ethanol production still contributes only marginally to meeting domestic demand for transportation fuel, says Dr. Peter Goldsmith, extension specialist, agribusiness management, in the Department of Agriculture and Consumer Economics at the University of Illinois at Urbana-Champaign.
"U.S. ethanol has no role in fuel pricing, while the reverse holds that ethanol prices are tightly correlated to petroleum prices. The corn-based ethanol market is still relatively small, so it only minimally reduces our dependence on foreign oil," Goldsmith says.
Government trade policies also have had an impact on food prices. The trend is toward increasing export tariffs and decreasing import tariffs on grain and oilseeds. For example, India has increased its grain export tariffs while lowering import tariffs on edible oils. China has announced a further increase in edible oil imports with projections currently up an additional 14 percent. The result of keeping domestic production off the global market while lowering barriers for the acquisition of grain and other commodities from the global market has been increased demand for U.S. grain and oilseed products.
Also worth noting is the recent attention focused on index funds. According to Commodity Futures Trading Commission (CFTC) data, there is no evidence that these funds are the cause of the bull market in grains. Data published by the CFTC indicate the percentage of open interest held by index funds has remained relatively constant since 2006, when this data was first published. This means that, while index fund positions are growing, positions by commercial and non-commercial participants have been growing at about the same rate. It should also be noted that wheat futures, which hit a record $13 in March, closed below $7 in the beginning of June. Speculators, including index funds, remained in grain markets throughout the price drop.
All market participants play important roles. The speculator's role is to provide liquidity. Speculators often take on the other side of the trade when a buyer or seller is needed. They are taking on the risk someone else wants to lay off. It is also important to note that speculators participate on both sides of the market - holding both long and short positions.
Responding to the market These issues are reflected in CME Group's grain and oilseed markets, which provide a venue for price discovery and a means to manage price risk. As a result of market volatility, increased access to the markets and expanded trading hours, volume in corn and soybeans is up 23 and 29 percent, respectively, and wheat volume is up nine percent.
CME Group has responded to rising volatility and prices in these markets by increasing price limits for its grain and oilseed contracts. This move was made to allow market participants to continue to utilize the contracts for price discovery and risk mitigation at levels more aligned with today's market. CME Group also has submitted a petition to the CFTC for approval to clear over-the-counter (OTC) calendar swaps for corn, wheat and soybeans and basis swaps for corn. These OTC swaps would enhance risk management practices, improve transparency in the OTC grains swap market, and reduce counterparty credit risk.
Beyond Feeding the Poor
On March 3, actress Drew Barrymore visited the CME Group trading
floor at 141 W. Jackson, with Josette Sheeran, executive director
of the United Nations' World Food Program (WFP). The two were in
Chicago for the Oprah Winfrey Show - where Barrymore announced a $1 million
personal donation to the WFP for feeding Kenyan schoolchildren. But they also
made a point to visit CME Group for insight into the global food markets.
"I think the traders have a feel for where things are going," Sheeran says.
"It's important for the World Food Program to get a better sense of whether
we are going to see a sustained high level of food prices, to help us help
those who are simply being priced out of the food market."
Although WFP's primary mission is to feed those in need, the organization also focuses on improving nutrition and quality of life, building assets and promoting the self-reliance of poor people and communities. For more information on this organization, please visit www.wfp.org.
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