January 22, 2008

 

Study dismisses ethanol as the chief factor stoking food price increases

 

 

A study done by Informa Economics has reported that contrary to popular belief, ethanol is not the major source of food inflation.

 

Informa is an agricultural and commodity research company based in Menphis, Tennesse.

 

Rising ethanol production has been blamed for fueling increases in corn prices, which in turn affected feed and food prices.

 

The report, paid for by Renewable Fuels Foundation, sought to disconnect meat prices from corn prices, arguing that in reality, feed prices has had little impact on the margins of meat producers over the past few years.

 

To support its case, the report said agricultural raw commodities now account for only a fifth of total US food costs and is thus not the chief factor fueling the current food price increases. Other than the 20 percent, the rest of the food price increases should be attributed towards increased costs of marketing, labour, transportation, energy, rent, profits, taxes and other costs.

 

The 20 percent attributable to raw commodities is a significant drop compared to the 1970s when they accounted for 37 percent of the price of food products, the study said. 

 

The study also pointed out that the smaller role that commodities play in consumer prices has enabled the percentage of US consumer income being spent on food dropping from 21 percent to less than 10 percent today. 

 

Although the study did concede that corn demand is expanding due to ethanol growth, it said the correlation coefficient of about 20 percent is minor in statistical terms.

 

The study also used statistics to show that only 4 percent of the increase in food prices is attributable to increased in CBOT corn futures.

 

The study mainly analysed the relationships corn prices had on beef cattle, hog, poultry and egg production.

 

 

Impact of Corn prices on cattle
 

The study pointed out that fed cattle prices had been in negative margins since 2004, long before corn prices started to rise. This followed uncharacteristically high margins in 2003, which resulted mainly from the large increase in cattle prices during the last half of that year.

 

In fact, over the long term from January 1985 to August 2007, average cattle feeding margins were negative, by an amount of -US$15.42/head.

 

However, this does not necessarily mean that cattle feeders have experienced sustained losses over the time period, since there are many cost markups associated with feedlot operations that are already included in their margin calculations, the study said.

 

In fact, lower feed costs did not result in higher margins and vice versa: Feed costs per head were about US$168 in 2004, dropped to US$136 in 2005 as corn prices declined, and then rebounded to about US$151/head in 2006 as corn prices turned higher.

 

Margins for feeding these animals were negative in each year under study, with 2004 and 2005 losses amounting to just over US$31/head while 2006 losses were more than double that at an estimated US$74/head.

 

However, the study noted the fact that even with a US$32/head lower feed cost per head in 2005 relative to 2004, per-head production losses were the same in both years, which reflects the disconnect that exists between the cost of corn and the price of cattle.

 

There are also many other factors, such as beef demand, that affect the sales price of finished cattle but have nothing to do with the corn price, the study said.

 

 

Corn prices on hog margins
 

The study used the hog industry, which saw more consolidation and which relies more extensively on feed as a better gauge.

 

Beginning from late 2003 to 2006, hog margins had remained at the US$20 to US$30 range thanks to unprecedented exports. The US hog industry headed into 2007 with a strong equity and financial condition fully able to withstand potential margin pressures arising from higher corn costs, the study said.

 

Even though the rise in corn prices took it down to the US$5 to US$25 range, it was largely overproduction which finally caused margins to turn negative, the study suggested.

 

 

Corn prices on poultry margins

 

The study also sought to de-link the connection between corn prices and poultry margins, arguing that the grain price movements has traditionally had little impact on the poultry industry, which saw the most integration in the industry and hence would be where corn prices had the most impact.

 

In fact, when corn prices were at their lowest in early 2006, poultry margins were negative, and as corn prices began to take off, poultry margins climbed, the study said.

 

In early 2003, poultry margins took a swing from negative to positive, despite relatively stagnant corn prices. This was a direct result from a cutback in production taken after the margin losses in 2002 and 2003. This cutback in production along with record high prices in late 2003 and early 2004 led to record high margins by mid-2004.

 

Then, as exports dropped off due to the high poultry prices, margins began to decline. Corn prices throughout all of this have had relatively little effect.

 

In fact, the record-high margins in mid-2004 directly followed a corn price spike in the preceding months.

 

 

Corn production feeds both ethanol and exports
 

Fueled by a record yield, the US harvested a record corn crop of 11.8 billion bushels in 2004. In 2005, a more average yield led production to fall to 11.1 billion bushels. Then, in the spring of 2006, price signals in the futures markets gave farmers the incentive to plant more soy, and the acreage planted to corn fell.

 

Combined with relatively flat yields, corn production fell for the second year in a row, to 10.5 billion bushels.

 

Thus, corn production fell by 1.3 billion bushels over two years, even though the usage of corn in ethanol production expanded from 1.3 billion bushels in 2004/05 to 2.1 billion bushels in 2006/07.

 

However, the ethanol industry was not the only source of additional demand, the study pointed out. US corn exports, which were 1.8 billion bushels in 2004/05, rose to 2.1 billion bushels in both 2005/06 and 2006/07 - a level that was at the top of the range experienced over the previous decade.

 

Rather than ethanol, the study cast the blame on global growth and middle-income expansions around the globe that are driving global commodity prices.

 

 

US corn production sufficient to meet demand

 

The study also dismissed any impending shortage, claiming that the industry has always been able to produce much more than domestically required.

 

Furthermore, a third of corn's volume used in ethanol production can be used as animal feed, which mitigates the shortage while GM crops would bring further gains in US corn yields, which are already higher than that of other countries.

 

The study said that with that in mind, the industry should be able to meet recent government mandates for increased ethanol production with ease.

 

US standards mandate 15 billion gallons of biofuels by 2020. 

 

The report can be read at http://www.informaecon.com/PressReleases.htm.