FYI | Jul 16 2007
By Greg Peel
If you live on the east coast of Australia you will no doubt have come to the conclusion that the weather has gone crazy. While Australia is known as the land of drought and flooding rain, it would seem the motif has been taken a bit too far of late. Recent news broadcasts, for example, have juxtaposed reporting on the cessation of irrigation access in the parched Murray-Darling system, while at the same time showing scenes of the Hunter Valley and Gippsland underwater.
Whether or not this has anything to do with global warming is by the by. The reality is the price of fresh food in the supermarket has skyrocketed of late as livestock and crops are dying of thirst one minute and being washed away the next. However, fluctuations in food prices are an age-old phenomenon. It is a fact of life that good seasons follow bad, and prices rise and fall as a consequence. That is why food prices are removed to arrive at a “core” inflation measure. Short term volatility in food prices will otherwise only ensure misleading short term volatility in the CPI measure.
On a global basis however, all focus is on the most staple of foods – the grains. Grain prices have also been skyrocketing of late. A lot of this has to do with, or at least has been sparked by, drought or flood conditions across the globe – from drought in the food belts of Australia and Europe to ill-timed downpours in the US bread basket. But there are two other elements that have become significant factors in the grain price surge – biofuel production and changing food consumption patterns in Asia. The production of ethanol has led to a reduction in acreage being given over to food production, which in turn has pushed up the price of remaining grains, and, as a consequence of feed costs, meat as well. At the same time, wealthier Chinese and Indians are now demanding a diet that includes more consumption of meat, as well as embracing other Western-style staples.
As a nation blessed with self-sufficiency in food production (we only import 10%), Australia is indeed a lucky country. The problem is however that Australian food is a huge export market. We export, for example, 60-70% of our beef and 60-70% of our wheat. Then there’s our fish, and our wine, and so it goes on. The price Australians pay at the supermarket is now inexorably linked to global food prices. Thus even if the weather were to return to some sort of normalcy, we cannot be locally ensured of returning to lower food prices if global influences are still suggesting higher prices.
But thinking locally for the moment, recent rainfall across NSW has been such that the Department of Primary Industry is now anticipating a bumper 2007-08 wheat crop, perhaps the best since 1982. Bureau of Meteorology modelling further suggests we have now moved out of the El Nino weather pattern, and into La Nina, meaning further rainfall ahead. Under any normal circumstance, this should be promising for a lowering of local, and global, grain prices at least.
But at the same time, water allocations to irrigators in the Murray-Darling Basin have been cut back to zero for the time being. UBS reports the Basin provides 48% of Australia’s grain production, 52% of fruit, 28% of vegetables, 43% of lamb, 61% of pork, 31% of beef, and 100% of rice (and 77% of cotton). The removal of irrigation rights to this region is no small matter. Unless the region begins to receive something more akin to average rainfall, food prices in Australia have only just begun to rise. And if that’s the case, ongoing inflation and interest rises will become a reality.
There is no need to be too panicky, say the UBS analysts. ABARE is suggesting a 50% chance that 2007-08 will see a return to average rainfall. While this is not amazingly comforting, at least ABARE is not suggesting that the rivers will never see rain again.
But the weather is only part of the equation. Wether it rains or not, there has long been a building argument that the rise of China and other emerging economies will ultimately have the same impact on “soft” commodities as it has on “hard” commodities. In other words, the secular jump in global metal and mineral prices, known variously as the “super-cycle” or the “stronger for longer” theme, will be followed by a similar jump in global food prices. As vast populations shift from being subsistence peasants to part of the global workforce, and while the middle classes begin to enjoy greater levels of wealth, there will be a greater demand for food, and in particular a greater demand for the sort of food the West takes for granted.
UBS does not buy into this argument. The analysts suggest “price rises we’ve seen to date are largely the result of a confluence of one-off temporary factors and in some places reflect a shift in relative prices rather than inflation per se”. Such one-offs include the biofuel boom and a change in EU dairy subsidies (and as any Kiwi will tell you, milk prices have gone through the roof). There is nothing to suggest, says UBS, we’re in the midst of a broad-based and secular food boom.
While changes in EU subsidies are one matter, one can only assume from the research that UBS does not see the biofuel boom as lasting (ie there is no elaboration). While a fall in the price of oil would pretty quickly flow through to a fall in the price of corn, there is little to suggest biofuels are going away anytime soon, particularly considering the massive subsidies being thrown at the industry across the globe. Unless this latest move in the oil price over US$70/bbl is just another temporary aberration, then one must assume biofuels will be around for a while yet, and that grain prices will reflect such.
On the matter of Chinese food consumption, UBS notes that China is simply not yet a major agricultural trading economy. Only 3% of agricultural products are imported at this stage, and as such there is not a lot of price flow-on from global prices to domestic prices. On that basis, UBS concludes we are not about to suffer a food price boom.
So all in all, UBS analysts are unconcerned about Australian inflation as a result of sustained high food prices. It is likely to rain, current prices are being pushed by one-off factors such as ethanol and the Asian food consumption argument is a myth.
Anyone with a mortgage might like to hope they’re right.
