Commodities | Oct 15 2007
By Chris Shaw
The drought has been blamed for many things in Australia, not the least is the likelihood of higher food prices in coming years. But as ANZ Bank senior economist Katie Dean points out rising food prices are a global phenomenon as over the past year food prices have grown faster than average inflation in the US, China and Europe as well as in Australia.
While there is no doubt in the Australian case the drought has played a role and some of the increases will be wound back once conditions improve, Dean notes the shift towards biofuels and other curbs on agricultural output could possibly see food prices permanently move to a new and higher level.
This would mark a significant shift from what has historically been the case, as the bank’s research shows food prices have risen by less than 1.0% on average since 1980, a rate well below the 2.9% average increase in metal prices over the same period.
This has changed over the past 12 months though, as the bank notes wheat prices are up 60% and barley has risen by more than twice this amount since September last year. The dairy sector has experienced similar increases, with powdered milk prices up almost 80% over the past year as well.
Gains are not universal as the bank points out prices for commodities such as pork, sugar and beef have actually fallen modestly since this time last year, but overall the trend has been to higher prices.
Weather conditions have been the primary contributor, as among the grains poor conditions in Australia, Europe, Canada, Russia and the Ukraine have limited production and brought down forecasts of global wheat production from an increase of more than 5.4% to just 1.7%.
At the same time stock levels for wheat in particular have fallen and are now at their lowest levels since the 1970s, meaning prices are now much more subject to volatility and therefore responsive to any bad news. It is a similar story for other grains and the dairy sector.
Short-term no improvement is expected, the bank noting weather forecasts for Australia and Canada suggest no return to more normal seasonal conditions is likely for at least another three months.
Longer-term as conditions return to normal weather-wise it will be price signals that change the composition of global food production according to Dean, something that has already occurred as there has been some rotation of crops towards grains and dairy to take advantage of higher prices.
Where there is a difference between agricultural commodities and metals is producers can switch to other commodities quickly and cheaply as it takes only a season to move from growing one crop to another crop.
This leads Dean to suggest global food prices in the medium-term are unlikely to experience the same sharp shift as occurred in resource prices a couple of years ago. Longer-term though it’s a different story, as here structural changes such as the impact of global warming are set to change the global agricultural outlook.
The bank suggests while the impact will take some time to filter through as minor changes in temperature will have only a small impact initially, a study by William Cline of the Peterson Institute for International Economics suggests by 2080 climate change could cut as much as 18% from potential world agricultural output.
But climate change is not the only story as the world’s population continues to grow and industrialisation continues, meaning over time the amount of arable land available for agriculture will be reduced.
With more intensive farming to be needed to offset the reduction in land available farmers will need to increase the use of fertilisers, so lifting costs and therefore prices. As a result the rate of food production growth will come down, The United Nations Food and Agriculture Organisation forecasting a fall in the global growth rate from 2.0% in 1998/99 to 1.6% in the period from 1999 to 2015 and to just 1.3% from 2015 to 2030.
At the same time the growth in global food demand is also tipped to slow slightly in coming decades, the result of a slowing in world population growth, the fact a large proportion of the world’s population is already on relatively high calorie intake levels and because poverty will prevent much of the potential growth in demand from being realised.
Where there will be an increase according to Dean is as incomes rise around the world there will be a shift towards higher protein goods such as meat at the expense of traditional staples such as rice, something that is already occurring in the meat sector.
Biofuel is the other factor impacting on agricultural markets as government support for various fuels has changed market dynamics, Dean pointing to the US corn market as an example as US policy here has created a scarcity factor in the market that previously was not apparent.
As a result farmers are attempting to expand the acreage given over to corn production, this coming at the expense of other grains such as wheat and so bringing down output in these crops. This in turn forces up the price of these other crops, particularly for those needing them for their own industry such as meat and dairy farmers needing grains to feed their herds.
Dean’s conclusion is the current sharp pick up in prices in the agricultural sector won’t continue, as at some point weather conditions will return to normal and production will then pick up, allowing prices to ease.
Longer-term though prices are likely to reach and maintain a higher level, meaning households will at some point simply need to put more aside each week to meet the grocery bill.
In an Australian context rising agricultural prices add to the upward pressure on inflation, particularly as it relates to core inflation. Dean estimates food prices in Australia will increase by 5% in FY08, which would add around 0.8% to annual inflation.
This leads her to suggest the Reserve Bank of Australia (RBA) will be forced to act again on rates, with at least one more rate hike coming in the months ahead.
