What's really behind food price hikes - Macleans.ca

What’s really behind food price hikes

Andrew Hepburn considers the influence of biofuel subsidies and financial speculators


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This is the last installment of a three-part series. In part one, Andrew Hepburn wondered whether rising demand from China and India can really be blamed for food price hikes. In part two, he delved into the supply-side of things, looking at food stocks. Here, he turns to U.S. biofuel subsidies and financial speculators.

From oil prices to rising consumption in China and India, the explanations tossed around to make sense of the sky-high food prices of recent years are many.

Yaneer Bar-Yam dismisses most of them.

He and his team of researchers at the New England Complex Systems Institute have mathematically modelled a well-known basket of food prices—the Food and Agriculture Organization’s Food Price Index—and concluded that two causes are behind expensive food: corn ethanol and financial speculation.

According to the NECSI model, shown below, corn ethanol production explains the gradual trend of higher food prices, while investor participation in agricultural commodity markets is responsible for the sharp spikes and crashes, such as the one seen in 2007/2008 boom-and-bust cycle.

Here’s how Bar-Yam explains his group’s methodology to me:

“We picked the biggest one of the fundamental factors, which is the ethanol and threw everything else out … then we added the mathematical model of speculation. And the only other thing we did is we said speculators will move their money between markets, so they’re should be a shifting between commodities and stocks and bonds … You add that in and the prices match very, very precisely.”

Indeed, only the massive drought in the U.S. midwest this past summer was enough to meaningfully affect NECSI’s model for agricultural commodity prices going back to 2004.

Food as fuel

If you think corn is overwhelmingly used as food, you’re living in the past. As NECSI notes, “Only a small fraction of the production of corn before 2000, corn ethanol consumed a remarkable 40 per cent of U.S. corn crops in 2011.” The shift, they say, was “promoted by U.S. government subsidies based upon the objective of energy independence and advocacy by industry groups.”

In particular, under a 2007 U.S. law, the so-called Renewable Fuels Standard stipulates that ethanol must comprise 9 per cent of fuel companies’ gasoline pools. Ethanol is used as an additive in gasoline, helping to reduce harmful emissions. Corn is the main “feedstock” for the production of ethanol in the U.S. Not surprisingly, the use of food as fuel as sparked calls for the U.S. government to withdraw the ethanol mandate given high food prices.

It’s important to note that what happens to corn prices affects other food commodities as well. As NECSI explains, “Corn serves a wide variety of purposes in the food supply system and therefore has impact across the food market. Corn prices also affect the price of other crops due to substitutability at the consumer end and competition for land at the production end.”

For all the disagreement about other possible causes of food price hikes, there seems to be more of a consensus that ethanol production has played a sizable role. In fact, a leaked report in 2008 by a World Bank economist argued that biofuels accounted for 75 per cent of the increase in U.S. grain prices up until late 2007.

Are speculators also fuelling price-hikes?

The question of whether speculators can influence commodity prices by purchasing futures contracts is the subject of intense academic debate. Many people, notably Paul Krugman, dismiss the role of investors in pushing up everything from crude oil to wheat prices.

These critics question whether what happens in the futures market can affect “spot” prices (i.e. the price of purchasing the physical commodity for immediate delivery). Unless higher futures prices induce people to hoard commodities now in order to sell them later, experts like Krugman don’t believe speculation has an impact.

Other, such as Prof. Stefan Tangermann of the University of Gottingen, note that futures markets are in some respects unlimited compared to the physical market. So if speculators are willing to pay unjustifiably high prices, knowledgeable players will sell as much as possible to them, ultimately driving the market back down.

NECSI found a strong connection between the paper market and the physical market for food. Their research showed that granaries set their prices for physical grains (i.e. the “spot” price) using the futures market price as a reference point. Futures markets, according to NECSI’s work ,are what drives the prices of everyday staples.

This is not to say that supply and demand don’t matter; Bar-Yam’s team believes that speculator-driven prices ultimately push the market into a large surplus, causing investors to exit their bets en masse as they see inventories rising—gravity can only be defied for so long.

Time for smarter policies and stricter rules

With two culrprits identified, NECSI suggests two straightforward solutions. First, “a significant decrease in the conversion of corn to ethanol.” Second, stricter position limits in commodity markets to prevent speculators from distorting prices. The deregulation of commodity markets of recent years, they argue, needs to be reversed.

“One has to step back and now say, What do we really want the world to look like? We have the power to change what the world looks like. If we can figure out where we want to go, our policies can reflect it.”

Andrew Hepburn is a former hedge fund analyst. He’s a commodities bear and a keen observer of financial speculators. For Maclean’s he blogs about the economy and financial markets.

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What’s really behind food price hikes

  1. Using food as a fuel is a prime example of the sheer evil that “environmental” groups perpetrate in the name of their false god. We let the poorest amongst us starve to death, all so some hippies can sleep well at night thinking they’re changing the world for the better, when in reality their silly experiments are costing people their lives.

    • While I agree that this might be a case of the law of unintended consequences with respect to environmental groups; the prime driving force behind ethanol as fuel were not the environmentalists; who if memory serves me really wanted us all to reduce carbon footprints and cease using fossil fuels altogether. From the above article (which I’m assuming you read as you’re commenting on it)

      ” The shift, they say, was “promoted by U.S. government subsidies based upon the objective of energy independence and advocacy by industry groups.”

      Military and political expediency backed by a demand for yet more corporate welfare appear to have been the main driving forces. I don’t think there are many hippies in the US Federal government or the corridors of industry.

      • Point taken!

  2. All the food industry in Canada has boards that monitor,limit eggs,milk,chicken,pork you name it.this drives up the price.Why do we the Canadian consumer pay more for the same products?I’m sick of seeing food prices going through the roof.How can the average Canadian keep up?We the tax payers must address this issue with our politicians,NOW! I’m sick of hearing the excuses!

    • Milk, eggs and chicken are supply managed. The farmers gets their cost of production and a reasonable return. At the same time the farmers make sure that all of the Canadian demand for milk, eggs and chicken are met. If you compare the prices in the USA plus the subsidies that their Government pays to farmers Canadians are getting a deal. Pork, beef and grains are not supply managed. As a farmer I got 23 cents per lb for a cow that would become hamburger. That is $0.23 per lb what did you pay for the hamburger at the store? The majority of the pork producers that I know have gone out of business because they were not getting their cost of production.

    • Canadian consumers do rather well in comparison with their farmer neighbours. Some 58% of Canadian farms have to have an off-farm income to stay in business. The younger generation is not staying on the farm, seeing the poor economics. The average age of Canadian farmers is now around 50 . Canadian farmers are in fact subsidizing food . If it were not for some of the supported commodities such as the dairy industry, you just would not have a sufficient , reliable , supply.

  3. I would like to see speculators out of the food basket, corn to ethanol phased out completely, and the auto industry forced to put out higher mpg vehicles. There is no reason why we don’t have 100 mpg vehicles.

  4. Incredibly well researched series.