The last year has witnessed increases in agricultural commodity prices. This is partly due to short-term supply-side factors. However, there are also mid/long-term trends that seem to be putting upward pressures on prices. I will discuss these, highlighting key drivers and uncertainties.
Commodities indices, 2010-11:
PowerShares DB Agriculture ETF (NYSEARCA:DBA), past 12 months:
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Some of these increases in commodity prices can be attributed to short-term supply factors. Critically, erratic weather conditions in places such as Canada, Australia and Central America, including rain and drought, have meant harvests have been reduced this year. Speculation may be another factor that will not result in a sustained price increase.
However, there are structrual factors that suggest that there is the underlying upward trend in prices. Back in 2008, DEFRA highlighted four of them:
- Population and economic growth in emerging economies will increase the demand for food and oil.
- Oil price increases will raise agricultural production costs.
- Rising biofuel production.
- A plateau in productivity increases in agriculture.
As with agricultural commodities, recent months have seen a spike in oil prices.
Brent crude oil spot $/barrel:
These rises can be attributed to concerns over supply arising from political instability, as well as speculation. Again, however, longer-term structural factors also point to a rising oil price. First, the growth of emerging economies will lead to an increased demand for oil. Second, although OPEC and the IEA make optimistic projections over long-term supply from conventional and unconventional sources, these are hotly disputed, and even optimistic projections acknowledge steep increases in production costs with deepwater oil, oil sands and shale, and coal and gas conversion. As well as being costly, there are increasing concerns over the environmental impacts of unconventional sources. The EU has recently moved to block imports of oil from Canadian tar sands.
Oil price increases raise the cost of agriculture by raising the costs of fuel, fertilizers and pesticides. The U.K. Sustainable Development Commission has estimated that a $50-$100 increase in oil prices could raise production costs by up to 13%.
These spikes and long-term increases in oil prices are heightening concerns over energy security and will make bioenergy production more desirable and competitive. Some food is used directly as a feedstock for bioenergy production. However, even non-food crops must compete with others for cultivated land.
Joachim Von Braun modeled the impact of planned biofuels production on commodities prices. He outlined two scenarios: one used current plans for bioenergy production, the second doubled these planned levels. Under the first scenario the price of oildseeds increased by 18% and maize by 26%. Under the secod scenario the increases were 44% and 72% respectively. Von Braun points out that these effects are not far off in the future, some of them are happening right now.
However, models such as this and those reviewed by the IEA are fraught with uncertainty regarding the strength of policies and the state of technology. The Institute of European Environmental Policy analyzes EU national renewable energy action plans, and predicts that, by 2020, bioenergy production (including solid heating fuels) will account for a massive 20% of total energy production for the 23 EU countries investigated. However, back in 2006 the OECD estimated that replacing 10% of (then) current transport fuel would require 30-70% of the current crop area, threatening food security. Politicians are rightly concerned that price increases would have an adverse impact on forests and the urban poor in developing countries.
The predictions are especially uncertain regarding the competitiveness and feasibility of technologies. Second generation, cellulosic biofuels could dramatically decrease the demand for land that biofuels generate. The numbers are game-changing. Examples suggest that miscanthus could yield up to 1,600 gallons per acre, compared with U.S. corn (400) and Brazilian sugarcane (660). The technology is demonstrated: for example a Canadian plant has been producing cellulosic ethanol since 2004.
Although productivity in agriculture seems to have plateaued, the potential for productivity increases is a crucial supply factor that could offset the other upward pressures, proving all these Malthusian predictions wrong yet again. Whilst European and U.S. agriculture yields around 6-9 tonnes per hectare for grains, much of Africa languishes at a desperate 1 tonne per hectare.
The key take-home message of all this brief discussion, therefore, is uncertainty. The second is a mid/long-term upward trend in agricultural commodity prices, especially for corn, with technological, policy and productivity gap riders applying.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.