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Food for Thought: How Energy Markets Determine How Much Your Dinner Costs

Jan. 23, 2011 6:05 PM ET
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Markets are everywhere. For instance, I’m currently petitioning my cell phone service provider to let me start a market for unused rollover minutes (I’m fairly confident that I have the length of my lifespan in unused minutes at this point). Much more interesting than the markets themselves is how they impact our everyday lives. In today’s world of increased interactions, a small movement in something as discrete as the price of rubber in China can translate into a jump in the price of a basketball at the Wal-Mart down the street.

These relationships aren’t always observed, but are felt in everyday life. Some are complex, but most can be pretty straightforward once you break them down. As the title implies, I’m going to take a look at a couple of those relationships in the energy markets. More specifically, how a rising (or falling) energy market can push the bill you pay at dinner higher (or lower). More often than not, we discuss how energy prices affect a business. However, more often than not, it is the individual consumer who is overlooked in this industry. Hopefully this will shed some light on how individuals are truly impacted by this market and stir some interest in more examination of the energy market by the reader.

Let’s start by taking a look at how natural gas prices can affect the cost of corn and wheat. Natural gas is heavily used in the production of ammonia through a process that uses words that I’m still not entirely sure actually exist outside the world of chemistry (caution: that link is heavily bogged with chemistry lingo). The refined ammonia is then used as an ingredient in most commercial fertilizers and is then used by farmers. Close to 90% of the total cost of ammonia is based on the price of natural gas. So, as gas prices rise/fall we tend to see pressure on fertilizer prices to increase/decrease. As fertilizer is a key component for crop farming, this typically translates to an increased cost to produce for farmers in a rising energy cost environment. Since these two crops are pretty much constantly in demand (making consumers price-takers), we see these increased costs result in a rise in the price at the dinner table.

Next up: crude oil. This relationship can be made in several ways. We could talk about anything from the cost to produce and transport goods, to the use of oil and its refined distillates in food manufacturing. However, I’m going to take a look at how prices at the pump can impact popcorn prices at the theater. We’ve all witnessed the growing interest over the past few years in ethanol as a substitute for gasoline. What are the implications of this growing focus on ethanol production? Aside from trying to figure out what the number after the “e” means, one implication is a possible rise in the price of corn, a crop used to produce ethanol. Ethanol in this instance becomes a substitute to traditional gasoline, and a rule of substitutes states that as the price of good 1 increases, so too shall the price of its substitute good 2. As long as the cost to produce the substitute remains below the price of gasoline, then there is still demand for the substitute, and production of ethanol will continue. While that last bit is somewhat controversial these days, the theory still stands. Thus, as hard as it is to believe, movie theater popcorn prices can get more expensive should demand increase for corn production as a result from increased ethanol demand, in turn lifting overall prices for the crop.

It’s important to keep in mind that these relationships are on a wholesale level. Regionally, relationships can break down due to subsidies, weather patterns, or any variation of internalized factors. However, fundamentally speaking, energy prices can impact the bill you pay at your favorite restaurant just as they impact the bottom line of your business.

In closing: relationships tend to become tangled webs. What I’ve provided here is really just the tip of the iceberg of a dynamic network of interconnected parts. It is an important factor of any risk management strategy to recognize these relationships as the impacts of a movement in one area typically will be felt somewhere else. While many of these relationships are somewhat invisible to the naked eye (and, to be fair, many of them are ridiculous…e.g. gas prices and popcorn), it is crucial that we here at Summit keep in mind that they exist, as these relationships can play out in a very big way for our customers.

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