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Assessing the Main Drivers of Market Uncertainties

Against the background depicted previously, the debate on food security and its repercussions for agriculture assumed, and continue to assume, a different twist based on the weight different observers place on the perceived causes of price developments. For example, looking solely at the evolution of agricultural prices, one would tend to identify a clear reversal in the long-term downward trend in agricultural prices occurring after 2000 which, when seen in isolation from other price developments, would tend to have a clear policy implication—market price signals should lead farmers to production decisions that would appropriately respond to market and policy challenges, and in the process correct any short-term market failures.

Yet observing the same figures by looking at the parallel movement of prices in the markets for fertilisers, energy, and metals and minerals provides a different picture. When seen from this angle, it becomes evident that three distinct features characterised commodity price movements during the recent decade: higher volatility, significant price co-movement, and a higher price level for all commodity price indexes. And while it is true that price volatility and price comovement, which initially led the debate on the causes of price developments, seem to be on the decline, agricultural prices continue to remain high compared to their pre-2005 level (Fig. 2.2), raising questions about their future level.

In search for explanations for these developments, alternative approaches were proposed, most of which were unidimensional in terms of the single factor causing price movements. The first and most prominent among these, especially at the early stages of the debate (spring 2008), was the previously mentioned association of the agricultural price boom to strong global population and income growth in emerging economies, especially in China and India, which has been often cited as the key driver of the past decade’s food and other commodity price increases (and the slowdown in world growth as the explanation of the recent bust).

Trends in monthly commodity prices (nominal). Source

Fig. 2.2 Trends in monthly commodity prices (nominal). Source: World Bank

Krugman (2008) argued that the upward pressure on grain prices is due to the growing number of people in emerging economies, especially China, who are becoming wealthy enough to emulate Western diets. Likewise, Wolf (2008) concluded that strong income growth by China, India, and other emerging economies, which boosted demand for food commodities, was the key factor behind the post-2007 increases in food prices. In a similar fashion, the June 2009 issue of National Geographic, the first in an eight-month series exploring the Future of Food, noted that the demand for grains has increased because people in countries like China and India have prospered and moved up the food ladder. Other authors have mentioned income growth as the main price driver well (see, for example, Hochman et al. 2011 and Roberts and Schlenker 2013).

That strong income and population growth led prices to rise is selfevident. The impressive increase of Chinese gross domestic product (GDP), both when compared to the GDP of major developed countries and growth in the other BRIC countries (Brazil, Russia, India and China) (Graphs 3 and 4), played its role in the increase of farm commodity prices through increases in demand, and not just in China and India. But was this the stronger factor, and did it influence the process in isolation from the impact of other factors?

In fact, the period characterised by high price volatility is also one characterised by low interest rates. This led to a more complex interaction of macroeconomic variables on GDP growth across the globe, among others via the depreciation of the US dollar, which led prices to rise since these prices were mainly expressed in US currency (the inverse is also evident in the more recent generalised price decline, which coincides with a stronger dollar) (Figs. 2.3 and 2.4).

Interestingly enough, the same world price expressed in US dollars is translated in a very different way in local currency. Figure 2.5 depicts this differential impact of exchange rates on the effective world market price seen by domestic producers with the world (US Gulf) price of maize as an example. (Of course, border measures also apply, but they do so also after the exchange rate is taken into account).

GDP growth—major economies. Source

Fig. 2.3 GDP growth—major economies. Source: World Bank

GDP growth—BRICs. Source

Fig. 2.4 GDP growth—BRICs. Source: World Bank

Despite continuing references to the alleged impact of income growth on food demand and thus food prices, it gradually became evident that there was an apparent contradiction in such expectations, and that the undeniable increase in global food demand was not necessarily changing faster than previously thought. Alexandratos (2008) concluded that

Maize price expressed in local currency (nominal). Source

Fig. 2.5 Maize price expressed in local currency (nominal). Source: Author's calculations based on World Bank data

China’s and India’s combined average annual increase in grain consumption was smaller in 2002—08 than in 1995—2001.

Similar findings have been reported in the briefs of the European Commission (2015) , which provide detailed information on developments in demand, supply, and prices of major agricultural commodities during different periods and regions of the world since 1960, and by Alexandratos and Bruinsma (2012), Baffes and Haniotis (2010), Sarris (2010), the Food and Agriculture Organization of the United Nations (2008 and 2009), and Lustig (2008). Deaton and Dreze (2008) noted that in India, despite growing incomes, caloric intake has followed a downward trend since the early 1990s.

But the continuous and at times explosive increase in price levels, not only in agricultural but also in all other commodities, brought then another source of possible explanation, linking the discussion to a ‘supercycle’ in commodities. The impact from ‘financialisation’, that is from the transformation of commodities into asset values, focused the discussion on market failures, real or perceived, which were exacerbated by the result of the financial crisis (Baffes and Haniotis 2010).

Yet another approach, forgotten for some time due to market developments in the late 1990s, came back with vengeance and linked what was happening in prices to changes in stocks (Wright 2012). Such changes, it was claimed, should be explained not as a result of market failure but as a sign of markets playing their role, especially since the decline in stocks in grains was pretty significant.

This was the case for wheat (Fig. 2.6) and rice, but maize in particular was the focus of much attention (Fig. 2.7) as the growth in biofuels throughout the past decade (mainly maize for ethanol in the USA) dominated the debate in the early stages of the boom.

Wheat stock-to-use ratio and wheat price. Source

Fig. 2.6 Wheat stock-to-use ratio and wheat price. Source: USDA for stocks- to-use, World Bank for whet price (No 1 HRW Gulf ports)

Maize stock-to-use ratio and maize price. Source

Fig. 2.7 Maize stock-to-use ratio and maize price. Source: USDA for stocks- to-use, World Bank for price (No 2 yellow, Gulf ports)

This created the tendency for many to attribute to biofuels a disproportionate role in the increase of agricultural prices, especially in the early stages of growth in mandate-driven maize-based ethanol (De Gorter and Just 2009). And although the explosive growth in the USA seems to have come to a plateau, the debate about the impact of biofuels on land use and the food versus fuel debate will certainly persist in the future. That the significant increase in the use of feedstuff for biofuels, driven by policy mandates, had an inevitable impact on market balance for cereals is evident also from Fig. 2.8, which depicts total changes in wheat and coarse grain demand among main players during 2005-14. Yet the figure shows that this was essentially a coarse grains (mainly maize) story, almost equally split between growth in Chinese demand (essentially for feed) and US demand for biofuels.

During this period, total demand for wheat in the largest developed and emerging economies, the USA, European Union (EU), China, and India, increased by 38 million metric tonnes, a rather moderate figure that also explains why stocks in wheat recovered faster than in maize. From this increase, China accounts for two thirds, essentially all for feed, in sharp contrast with India, where essentially all increase was for food. Total demand in the EU declined (due to feed decline), thus counterbalancing the increase in the USA (for food). In coarse grains, global demand grew by 160 million metric tonnes, 90 million of which

Changes in cereal demand 2005-14. Source

Fig. 2.8 Changes in cereal demand 2005-14. Source: Author's calculations based on OECD data come from US industrial demand (essentially for biofuels). In feed demand, though, the increase in China (57 million metric tonnes) is to some degree mitigated by the decrease in US feed (21 million metric tonnes).

Overall, patterns of growth in world food demand exhibit a rather diverse picture, as annual growth rates in the demand for major food commodity groups demonstrate (Figs. 2.9, 2.10, 2.11, and 2.12).

The above figures lead to one counterintuitive (at least with respect to popular press beliefs) conclusion. The main pressure on world food demand does not seem to stem from meat consumption, whose pat-

World grain consumption patterns

Fig. 2.9 World grain consumption patterns

World meat consumption patterns

Fig. 2.10 World meat consumption patterns

World milk consumption patterns

Fig. 2.11 World milk consumption patterns

World vegetable oil consumption patterns. Source

Fig. 2.12 World vegetable oil consumption patterns. Source: DG AGRI calculations based on FAO. The bubble size corresponds to the relative consumption size

tern of annual growth has been clearly declining over the years. More detailed analysis (European Commission 2015) demonstrates that the significant decline in beef consumption in the developed world, which is not compensated by increases in the developing world, led the annual rate of beef consumption growth to fall below the population growth rate. If meat consumption grows more than population, this is mainly due to poultry, the only meat whose consumption growth has increased in recent years (pork and poultry growth has also slowed down).

In the other product groups presented here, vegetable oil consumption remains very strong, and significantly above population growth, while a very strong pattern of milk consumption recovery (mainly in the form of dairy products) is also evident. So is the significant recovery in grain demand, a result of both food and feed demand growth, but not so much of biofuels after 2009.

As the focus on biofuel demand in both the USA and the EU drew attention to real versus perceived impacts on food, a less direct and more complex link of agriculture to energy markets also became apparent. In the early years of the commodity boom, US energy prices broke the link between crude oil and US natural gas prices, linking the latter directly to the price of coal (Fig. 2.13).

Although developments in 2015 led, to some degree, to the coupling again of these prices, the impact of lower US gas prices compared to both Europe or Asia (the result of shale technology) led the USA to reap the resulting energy premium with huge investment in energy-intensive

The diverging paths of energy prices. Source

Fig. 2.13 The diverging paths of energy prices. Source: World Bank

The diverging paths of gas prices. Source

Fig. 2.14 The diverging paths of gas prices. Source: World Bank

industries, based both on the direct energy cost benefit vis-a-vis its competitors and also on the indirect one linked to new investments in fertilisers (Fig. 2.14).

 
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