Food Inflation Perks Up With BioFuels
Corinne Alexander, Assistant Professor and Chris Hurt, Professor
Using crops for fuel creates concerns over competition with food uses and raises the question of how far along that path the U.S. can move. The answer is complex and involves many U.S. and world food and energy markets. This includes not only the amount of crops that can be converted to biofuels, but the ability of the world's crop producers to increase supply. In addition, new technology and governmental energy policies regarding biofuels will be critical as well.
The purpose of this article is to examine how food prices may be impacted by the current biofuels surge. How much of an increase in food prices might be expected? Some have predicted dire consequences resulting in food shortages in parts of the world and surging food prices. Others, particularly those in crop production and the biofuels industry argue that with technologic advancements they can continue to be reliable suppliers of food while also providing a growing portion of the world's fuel.
A starting point is to review the historical record. The previous boom in crop values was in the 1970's. At that time, food prices exceeded the general inflation rate in the early stages of the inflationary period. As shown in Figure 1, food inflation exceeded the general inflation rate in 1972, 1973, and 1974 by an average of 3.5 percentage points. For these three years, the general inflation rate averaged 6.8 percent per year with food inflation leading the general inflation rate at 10.3 percent annually on average.
During the disinflation period from 1980 to 1982, food prices tended to lead the downward general inflation path. Annual average food inflation was 6.8 percent compared to a ten percent general inflation, a 3.2 percentage point lower inflation impact. Interestingly since that time, annual food inflation has not registered more than a 2.0 percentage point difference from the general inflation rate. In fact in the last ten years, 1997 to 2006, average annual food inflation at 2.5 percent has been very close to the general inflation rate of 2.6 percent.
Less Impact on Consumers Today
The primary impact on food inflation from biofuels is from increases in the farm level values of the raw materials that go into producing our food supply. There are several reasons why a given increase in farm level prices will not have as large of an impact on consumer food prices as the early 1970's. First, the farmers' share of the consumers' food dollar has gone down. In the three years prior to the rapid food inflation, 1969-1971, the farmers' share of the consumer food dollar was 32 percent according to USDA. For the three years of rapid food inflation, 1972-1974, that rose to 35 percent. Today, the farmers' share of the retail food dollar is down to only 20 percent.
Second, the importance of food and beverages in the weighting of the Consumer Price Index (CPI) is smaller. Exact data for the early 1970's could not be found, but was 18.3 percent in 1980. Thus food may have been weighted around 19 percent in the early 1970's. Today the weighting for the "food and beverages" category in the CPI is only 15.0 percent.
These two factors alone are substantial. This is illustrated in Table 1 which compares the impact of a 40 percent increase in farm level prices in the early 1970's (1969-1971) with the same farm level impact today (2004-2006) given the smaller farmers' share and smaller weighting of food in the Consumer Price Index (CPI). In the early 1970's, a 40 percent rise in farm level prices would result in a 12.8 percent increase in food inflation, and a 2.43 percent rise in general inflation. Today, the same 40 percent increase in farm level prices would only result in an 8 percent rise in food inflation and a modest 1.2 percent rise in general inflation.
In addition, the world is more global today. This means greater geographic diversification of crop and food production such that it may be more difficult, for say a drought, in the U.S. to have that hypothetical 40 percent price impact on farm level prices. This is illustrated in Table 2. Compared to the early 1970's (1972-1974), the portion of the world's corn, soybeans, and wheat raised in the U.S. has declined. In addition the portion of food we import has increased in importance from about ten percent of U.S. farm production receipts in the early 1970's to over 25 percent in recent years (2004-2006).
What We Know So Far
In the past two years food inflation has been lower than the general inflation rate. The average general inflation rate for 2005 and 2006 was 3.3 percent and the average annual food inflation rate was just 2.4 percent, nearly one percentage point lower. Thus food has helped moderate the general inflation rate for the past two years. However, that has changed in 2007 as food inflation has turned higher and moved well above general inflation. Over the last year, grocery store prices, shown as "food at home" in Figure 2, rose almost 4.5 percent between May 2006 and May 2007, more than double the 2006 inflation rate for that category. This food price increase is well above the 1995-2005 average annual food and beverage retail price increase of 2.5 percent and above the non-food inflation rate of about 2.5 percent. The USDA estimates that grocery store price increases will be in the 3 percent to 4 percent range for the rest of 2007, which is approaching twice the rate of core inflation. Restaurant prices ("Food Away" in Figure 2) are expected to increase at 3-3.5 percent for the rest of 2007, a slower pace than food at home because farm level commodities are a much smaller share of the restaurant expenditures compared with grocery store expenditures.
Rising prices over the last 12 months have been lead by 3 different food categories: fruits and vegetables, wheat products including bread, spaghetti and flour, and eggs. The cause of these price increases differs for each category. In the case of fruits and vegetables (typically the food category with the most volatile prices), price increases are the result of lower planted acreage, a January freeze in California, a cold wet February in Florida, and early spring weather damage in Mexico. In addition, honeybee colonies are threatened which may result in inadequate pollination for fruit and nut trees and vegetables such as melons, cucumbers, pumpkins and squash. These factors cannot be blamed on the biofuels demand surge.
In the case of bakery products and other wheat products, price increases are the result of higher wheat prices due to very tight U.S. and world wheat supplies that resulted from poor 2006 wheat crops in the U.S., Canada and Australia. The 2007 U.S. crop was also impacted by excess moisture in the Great Plains region. Looking forward, wheat prices will likely remain elevated in order to compete with corn for acreage.
In the case of eggs, the recent dramatic price increases on the order of 20 to 30 percent are largely due to the higher price of corn. One reason the retail price of eggs is so influenced by the price of corn is that the farm share of the retail price of eggs is 53 percent, the highest of any food product. Other meat and poultry product prices will also be expected to increase over time as higher feed costs move toward consumers.
Food Inflation Outlook
There are two current studies that examine food inflation. The first is a study at The Center for Agricultural and Rural Development (CARD) at Iowa State University. This examines the impact of the biofuels surge on food prices. As with all studies, they have multiple assumptions that are critical to the results. They assume that corn prices move to $3.40 per bushel and soybean prices to $7.00 per bushel under a scenario of a 10 percent ethanol blend in gasoline by 2011. Results are for food inflation to be higher than they would have been without biofuels by 1.1 percent to 1.8 percent.
USDA has updated anticipated food inflation for 2007. This update is simply based on what may happen to food prices for the calendar year of 2007. It does not make any attempt to identify how food inflation is tied to biofuels. In this update, USDA now estimates food inflation in the U.S. will be three to four percent in 2007 and that is up from an annual inflation rate of 2.4 percent in 2006. Thus, this reflects an increase from 0.6 percent to 1.6 percent higher than in 2006.
We will add our evaluation of the impacts of higher farm prices on food prices. This analysis uses limited modeling, but assumes that the increased demand for biofuels is reflected in prices of basic grain and food commodities. This is particularly true on increases in corn, soybean oil, soybean meal, and wheat prices. These increased costs of basic commodities are assumed to be passed upward through the food system over time. In inflation terminology this is often called "cost-push" inflation. That is to say that some outside force causes grain prices to rise, and over time those higher prices go through the marketing system to food consumers. We assume the costs-push is dollar-for-dollar such that each $1 increase in a basic grain value is pushed through to consumers as a $1 increase in retail food costs. Price levels used for corn, soybeans, wheat, and soy products are shown in Table 3.
As a final summary of our methodology, we use the price and quantities from the May 11, 2007 USDA Agricultural Supply and Demand Estimates and use the 2005/2006 marketing year as a base for comparison. Estimates of the higher commodity food costs for the 2006/07 marketing year and the 2007/2008 marketing year are compared to 2005/2006. Finally, a drought scenario reflecting approximately a five percent reduction in average U.S. crop yields is examined as well for the 2007/2008 marketing year.
The estimated impacts on food prices are illustrated in Table 4 and are allocated to various food subgroups. For 2006/2007, the total estimated impact on food costs is an additional increase of about $15 billion or an additional 1.2 percent compared to 2005/2006. For 2007/2008, food costs would rise by an additional $22 billion or 1.8 percent compared to the 2005/2006 base year. The composition of these increases is also important as nearly 50 percent of the food impact is in the animal sector.
If a weather event were to reduce national production of primary crops by five percent for the 2007 crops, the estimated impact on basic crop prices is for the farm level value to increase from 30 to 35 percent compared to a normal yield. That magnitude of price increase is very large reflecting the current tight U.S. and world stocks situation such that even small reductions in production would stimulate much higher farm level prices.
Under the five percent reduced production scenario, estimated food prices would rise by an additional $39 billion representing an additional 3.3 percent increase over 2005/2006 food expenditure.
Summary: Biofuels Will Add to Food Inflation
The dramatic increase in the use of crops for fuel is going to increase food prices, at least for the next several years. The magnitude of that increase however, may not be as large as some expect. Probably the three most important reasons why the impact will not be as large as in past years are: 1.) the share of the retail food dollar contributed by the farm level commodity value has been sharply reduced to just 20 percent today; 2.) the importance of food in consumer budgets has continued to drop such that the "food and beverage" category in the Consumer Price Index (CPI) is now weighted at just 15 percent; and 3.) the sources of our food are more global and diverse than in the past.
Retail level food prices are expected to increase an additional 1.2 percent to 1.8 percent above their 2006 level due to higher farm-level grain and commodity prices partially attributable to the use of grains and oilseeds for biofuels. This will roughly parallel the calendar years of 2007 and 2008. This analysis is based upon the assumption that higher farm-level commodity prices are eventually passed to retail food consumers. Our assumption is that transferal is dollar for dollar. Not all of the current increased food inflation is attributable to increased use of crops for energy, as poor weather conditions have also contributed to poor world wheat crops in 2006, and to losses of some fruit and vegetable production in 2007.
For the past two calendar years of 2005 and 2006, food inflation at 2.4 percent had been lower than the general inflation rate of 3.3 percent for the Consumer Price Index (CPI-U). For 2007 and 2008, food inflation is expected to increase and fall in a range from 3.5 percent to 4.5 percent. This means food inflation may outpace the general inflation rate which is expected to be about 3.2 percent in 2007 according to economists surveyed by the Philadelphia Federal Reserve Bank (http://www.phil.frb.org/files/spf/survq207.html).
Nearly one-half of the additional increase in food inflation will be experienced by the animal production sector. Meat, dairy, and poultry producers will experience higher costs feed. In the short-run, these producers will absorb much of the higher costs through reduced returns. However, over time as aggregate supplies of these products decline, higher feed costs will move through the food marketing system to retail consumers. The length of time for this adjustment can be fairly short for eggs, and multiple years for pork and beef.
The total additional costs of retail food is estimated at $22 billion per year based on estimates for farm level grain prices for the 2007 crops compared to the very low valued 2005 crops. While it was not the objective of this study to sort out what portion of the 2007 crop price increases were due to biofuels, the dominant portion of corn and soybean price increase are, while wheat prices have also been impacted by adverse weather.
What if a poor growing season were to reduce U.S. crop production by five percent in 2007? The impact on food prices would be to push them up $39 billion above their 2006 level, or an additional inflationary pressure of 3.3 percent. This means annual 2008 estimated food inflation might increase to 5.7 percent.
In the long run, food will be able to compete successfully with the use of crops for fuel, but with higher food prices. The magnitude of that impact will depend on the ability of the world's crop producers to expand ouput, energy and biofuels technology, and global energy policy. Policy makers examining various biofuels alternatives are encouraged to consider broader implications including the impact on consumer food budgets.
References
Food Costs Review: 1950-1997. AER #780. Economic Research Service, USDA, June 1999.
Leibtag, Ephraim. "Food Price Outlook, 2007." USDA. ERS, May 21, 2007 at http://www.ers.usda.gov/Briefing/CPIFoodAndExpenditures/consumerpriceindex.htm
Light, Jerry and Thomas Shevlin. "The 1996 Grain Price Shock: How Did it Affect Food Inflation?" Monthly Labor Review. Bureau of Labor Statistics, U.S. Department of Labor, August 1998.
Tokgoz, Simla, Amani Elobeid, et al. Emerging Biofuels: Outlook of Effects on U.S. Grain, Oilseed, and Livestock Markets." Staff report 07-SR 101, Center for Agricultural and rural Development, Iowa State University, May 2007. http://www.card.iastate.edu/publications/synopsis.aspx?id=1050
Understanding the Impact of Higher Corn Prices on Consumer Food Prices. National Corn Growers Commissioned Study. March 2007. http://www.ncga.com/ethanol/pdfs/2007/FoodCornPrices.pdf
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