Fears of a global food crisis that dominated news headlines barely six months ago have quickly dissipated, with global grain prices having fallen more than 50 per cent from their record highs earlier this year. We believe the depressed prices are temporary, however. Stocks are low by historical standards and any fall in production if farmers cut back on plantings will make for continued volatility in agricultural commodity markets.
In May 2008 our trusted source, a grains economist at the UN Food and Agriculture Organisation, argued that the price increase last year was due primarily to short-term production constraints and that supply responses would rapidly result in a decline in prices. Indeed, world cereals output is expected to reach a record in 2008 as high prices have boosted plantings. However, the collapse in cereals prices, continued high input prices and credit stringency have set the stage for a new round of supply shortfalls and higher prices that could come as soon as next year.
Concerns about a food crisis earlier this year were overblown. World cereals production will increase 5.3 per cent this year to 2.2 billion tonnes on the back of favourable weather conditions in key growing areas and expanded production as farmers have responded to higher prices. Wheat harvests are at record levels in Europe (Russia has had its best harvest in decades), North America and Australasia, and the outlook for winter plantings continues to look favourable. As a result, prices have fallen sharply from their highs in the first half of this year (see chart below).
Almost all the increase in cereals production in the 2007/08 crop year has come from developed countries, where farmers had the resources to quickly increase plantings in response to the higher world prices. In contrast, underinvestment in agriculture in developing countries left farmers struggling to boost output.
Record cereals production in 2008 has helped raise global stocks from their lows last year. However, stocks are still relatively low and will be quickly drawn down should there be any decline in production in 2009.
In its November 2008 “Food Outlook”, the UN Food and Agriculture Organisation (FAO) notes that the rapid rise in prices in 2007 and early 2008 came despite a record cereals crop last year. The main factor behind the price increases was the reduction in supplies in some key exporting countries that experienced smaller-than-expected harvests due to adverse weather conditions and the imposition of export restrictions by other exporters. In this regard, the market remains vulnerable if prices stay low and plantings decline next year. The relatively low level of stocks held by major cereals exporters highlights this vulnerability. The cereal stocks-to-use ratio is at its second-lowest level in 30 years. Only China has significant stocks, especially of soybeans, which it accumulated in advance of this summer’s Olympic Games.
As prices have fallen, so has concern about the food crisis. The food riots that convulsed developing countries from the Caribbean to Africa earlier this year have largely subsided. The alarms raised by UN officials, politicians and the media look more than a little bit like too much ado about not so much. To be sure, the FAO has identified 36 countries that are in dire need of international assistance because of high prices or crop failures, and the cost of the food import basket for developing countries is still expected to be 40 per cent above 2007 levels. Yet in the current environment of rapidly slowing global growth worries about agricultural commodity shortages no longer compel mainstream attention.
However, there are indications that lower prices and lack of availability of credit will affect plantings in key producers next year. In agricultural commodities powerhouse Brazil, the Ministry of Agriculture projects that grain and oilseed production in the 2008/09 harvest will be lower than in the previous year, mainly as a result of lower productivity as cash-strapped farmers have been forced to reduce fertiliser consumption. Output per hectare is expected to contract by 4 per cent in the main centre-west producing area and 7 per cent in northern Brazil.
The credit crunch is also affecting farmers’ crop choices. Brazil’s corn crop is likely to fall by as much as 7 per cent as farmers opt to produce more soy, which requires fewer inputs and less upfront investment. Nonetheless, Brazil’s soy crop is expected to fall as much as 2.7 per cent year on year.
Farmers in other key producing areas are likewise expected to suffer from the lack of availability of credit. In Russia agricultural loan rates have increased significantly, and that country’s financial crisis will further limit credit in future. In the US, the world’s largest cereals producer, farmers who invested heavily to expand production last year are now facing a significant drop in demand for their crops. Demand for US corn and wheat has been hit by declining biofuel demand as oil prices have dropped and by increased competition from low-cost producers in Russia, the Black Sea region and North Africa. The more than 90 per cent drop in international freight rates this year has also contributed to a relative decline in US farmers’ competitiveness: it is now cheaper to ship Russian grains to the US east coast than to source them from the US midwest.
Corn producers, many of whom locked in fertiliser prices at high levels but did not lock in corn prices, will be particularly hard hit. The quarterly survey of farm credit conditions by the Federal Reserve Bank of Kansas City warned that lenders were increasing collateral requirements and tightening credit standards. According to the US Grains Council, US farmers could stand to lose US$200/acre cultivating corn next year.
Abdolreza Abbassian, senior grains analyst; Secretary, Intergovernmental Group for Grains, UN FAO
Earlier this year, policymakers and commentators considered the soaring prices of agricultural commodities in international markets as a prelude to a global food crisis. While it may be fair to say that there was no global food crisis in the same scale as the one in the mid-1970s, several countries, many of them poor, experienced escalating domestic food prices as a result of a temporary shortfall in cereals supply caused by a drop in production in major exporting countries. The imposition of export bans or taxes in key producing countries also drove the surge in prices.
The market remains tight
The current fall in prices as a result of the global economic deceleration is much sharper than anyone anticipated. A decline in plantings in developed countries combined with a drop in financial assistance to support increased agricultural production in developing countries could set the stage for a price surge that is much faster than the previous one. That run-up in prices could come as soon as the 2009/10 season.
The bulk of the supply response in cereals production came from the US, Australia, Europe and Canada, which together increased production by 10 per cent in 2008. Farmers wanted to cash in on the high prices, but because they all simultaneously boosted output crop prices across the board now face downward pressure.
At the same time, demand growth is expected to remain positive even as the world economy decelerates sharply – demand for food typically is a function of population growth, urbanisation and incomes and increases from one year to the next. India and China will continue to grow, albeit much slower than previously anticipated. One question mark is biofuel demand in 2009 in an environment of significantly lower oil prices; much will depend on US ethanol policy. Forecast global demand does not support the current low prices. We never expected to see corn at below $4 a bushel or wheat at less than $8 a bushel.
There exists a very high probability of a fall in grains production in 2009 compared to 2008. Developed country farmers will find it difficult to maintain 2008 levels of plantings going into next year given the current depressed agricultural commodity prices. Many US farmers have suffered and in Europe there are indications that the winter wheat harvest could be down as much as 2 per cent. Another factor is the weather. Conditions have been favourable for two years in a row, setting the stage for record crops, but we would need now to assume a third year of good weather, the likelihood of which remains uncertain. It should be noted that rice will remain an exception to this trend and could instead continue to fall further in price. Rice is thinly traded and is basically a food that is produced where it is consumed. The amount of rice traded is expected to fall in 2009 as importers find it difficult to obtain necessary trade credits.
The credit crunch and production
In the agricultural system credit is important but not decisive in determining production capacity – other factors include the cost of inputs including oil and fertiliser. Therefore the credit crunch most affects those farmers who already have access to credit. The lack of credit is more important for developed country farmers in the US, Australia, the CIS, Brazil and Argentina. Developing country farmers will continue to find it difficult to increase production given the higher prices of agricultural inputs relative to product prices and continued inability to access credit. Meanwhile, land and water constraints still need to be addressed and investment in agricultural extension, research and rural infrastructure remains low.
Even a small decline in grain plantings would result in a drop in production (that in turn may or may not be exacerbated by weather conditions) and a heavy drawdown in stocks in 2009/10. Despite an increase in stocks this year they remain low, and it would require another major production increase in 2009 to return cereals stocks to more comfortable levels. If world cereals production does not increase, or even remains steady at the record level of 2008, the result will be a repeat of the shortages and price rises of 2007 in 2009. At current prices some farmers will be forced to diversify their crops; some may cut plantings. If production declines in 2009, the chances of exceeding this year’s price increases are high.
The problem is a lack of necessary investment to boost productivity, particularly in developing countries. We have been adding to the uses of agricultural commodities without looking at supply, saying that the market will take care of it. Low prices will discourage investment in the developed world, volatility will return to the market forcing producing countries to reimpose bans or restrictions on exports. Looking out longer-term, agricultural commodity prices will remain higher than historical levels even if there is a significant downward revision to economic growth for the next couple of years.
Lower agricultural commodity prices will cause farmers to reassess their planting strategies for the 2009/10 season. As our trusted source points out, decreased profitability, high input costs and lack of credit availability pave the way for a significant drop in cereals planting and production as early as 2009. The lack of investment will cut production growth at a time when inventories remain at historically low levels. Any significant decline in production will put pressure on inventories and drive up prices again.
Farmers who invested heavily in expanding production and failed to lock in crop prices will suffer, as will less efficient producers who may be forced out of business. Those companies that survive – the bigger producers with better access to credit – will be well positioned to benefit when prices rebound. The biggest uncertainties for the grains market will continue to be the weather in key growing areas and farm input prices, which have been “stickier” than crop prices: will they decline enough to mitigate some of the impact of credit stringency?
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