Supply & Demand Forces behind Food Commodity prices: During boom and bust
Thanks to my involvement last month in devising an enterprise application strategy for a food supply chain major – experience is detailed here and here - I had the opportunity to understand the food commodity market a lot better. And like any other market, the forces of Demand and Supply are much at play to decide the market price equilibrium. Let’s look at those forces on the back-drop of the unprecedented food prices last year and then see the impact of recession on these forces. A run-down on the demand forces at play first:
If surging population is the time immemorial cause, high crude prices was the flavor of last year. The spiraling crude prices increased the input cost via high fuel cost for farm equipments & high fertilizer cost. Farmers had no choice but to pass-on the cost to the consumers. Also, the controversial bio-fuels (food vs fuel debate) had a prime role to play. Agricultural commodities, used till now for food, feed and fiber now had to contend with this new demand source.
While the above demand factors are fairly well-known, the following “money-market” factors are relatively less broadcasted. The growing commodity based financial fund indexes added the “hype-fuel” to this price inflation. With growing investor base pumping in liquidity leading to speculative positions, the markets can be blamed for the short-term volatility in the price. Additionally, the slow depreciation of the US dollar till mid of 2008 against currencies of developing nations resulted in relatively cheaper food prices outside the dollar economy; thus fueling demand in the emerging economies. The growing demand was satiated by these economies by indulging in global bidding wars using the huge foreign exchange reserves they had accumulated. Naturally, prices had to rise.“Okay, agreed that the above factors convey that the demand was genuinely there, but what was happening on the supply scene – didn’t supply respond appropriately to reign in the prices”, would the logical-mind ask. I fear not. The slower growth in arable land under cultivation as compared to population growth, the declining growth rate in crop yield and the climate changes due to global warming had put immense pressure on the Supply scene.
“But what about inventory – wouldn’t the stock-in-hand cushion the increased demand and supply pressure”, asked the skeptical-mind. Again, I fear not. The global demand has grown at a rate faster than the supply growth for close to a decade now resulting in an eroding inventory stock. As a result, inventory for wheat is estimated to be at its 60 year low, ditto for rice and for corn with inventory at a 40 year low and a 20 year low respectively.
Finally, how has the recession impacted the scene? Obviously the demand forces have eased to such an extent that world prices have taken a nose-dive from their peak in early-mid 2008: rice by 50%, wheat by 30% and milk by a huge 54%. The lower energy prices have also contributed by slashing the production cost (predictions released by EuroMonitor International Trend Watch is a good concise read). Will reduced demand lead to the much needed inventory build-up? I am afraid not unless investment in agricultural R&D is increased substantially to arrest & reverse the decline in crop yield. With arable land already at a premium, increasing farm productivity is a dire necessity else the supply forces are bound to hamper the next growth cycle!!
