July 24, 2008

Oil, weak dollar biggest driver in food costs

A Farm Foundation study written by three economists at Purdue University offers an interesting look at the the forces driving food prices. The study, “What’s Driving Food Prices?”, is available here. If you have a few minutes, the audio report by the report's lead author Wally Tyner is a good listen.

Tyner noted that in the 2004 to early 2008 period, oil prices went from $40 to $120 a barrel, while corn went from about $2 to $6 a bushel. He said 75 percent of that increase in corn price was due to high oil prices, while only 25 percent was due to an ethanol subsidy. He noted, though, that the subsidy was important and essential for development of the ethanol industry and that in recent times it has not been as nearly an important driver in corn prices as has oil.

In the report, Tyner said removing the subsidy would not return corn prices to those seen over the past decade - unless crude oil prices fell as well.

Interestingly, the study does not attribute growth in demand for grains by India or China as a driver in higher grain and food prices. Tyner said although demand is increasing in those countries, their production is also growing, as both countries would like to be self sufficient in these areas. He said China and India don't trade ag commodities to any great degree, especially corn or wheat, so their impact is minimal. China's demand for oil, however, does impact the oil markets.

As for the weak dollar, the study said the dollar's decline over the last few years has been an important factor in overall higher prices. The analysis "clearly shows" the historic links and how they have differed from one period to another depending on what else was going on in the global economy, the study said. "Oil, agricultural commodities and most other commodities are priced in U.S. dollars but are purchased in the local currency. So when the U.S. dollar falls as it has over the past six years, there must be a link with commodity prices," it said.

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