One of the many important changes in the new global economic system is the renaissance of agriculture. Once thought of as an outdated, inefficient sector propped are by politically motivated subsidies, agriculture has returned to favor as an activity which is rightly recognised as one of the key preconditions for our subsistence. No society can thrive without adequate access to food and water. The global food crisis of 2007-2008, which led to riots in the streets and triggered a trade war, should have reminded us of the ultimate fragility of the global economic system in the face of weather-related disturbances. Problematically, the crisis ultimately passed and was dismissed by too many people as a temporary aberration.
The myopia inherent in that complacency is now being revealed as agricultural commodities are once again becoming front page due to mounting anxiety over a string of supply shocks. The previous optimism about the current growing season had to be abandoned in the early summer when the supply situation in Russia and Eastern Europe was disrupted by adverse weather conditions. More recently, it has become clear that such problems were not isolated but have in fact affected a number of agricultural commodities and geographies. As a result, the rapid food price inflation triggered by the Russian problems is continuing and potentially gathering steam.
The latest act in the drama of what is now threatening to turn into a global food crisis was triggered by the US Department of Agriculture warning of “dramatically” lower supplies of key staples on 8 October. Having previously projected a record corn crop this year, USDA was forced to reduce its estimate by 4 per cent to 12.7bn bushels. Although this figure, if met, would still make 2010/11 the third-best harvest season on record, it triggered a market reaction close to panic because of the highly dynamic demand side. Indeed, USDA issued a warning that under current trends, US corn stocks would halve to their lowest level in 14 years, some 900m bushels. In response, corn prices surged by 15 per cent within two days and the Reuters-Jefferies CRB commodities index rose to a two-year high. Also the outlook for wheat and soybean has become less favorable.
The same picture applies to a number of agricultural commodities with varying degrees of severity. Cotton prices are amidst an unprecedented boon as China and India – the two leading markets – have had bad harvests, in response to which China ramped up imports and India capped exports. Weather conditions in Latin America are threatening the global coffee crop while US stockpiles stand at a 10-year low. The higher grain prices are in turn creating pressures elsewhere, most notably for livestock given the widespread use of many grains as fodder. Here the situation is further complicated by sharp cuts in headcount following the cost pressures created by the previous soft commodity boom of 2007-2008.
Supply side trouble. It is clear that, as much as longer-term structural pressures have been building up in the commodity space for some time, the latest flash of food price inflation is due to a sudden, unexpected deterioration of supply conditions. Weather-related disturbances have been especially important, with the key grain producers Russia and the US hit by exceptionally hot and dry weather, whereas Canada and parts of Europe have been inundated by excessive rain. Also Brazilian crops have been adversely affected by poor weather conditions and the Indian and Pakistani cotton crops were decimated by severe flooding during the monsoon.
These developments highlight the vulnerability of the global supply chains to shocks. Near-term relief is impossible because of the length of the growing cycle, which in the case of cotton lasts up to 18 months. The supply restrictions have in turn prompted many buyers to engage in stockpiling and strategic or speculative purchases, thereby amplifying market stress. The great concern under the circumstances is that the hardest-hit producers will respond to the situation through export restrictions. Some key wheat producers, notably Russia and Ukraine, have already done so. Vietnam and Brazil, which account for almost half of global coffee production, are understood to be considering export restrictions. Nor are there guarantees that the eventual supply response will bring much relief. Grains can only really increase their acreage at the expense of other crops and the production of bio-fuels in many countries benefits from generous subsidies. In the US, there are plans to further increase the amount of ethanol than can be mixed with gasoline from 10 per cent to 15 per cent.
A demand revolution. While the supply shocks are temporary in nature, their impact has become increasingly disruptive because of the structural drivers underpinning the demand for agricultural products. In many ways, the soft commodities market now appears to be matching the trends seen in other commodities: increasing ‘financialisation’ along with the volatility this entails and rapid growth of emerging market demand. Investor interest in soft commodities has grown and is underpinned both by a favorable liquidity situation and poor returns from more traditional assets, such as bonds. But the main driver seems to be the dynamism of especially the Asian emerging economies, where demand is supported by a combination of rapid population growth and increasing prosperity. This in turn in transforming tastes, with grains and vegetables increasingly giving way to typically much more resource-intensive meat. For instance China, which was self-sufficient in corn until recently, is becoming an increasingly important corn importer, not least because of the growing use of corn to fatten livestock but also due to harvest failures. This leaves the US, the world’s leading producer with a 55 per cent share of exports, in a pivotal position.
Troubling news for the Gulf. The renewed price pressures in the soft commodity space leave the GCC economies directly exposed. They typically import 70-100 per cent of key foodstuffs, which suggests a potentially significant impact on their import bill. More problematically, as in 2007-2008, the GCC faces an acute quantity risk in the event that exporters decide to limit sales. As during the previous commodity boom, this presents a credible prospect of additional inflationary pressures at a time when price pressures are climbing virtually across the region. Problematically, the regional monetary policy-makers will have few instruments to respond to the situation, not only because of the Dollar pegs and the low interest rates they entail but more fundamentally because of the ineffectiveness of monetary tightening in the face of supply shocks
Email the writer:
j.kotilaine@alrroya.com
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