Purdue Report: Causes Of High Commodity Prices

US - Growing demand for corn to use in biofuels and for soybeans to help feed a booming Chinese economy are among key forces driving commodity prices higher this year, according to a report by three Purdue agricultural economists.
calendar icon 20 July 2011
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A weak US dollar, high oil prices, declining grain supplies and poor harvests in 2010 also contributed, they wrote in the report, which predicts that high prices will continue beyond the 2011 crop year.

The economists – Phil Abbott, Chris Hurt and Wally Tyner – detailed their findings in What's Driving Food Prices in 2011, commissioned by Farm Foundation, NFP, and released yesterday (19 July). Costs of commodities influence retail food prices as do general inflationary pressures such as transportation, packaging and food processing.

The report follows their analyses for Farm Foundation, NFP, in 2008 and 2009, when retail food prices also peaked.

For commodities prices in 2011, it comes down to world food and fuel demands exceeding supply in recent years.

"In the United States, we've typically had more grain and soybeans than we could use here," said Professor Chris Hurt, who specializes in grain and livestock markets. "Now we have to ask ourselves, can the US and the other major suppliers meet all these world demands?"

Corn use for ethanol represented 27 per cent of the 2010-11 crop usage, compared with 10 per cent of the 2005-06 crop. The growing demand for corn to make ethanol and China's increasing desire for soybeans have been two big "demand shocks" for agriculture, the report states.

"When you put them on top of each other, the price impacts are a lot bigger than either one separately," Professor Hurt said.

The amount of US farmland needed to meet those two surging demands has increased from 16.1 million acres in 2005 to 45.6 million acres in 2010, an increase of 189 per cent, according to the report. US agriculture met these demands in two ways, the economists said:

  • First, US farmers shifted land into producing corn and soybeans and out of other crops such as cotton, wheat and sorghum. As a result, prices for most other crops also rose.

  • Second, US stocks were used to the point where there is a minimum inventory of grains today to meet any production shortage. As a result, any weather threats to normal yields in 2011 will mean higher prices.

China's rapid economic growth is resulting in more demand as their consumers both buy more food and shift their food mix toward more animal products such as meat, milk and eggs, which require corn and soybeans to produce, said Professor Abbott, whose work focuses on international trade and agricultural development.

"However, we also found that about 40 per cent of the increase in Chinese soybean imports in recent years was due to increasing their inventories - building stocks," Professor Abbott said. "We believe they now have sufficient stocks levels, and that could slow their overall rate of growth of purchases in coming years."

That economic growth contributes to China's demand for soybeans, crude oil and other commodities, Professor Abbott said.

"The movement of agriculture into biofuels has now linked the oil market to the corn market and to agricultural markets in general," he said. "If oil is high-priced, this will tend to mean agricultural markets are high-priced as well. All of that is contributing to higher commodity prices in general."

The authors also noted that agricultural markets have become less responsive to price changes, leading to both high prices and greater volatility in prices. Most of the US corn used for ethanol is mandated by the government. The mandate requires that 12.6 billion gallons be blended into gasoline in 2011. It will increase to 15 billion by 2015.

That requirement creates what economists call an "inelastic" market.

"The amount of corn that it takes to produce that will be used in the US whether corn is $2 a bushel or $10 a bushel," Professor Tyner said. "That's pretty inflexible."

Other inflexibilities are coming from foreign buyers who want basic food commodities - almost regardless of price - and from the livestock sector, which now can afford to pay much higher prices for feed than just a few years ago.

High corn, soybean and fuel prices eventually make their way into higher retail meat prices, the economists noted. The animal industries suffered heavy financial losses in 2008-09 when producers began to reduce herds and flocks after feed costs escalated and a world recession set in. That reduction in meat supplies forced retail prices up in 2010 and now to record-high retail prices for beef and pork in 2011.

Ethanol production has grown rapidly the past five years, but the rate of growth in mandated levels is beginning to slow, the authors said. This means that the demand base that has built up will persist but will not grow as quickly in the next few years.

Looking to the future, they say a slowing rate of growth in both corn use for ethanol and in soybean purchases by China could provide a better chance for world grain supplies to catch up to slowing demand surges.

"But it's unlikely that we will go back to having huge surpluses because that demand base remains so strong," Professor Hurt said.

The full report is available by clicking here.

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