Ethanol: How Significant is it in Higher Food Prices & the World Food Crisis?

AgMRC Renewable Energy Newsletter
June 2008

  Robert Wisner
  Professor of Economics and Energy Economist
  Ag Marketing Resource Center, Iowa State University
  rwwisner@iastate.edu
  515-294-6310

 
U.S. food prices, while still a bargain when compared to other countries, have increased in recent months at the fastest rate in 17 years. In the international arena, rioting over limited rice supplies and extreme price increases have occurred in some southeastern Asian nations. Some in the U.S. as well as a recent World Bank report have indicated conversion of corn to ethanol is a primary cause of these situations. U.N. officials are beginning to speak of a global food crisis. Here are some perspectives on the impact of ethanol on both U.S. and world food prices.
 
World Food Perspective
 
The major types of food with extremely tight supplies and food shortages are food grains, namely wheat and rice, neither of which is used extensively for ethanol.
 
Wheat Supplies
Ending world wheat stocks as a percent of annual use are projected this marketing year to be the lowest on record, or at least the lowest going back into the 1970s. The global wheat supply has tightened substantially due to a number of weather-related problems in several countries including the U.S. The most severe problem has been two consecutive extreme droughts in Australia. The 2006 Australian crop was down approximately 66% from normal and the 2007 crop was about 46% below normal. Australia usually is the world’s second or third largest wheat exporter, after the U.S. and sometimes ranking third after Canada.

With reduced global production and stocks, world wheat prices this past winter rose briefly to a new record price of about $22 per bushel in Minneapolis for high-protein bread-type wheat. The previous record high U.S. wheat price was in the $7 per bushel range. Weather problems, not ethanol, drove wheat prices to these levels.
 
In the U.S., the all wheat planted area increased for the crops harvested in 2006 and 2007 and for winter wheat planted in the fall of 2007 for harvest in 2008. However, yields were hurt by a late spring freeze in 2007 as well as severe drought in the southern Great Plains. This season, drought is continuing in wheat areas of Texas, Oklahoma, and parts of Kansas and Colorado. Adverse weather also reduced 2007 wheat yields in Canada, parts of Europe, and the Ukraine. Canada’s crop was down 21% from the average of the previous two years. The EU crop in 2007 was down 10% from 2005. In 2006, it was 6% lower than in 2005. All of these are major wheat-producing and exporting regions. In 2007, wheat production also declined sharply in North Africa, which is a major wheat importing region. With tight domestic supplies, Argentina, China, India, Russia, Ukraine, Kazakhstan, and Vietnam have either halted exports or increased export taxes on wheat, rice, and other products to insure adequate domestic supplies and to restrain inflation. However, the U.S. has allowed free exports of these crops. Its wheat exports in the current marketing year are projected to be 41% larger than last year, and U.S. rice exports are expected to be up 22% from the previous year.
 
Foreign crop prospects for 2008 are not yet clear, but early reports indicate world planted wheat area will be significantly larger than last year. The EU has released its 10% set-aside land reserve for production this year, and European sources anticipate double digit percentage expansions in wheat area in several European countries. USDA on May 9 projected the EU wheat harvest for this summer to be 17% larger than last year. If weather cooperates, Australia’s wheat crop also will be up sharply.
 
Rice supplies
The biggest concern about developing country food availability and cost has been in rice supplies. There is limited substitution between wheat and rice since both are food grains. Because of that, higher wheat prices tend to increase rice prices. USDA World Agricultural Outlook Board estimates of global rice supplies and demand do not look materially different than in recent years, but rice prices have increased sharply to new record highs earlier this year. The increase in part reflects a historical relationship between wheat and rice prices, with wheat pulling rice prices up.

In developing countries, as prices rose sharply, it is likely that some hoarding of rice supplies occurred at the consumer, retail, and wholesale levels. Where price controls existed, the controls would amplify the effect, creating the appearance of shortages. Again, weather problems in wheat producing regions rather than ethanol appear to be behind these increases.
 
Developing Country Ethanol Impacts
One part of the world food sector where food price impacts from biofuels have been much more significant than in the U.S. is low-income urban consumers in developing countries where corn-based foods are a staple part of the diet. This includes parts of Africa and Mexico. At the same time, the higher corn prices, if governments in these countries allow the marketing system to passed higher prices through to producers, should stimulate increased local production. The U.S. government is partially compensating for higher grain and vegetable oil prices by increasing its dollar outlays for food aid to developing countries.
 
U.S. Food Perspective
 
In the first quarter of 2008, the index of all U.S. food prices was 4.9% above a year earlier. Some industry sources estimate that about 15% of the recent increase in U.S. food prices last year was due to biofuels. This appears to be a realistic number. The farm value accounts for only about 20 cents of each dollar spent on food. For the first quarter of 2008, the index of prices for all farm products was up 15% from a year earlier, although prices for some individual commodities were up much more sharply.
 
The big driving force behind higher U.S. food prices through spring 2008 has been the sharp increase in energy costs. Crude oil prices a year ago (early May) were $62 per barrel. At this writing, they are $125 per barrel. The higher costs for energy for processing, transportation, petroleum-based packaging materials, and other energy-based products and services has been a major force driving up food prices. Other cost-increasing factors include the 13.6% increase in the U.S. minimum wage rate that went into effect last year, a decline in the exchange rate of the U.S. dollar relative to foreign currencies, and severe reductions in wheat yields in major producing countries. A Texas A & M University study indicates labor accounts for $0.38 of the consumer’s food dollar.
 
At prices of $4 per bushel in mid-2006, the wheat in a one pound loaf of bread represented about 06.7 cents. At the peak of the market, the cost of wheat in the same loaf of bread would be 36.7 cents. However, only a small part of the wheat used for bread was purchased at that price. The price of hard bread-type wheat in Kansas City at this writing is about $8 per bushel, representing a cost of about 13.3 cents for a one pound loaf of bread or box of cereal. While these are significant increases due to wheat prices, they should not be attributed to ethanol. For the current marketing year ending June 1, 2007, official USDA projections indicate average wheat prices paid to farmers will be 54% higher than the previous year. The increase is equivalent to 3.8 cents increase in the farm-level cost of wheat for a one pound loaf of bread or box of cereal.
 
Corn prices have risen sharply in the past two years in response to increased demand for ethanol. The expanding demand for ethanol is driven very significantly by high crude oil prices that have pushed U.S. unleaded gasoline prices into the $3.60 to $4.00 per gallon range, as well as by government mandates and other incentives.
 
The increase in corn prices from $2 per bushel to a recent level of $5.60 per bushel has increased the cost of corn in a one-pound box of corn cereal by 6.25 cents per box. Rising corn prices also have increased the price of fructose, a widely used corn sweetener for various processed foods and soft drinks. But these represent relatively minor portions of the total increase in food costs. For example, the Texas study indicates that a 12-pack of non-diet soda pop contains approximately $0.11 worth of corn in the corn sweetener when the price is $2.06 per bushel and $0.22 worth of corn at $4.00 per bushel. Other factors behind the increase in corn prices include (1) a 15% decline in the trade-weighted value of the U.S. dollar vs. major foreign currencies in the last two years and (2) an 18% increase in U.S. corn exports in response to reduced foreign feed wheat supplies and increased demand stemming from the lower value of the dollar.

Rising Dairy Product Prices Reflect Demand Pull
Sharp increases in U.S. retail prices for dairy products also occurred in 2007. Dairy economists tell us milk prices have increased more than the increased feed costs that are related in part to expanding ethanol production. In other words, the retail price increases reflect demand-pull pressures rather than cost-push increases. Factors behind the increased product prices include the weak dollar, demand growth in developing countries, and adverse foreign weather that has limited milk production in some countries. Weakness of the dollar, in effect, lowers our price to foreign buyers vs. what it would be with no change in the exchange rate.
 
Higher Meat Prices Likely Over Time
Later this year, some increase in prices for certain types of poultry products may occur as the industry adjusts to higher feed costs. Over the next 15 to 24 months, increased beef and pork prices also can be expected as these industries adjust production in response to sharply higher feed costs. The exact impact is yet to be determined. Part of the higher feed costs may be divided between producers, processors, and retailers.
 
Growing Protein Food Demand
China’s rapidly growing economy and the resulting increased demand for protein foods also is part of the picture in that it has sharply reduced China’s corn exports. In most years since the early 1980s, China has been the No. 2 or No. 3 corn exporter in the world. But this marketing year, its net corn exports are projected to decline to only 16 million bushels. Its net corn exports in 2006-07 were about 210 million bushels. U.S. corn has had to fill the gap left by smaller Chinese exports. In the world picture, it is also important to note that the U.S. is exporting more corn than ever before this marketing year.

Food Price Impacts vs. Fuel Price Impacts
These details as well as Texas A & M University study support conclusions of the USDA Chief Economist that biofuels so far have had only a small role in the recent accelerated increases in food prices. Since the U.S. is exporting all-time record amounts of corn and wheat this year, the underlying facts also support the view that U.S. ethanol as of May 2008 has not contributed significantly to global food shortages. Costs of some food ingredients have gone up as a result of ethanol production, but the doubling of fuel prices in the last year and the sharp decline in the value of the U.S. dollar appear to be more significant factors behind the higher food prices. For the longer-term, yet to be determined upward pressure on prices of foods produced by animal agriculture can be expected.
 
Conclusions
 
Through May 2008, the major factors in rising U.S. food prices appear to be the tremendous increase in fuel costs during the past two years and the sharp decline in the value of the U.S. dollar. In the next few years, there likely will be increases in meat and poultry  prices as those industries adjust to higher feed costs and as part of the increased costs are passed on to consumers. In the global picture, reports of a food crisis have been mainly about rice supplies and sharply higher costs for both wheat and rice. Weather has been the primary factor behind higher prices of these crops, and rising fuel costs have increased the cost of getting supplies to importing countries.
 
Recent policy discussions have focused partly on a reduction of the ethanol production mandates contained in the December 2007 Energy Bill that was passed late last year. Actual production appears likely to exceed the mandates during the next few years if crude oil prices remain at or above current levels. Thus, reducing the mandates probably would have little effect on production in the 18 to 24 month horizon. Beyond that, reducing the mandates would discourage additional investment in new plants and would signal to potential investors in cellulose plants that government production incentives can be removed quickly and unexpectedly.