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Price Volatility in Agricultural Commodities: Market Fundamentals
By Brain Wright - Professor and Chair, Department of Agricultural and Resource Economics, University of California, Berkeley.
Presentation at the FARMD Annual Conference: Price Volatility and Climate Change, Implications for the Ag-Risk Management Agenda. Zurich, June 9-10, 2011.
FARMD (July 2011) | Professor Wright, who has long followed the markets for storable commodities, elucidates the causes of the recent food price spikes and unveils some of the erroneous beliefs behind the food crisis of 2008.
While getting the facts straight, Brian Wright, Professor and Chair Department of Agricultural & Resource Economics in the University of California, Berkeley, presented graphs and data showing why each one of these points he has identified are either misleading or false cause of prices spikes in grains.
These are the 8 points Wright indentified in his presentation at the 2011 FARMD's Annual Conference:
- In 2008, and currently, we have had price spikes in major grains at levels not seen before.
- Recent price spikes were associated with largest harvest shortfalls since 1970s.
- Higher energy prices led commodity prices as in 1970's and other commodity booms.
- Higher energy prices caused higher commodity prices.
- Climate change is reflected in recent increased harvest volatility.
- Price spikes are related to growth of the middle-class in certain economies, like China and India, where consumption has increased directly; in other words, an anticipated increase in beef or pork demand in these countries.
- The 2007/08 food crisis was the result of a "perfect storm" in grain markets.
So Who Sank the Boat Then?
Professor Wright introduces a storage theory that may better explain price spikes. This theory says that stores smooth out troughs in price and low-value consumption after high harvest by "buying low to sell high." In other words, the relationship between harvest shortfalls or demand increases and price is highly non linear. This means, says Wright, that any little disruption will cause price spikes.
"Stores smooth out peaks after unexpected shocks, but only until their stocks run out. When stocks run out, price spikes are required to force consumers to respond one-for-one to shocks," says Wright. To exemplify this, Wrights recalls the recent Australian droughts. He says that when there are no stocks in the market, a drought in an insignificant country, as Wright called his native country, drives the markets crazy. But that doesn't mean Australia caused the shortfall, he says. You have to ask first why were the stocks so low in the first place.
Something caused the shortfalls, and this something, for Prof. Wright, is biofuels. Professor Wright recalls the scenario in the United States, the biggest maize producer in the world, in the recent years. Maize energy for foods and feeds was reduced a lot after 2007, and in fact is now a bit more than 30 percent. Wright says that the in the peak in 1997 there was more maize available for food and feed than there is available in the markets now. His graphs show how all the productivity increase since then have been taking up by biofuels.
"So there is no doubt this is having an effect in the markets" Wright continues, "soy availability fell, as did canola in Europe; the substitution of grains in use on the land side as well as the consumption side, stocks fell to match this increase and that's why the market was vulnerable to spikes in 2008."
Beyond Price Spikes: Corn Ethanol Policy as Classic Price Discrimination
Professor Wright explains that if you take supply from a market with a very inelastic demand as the grain and food market, and you put it in a market with a very elastic demand –because the amount of extra supply you are supplying to the biofuels market is a very small amount out of the total of the energy market— so you take grain from one market where you raise the price a lot and you put in to another market where you don't know the price at all. So, you make more money in both markets. "And that is exactly what's happening now and U.S. farmers and European farmers are gaining,” says Wright.
Therefore, price rises, farmers gain, consumption raises a lot less, and food consumers lose. "This is something seen not only in developed countries", Wright adds, "but in developing countries, too."
Are Speculators Causing Spikes?
Wright explains that speculators can only affect price if they affect consumption, and they could only do that by increasing stocks. Prices spikes only happened when stocks read historic lows. "Anybody that tells you that speculators are driving prices up "says Wright, "in terms of food grain consumption, it has to be because consumption fell, and that must be because stocks rose."
Brian Wright's Conclusions:
- There is no evidence of climate change in harvest volatility;
- Price spikes: occur only when stocks/use ratios are minimal and market is fragile, do not match chicks due to storage; match times of low stocks, not low production;
- Food-competing biofuels expansion can: maintain a medium term regime change in price levels, and keep farmers, landowners rich, in countries at all development levels; and
- Biofuel options can counter volatility effects, not higher price levels.