Global demand lifts grain prices, gobbles supplies

Soaring energy costs may be roiling the financial markets, but world governments are also being rattled by a more basic form of inflation: sky-high food prices.

Pakistan is stockpiling wheat and using its military to guard flour mills. Indonesian consumers have taken to the streets to protest rising soy prices. Malaysia no longer lets people take sugar, flour or cooking oil out of the country. North Dakota, the top U.S. wheat-producing state, may import from Canada due to tight supplies.

The world is facing the most destabilizing bout of food inflation since the "Great Grain Robbery" of the early 1970s when the former Soviet Union bought massive quantities of U.S. grain, sending prices soaring. That episode helped fuel a Farm Belt boom — and later bust — as soaring exports soured and record agricultural land prices fell.

Soaring demand, rising oil prices and government-mandated biofuel use have sent many commodity prices to their highest levels in history. The impact is hardest in the developing world: The United Nations says increasing prices will make it tougher to meet international goals of reduced hunger. Rising prices are squeezing food aid budgets that were already falling far behind growing need caused by war and increasing weather disasters. Worse, soaring costs are adding to political instability in countries such as Afghanistan, where flour prices are up more than 60% in the past year, and as much as 80% in some areas.

The bulls may not be running on Wall Street, but they're charging in the commodities pits. Prices for some varieties of wheat are at an all-time high of more than $16 a bushel on the Minneapolis Grain Exchange. Soybean futures prices have jumped to $13.26 a bushel in Chicago trading, from less than $7.50 a bushel in 2007. Corn, which has averaged about $2.50 per bushel in recent years, is above $5 today. Rice prices have hit records. Palm oil prices, in demand for biofuels production, have risen. The U.N. Food and Agriculture Organization food price index jumped nearly 40% in 2007, following a 9% increase the previous year.

The driving force behind higher food prices: More people in developing countries are earning more money and living better. And the first step to a better standard of living is a better diet. It's a phenomenon called Engel's law, named after the 19th-century German economist, Ernst Engel. Engel's law says that as incomes increase, people spend a smaller percentage of their incomes on food — but they also switch from cheaper to more expensive food.

Grains make up around 60% of the diet in low-income Asian nations, North Africa and the former Soviet republics. Vegetable oil is about 12% of the diet in Sub-Saharan Africa and about 10% in some Asian and Latin American countries, according to the U.S. Agriculture Department. The vegetable oil share of diets is growing as more processed foods are available in low-income countries.

People in developing countries are also starting to eat more meat, and that drives up demand for grains. It takes about eight times as much corn to produce the same number of calories from meat as from bread, says Homi Kharas, senior fellow at the Brookings Institution.

Surging demand for food and feed has tightened grain stocks. The U.S. Agriculture Department, for example, pegs U.S. wheat stockpiles at the lowest level since shortly after World War II. Farmers are reporting tight supplies of seeds for planting.

And, says Bob Lee, manager of Fidelity Select Consumer Staples, planting more grain isn't as easy as it may sound. "There's only so much arable land in the world," Lee says. "It's not just pouring capital at the problem; you have to find appropriate land, too."

But higher demand isn't all that's pushing food prices higher:

•Spiraling oil prices. Food needs fertilizer, and to make fertilizer, you need energy. The cost of natural gas, for example, is one of the biggest components in the price of ammonia and potash. While natural gas prices have tumbled from their 2005 highs, the price is still nearly double its 2001 levels. And to get food to market, you need trucks, trains and barges, all of which consume oil and gasoline, which have soared nearly 70% in the past 12 months.

•Government mandates for biofuels. In a bid to reduce oil dependence, many countries are requiring additional use of biofuels, such as ethanol and biodiesel. That, in turn, competes with food destined for the table — and increases the prices of what consumers eat.

Partly because of the U.S. energy bill requiring increased use of corn-based ethanol, farmers have planted less soybeans and wheat. Winter wheat plantings rose 3.6% this year, even with high prices, vs. an expected 8%, according to Merrill Lynch.

"We've not really had anything like the situation we've had today," says Bruce Babcock, head of Iowa State University's Center for Agricultural and Rural Development. "The reason why this won't be over as quickly as other price shocks … is that biofuels mandates are increasing at the same time that countries are being signaled to grow more."

Global impact

Those hit hardest by the soaring price of food are those who were already struggling to afford it. "You have people who could get along with bread at 30 cents, but not at 65," says Nancy Roman, the World Food Programme's communications and policy director.

Food prices have risen so rapidly, Roman says, that the WFP will need $520 million more to provide the amount of food they had budgeted for this summer. They have saved some costs by buying food locally rather than importing it from abroad, Roman says. That saves transportation costs, and helps local farmers, too. Still, she says, "At some point, you're out of tricks."

Already, higher food costs are becoming a political issue.

•Thousands marched in Mexico City in late January to protest the increase in the price of corn tortillas, which had soared 400%.

•Argentina sharply limited beef exports last year to fight food price inflation.

•Police arrested 56 protesters in Malaysia this month during demonstrations against rising food prices.

In China, inflation may hit a 10-year high, thanks to higher food prices. Costs in Singapore are rising faster than at any time in the past 30 years, according to Merrill Lynch.

"A lot depends on how countries with large resources like the U.S. or EU or Brazil, how they invest and how they proceed with this biofuels initiative and how much extra land they will bring in," says Shahla Shapouri, a senior economist at the USDA. "Low-income countries are basically price takers; they are not movers and shakers."

But the rising cost of food isn't all bad, says Brookings' Kharas. A better diet in the developing world is a good thing. And because rising food prices have helped farmers in the Third World, fewer people from rural areas are moving into sprawling urban slums. "To a significant degree, this is very good news," Kharas says.

The USA isn't expected to relive the crushing double-digit food inflation of the 1970s. Still, food prices last year rose at the fastest pace in 15 years, hitting U.S. companies and consumers even as the economy slowed. Purdue University economist Corinne Alexander says U.S. food inflation could range as high as 6% this year, compared with 2.1% in 2006.

Higher food prices have been gouging profits at some U.S. companies.

•Kraft Foods' fourth-quarter earnings were hit by a nearly 40% jump in dairy prices.

•Tyson Foods in late January said it would raise prices "substantially." The company, which in November forecast a $300 million increase in feed costs during its fiscal year, boosted that figure to $500 million.

Other companies are raising prices, something that would have been unthinkable five years ago. Hershey increased the price of candy bars 4% to 6% in April, citing the costs of raw materials, packaging and fuel. Starbucks bumped up the price of lattes an average of 9 cents.

The past year has seen a lobbying war between ethanol supporters and food processors, such as Tyson, who say they are bearing the brunt of higher food inflation due partly to subsidized U.S. corn ethanol production. Processors are apoplectic about an energy law signed by President Bush in December that requires 36 billion gallons of renewable fuel by 2022. That includes 15 billion gallons of corn-based ethanol, about double current production ability.

Though corn production has increased to historic levels, a third of the U.S. corn crop could be devoted to fuel. Further, farmers have been cutting plantings of soybeans, wheat and other crops, even as demand for those commodities is growing.

"This is a mandate that would make Stalin blush," Scott Faber, vice president of federal affairs for the Grocery Manufacturers Association, says of the energy bill. "Ethanol is seen in the minds of some very smart and some very powerful legislators as a silver bullet. It's not a silver bullet, it's a hand grenade."

Ethanol defended

Bob Dineen, head of the Renewable Fuels Association, in recent testimony to Congress defended the ethanol industry as a bright spot in the midst of a U.S. economic slump, saying the ethanol sector created more than 238,000 jobs in 2007.

Other farm groups call current corn prices reasonable after years of low returns. But the rise of ethanol is causing dislocations in the U.S. farm sector.

In North Dakota, farmers are up in arms about a state proposal to allow wheat purchases from rival Canada. Stocks are so tight that a state-owned mill might not have enough supply.

"We feel we'll have enough to get us through the next harvest. We may be proven wrong if exports continue at the pace they're running," says Jim Peterson, marketing director for the North Dakota Wheat Commission.

It's hard to say exactly how much wheat is available. Farmers who have supplies of coveted spring and durum wheat are holding it back from the market, seeking even higher prices. "Producers right now are in a very bullish sentiment," Peterson says.

Even an explosion in spring wheat prices in the past month may not mean a big boost in acreage. Food processors have been aggressively contracting with farmers to plant crops such as malting barley, peas, lentils or sunflowers, supplies of which are also tight. There is limited availability of some wheat seed, Peterson says.

Randy Spronk of southwest Minnesota produces hogs and corn. He's doing well, but many pork producers are losing money, crushed by rising feed prices. Meat prices are expected to jump as producers cull herds.

Though Spronk grows corn, he's skeptical of the ethanol boom, saying the industry expanded too fast. Land prices have soared, leading to higher costs for many farmers who rent acreage. Fertilizer, seed and other input prices are rising. Spronk says corn production costs will be $600 an acre this year, compared with $400 last year.

"If you don't get (a good) price or you don't get yield, the pinnacle from which these farmers are going to fall is going to be higher, and you're going to hear the thud," Spronk says.

The issue is coming full circle, with the government looking at increasing subsidies to provide food to low-income consumers who are suffering from the food inflation its energy policies have helped to create.

"For Kansas, for the last few months, every month has been a record expenditure," says David Thomason, state director of the federal Women, Infants and Children feeding program, providing nutrition education, health services and food to low-income pregnant women and children up to age 5. He worries about funding.

"As the economy changes and as people's income change, they are more apt to apply for programs like WIC … at the same time with the food costs going up; it's like a perfect storm," Thomason says.