World events work against grain buyers

PORTLAND, Ore. -- The Baker & Spice bakery paid $19 for a 50-pound bag of flour in August. By the end of September, co-owner Julie Richardson was staring at $27 a bag, reading startling messages from her supplier warning of dwindling world wheat stocks and wondering how long she could hold out before raising prices.

"We're going to have to pass it on," says Richardson, 37, who opened her bustling bakery in this hilly Portland suburb three years ago. Richardson raised prices 12% this spring due to higher flour and other prices, the first increase since she opened. She anticipates another, smaller price increase before the busy holiday season.

"We can only (boost prices) so much until the customer sees the pinch," says Richardson, who uses organic ingredients but hasn't touted it in her advertising. That gives her more latitude to switch to conventional flour, which now costs about $10 a bag less than organic, though it's experienced similar price jumps this year. It also means she must rework baking formulas to ensure the product her customers expect and, she says, lower her "laurels on flavor and sustainability."

The tightest world grain stocks in about 30 years are contributing to rising food inflation, fueling worries about food shortages in some countries and straining international aid budgets. Russia recently imposed taxes on barley and grain exports to control domestic food prices before pending presidential elections.

Prices are being pushed up by bad weather in a host of countries, surging world demand and a drive in the USA and abroad to devote more acres to corn for ethanol production, which has tightened supplies of some grains and tied crop prices more closely to energy prices.

The decline in the value of the dollar has also contributed to surging international demand for U.S. grain. The falling dollar makes U.S. grain more affordable for foreign buyers as their currency picks up purchasing power. It also makes foods imported to the USA pricier.

Wheat touched $9.61 a bushel on Chicago futures markets in late September — doubling from the previous year — after it became clear that drought in Australia, a major exporter, would dramatically reduce production. Europe, Canada and other countries had poor crops. U.S. production was above last year's, but demand surged. U.S. wheat stockpiles are expected to be the lowest since 1948-49, the U.S. Agriculture Department says.

Futures prices have jerked around in the past couple of weeks as traders assess the supply outlook; still, they're up about 75% from a year ago. Corn futures are well down from the roughly $4.20 peak earlier this year but still well above the $3.00 levels of last fall.

High prices to stick around

Prices are likely to stay elevated for awhile. Global demand is so strong that record crops are needed just to keep up: World wheat consumption has outpaced production for much of the past decade. Better crops next year will not likely allow for significant rebuilding of the grain stockpile, due to increasing demand in surging economies such as China and India, according to an October report by the U.N. Food and Agriculture Organization, which called the outlook "grim."

"This is very uncertain, when you look at the history of agricultural prices, but I would say we're probably moving toward a higher average level of prices," says Keith Collins, Agriculture Department chief economist.

"We have a global economy that's growing at near 5%, which is unusual in and of itself. We have emerging middle classes all around the world, and we have the biofuels situation … adding significantly to the industrial demand for agricultural products. Then we have the supply disruptions, which have been most pronounced for wheat," Collins says.

Grain prices, along with higher energy and other costs, are rippling through the agricultural sector. Higher feed prices are a factor pushing up the prices of beef, chicken and pork. Tight supplies have increased domestic and international demand for alternative feed grains, including barley and sorghum. In the USA, the average price for a loaf of bread is up 11% over the past 12 months. Ground beef has risen 6%, chicken is up 9%, and eggs are up 31%. Overall U.S. food inflation is running 5.6% so far this year, compared with 2.6% for all of 2006. Consumers spend about 10% of take-home pay on food.

"Generally, you see wheat prices maintaining strength until we get past the holidays," says Jack Scoville, vice president of Price Futures Group. He notes that futures prices for wheat to be delivered next year are below $7 — but still well above historical averages.

Food companies are feeling the squeeze. In announcing third-quarter earnings last month, Maryland-based McCormick mkc, which makes spices and seasonings, said it had a "tough quarter" regarding its restaurant customers, due to sluggishness in that sector and rising commodity prices including pepper, soy oil and flour. It said its profit margin in that sector will be under pressure through the end of 2007. Sara Lee sle, Kellogg k and General Mills gis are among companies that have raised prices, changed packaging sizes or shifted ingredients to cope with price increases.

Richard Turanski, president of GloryBee Foods in Eugene, Ore., a direct importer, distributor and manufacturer of natural foods, is baker Richardson's supplier. Turanski says he can't find even short-term, three-month contracts for flour, given the volatile price situation. He has seen huge price jumps for goods from safflower oil to sunflower seeds, adding that producers had to be lured into planting sunflowers last year, instead of corn for ethanol.

"Typically, we buy a six-week supply at any one time," Turanski says. "If we can afford to buy a little more, we'll buy a little more, but we've got to be careful not to hoard the wheat any more than anyone else. Panic will throw this thing into further disarray."

World grain supply low

World grain stocks are on pace to be the lowest since the U.N. Food and Agriculture Organization began keeping track 30 years ago, even as consumption increases in emerging economies — including demand for grain-fed livestock — and population growth continues. The high prices have already led to food riots in some nations and are hurting food donation programs.

Josette Sheeran, executive director of the United Nations World Food Programme told a U.S. House committee earlier this month that in the past five years, the cost of obtaining basic commodities — wheat, rice, corn — has risen 50%, while fuel prices have jumped 40%. The U.N. has shifted the mix of foods it donates, sourced products locally and taken other actions to blunt the impact. But that could get harder, given the U.N. forecast for a 35% jump in commodity prices in the next two years.

Overall, global food aid has fallen from 10 million metric tons in 1995 to 6.7 million metric tons in 2006, the lowest in 15 years, Sheeran says. At the same time, the number of natural disasters requiring assistance has risen as weather patterns have shifted. Food aid groups have begun planning for even tougher challenges due to global warming.

Wealthy nations are also feeling some impact. The European Union faces a shortfall of grain, particularly for livestock feed. But EU policies don't allow the import of U.S. corn because it is genetically modified. Wheat producers have stayed away from genetically modified seed due to concerns about consumer acceptance. Producers in Europe have been scouting for substitutes, importing large amounts of U.S. sorghum for livestock feed, says Chris Corry, senior director for international operations for the U.S. Grains Council, who recently wrapped up a round of meetings in France.

Corry adds that European consumers haven't seen the full impact yet. Many pork producers, for instance, haven't marketed the animals they're fattening with the higher-priced feed. Still, there have already been protests in Italy about rising pasta prices. Costs for durum wheat, used for pasta, have soared even higher than for other wheat varieties, hitting more than $13 a bushel on the cash market.

Market to stay firm

As farmers begin seeding winter wheat for harvest in the spring, signs point to a large increase in acreage. But yields per acre aren't advancing as fast as a decade ago. Strong prices for crops from corn to soybeans and high costs for petroleum-based fertilizer will affect planting decisions, though some farmers can double-crop, planting a second crop in the spring after harvesting winter wheat.

"It appears that we'll have a firm market for another year; the world needs wheat, and the price won't go down," says John Thaemert a farmer from northwest Kansas, who is president of the National Association of Wheat Growers. Thaemert hastens to add that he's seen a situation such as this before, when wheat prices surged in the 1970s after what was then the Soviet Union had a dismal crop. "People planted a tremendous amount of wheat all around the world for several years after that, which led to a glut … the cure for high prices is high prices," Thaemert says.

Lester Brown, president of the Earth Policy Institute, a non-profit that focuses on sustainable growth, sees the situation as part of a longer-term challenge without a quick fix. There is no magic technology in sight to increase crop yields. Water supplies are being strained. The ethanol market absorbed more than 15% of the U.S. corn crop this year and could take 30% next year, if all the ethanol plants now under construction come on line. Ethanol prices have recently fallen due to problems in transportation and a glut of product, though those could be temporary growing pains.

"What we're looking at right now is an unfolding competition between 860 million people in the world who own automobiles and the 2 billion poorest in the world who are simply trying to survive," Brown says.

Already, some nations such as Ukraine have taken steps to limit exports of their crops to ensure adequate supplies and limit price increases. Other nations, such as India, which subsidize food rations for their populations, have had to take a financial hit. The United States, which normally exports about half its crop, has seen a sales surge in recent months. Wheat exports are expected to rise 27% from last year.

For now, there's little talk of what could happen if the weather doesn't cooperate next year. USDA officials and analysts such as Scoville doubt the U.S. would ever limit exports, referring to the 1980 grain embargo against the Soviet Union, which undermined the USA's reputation as a reliable supplier. Scoville says other options to alter production patterns would be to allow more land now set aside for conservation into production or to limit ethanol subsidies.

"The debate is not going to play out on whether we're going to control exports. The debate will be on what are we going to do about demand," says the USDA's Collins. "If you're concerned about dwindling supplies, then you might take a look at your biofuels policy. That's more likely."