It happened so fast. When grain prices soared in 2007 and 2008, many of us hoped that agriculture was entering a new golden age. Some of us were actually sure of it.
Then came 2009. Grain and oilseed markets collapsed, yet input prices stayed painfully high, leading many growers to wonder, “When will grain prices rebound?”
Now, several months further into the market, the question isn’t “when” will prices recover. It’s, “will” prices rally.
Really what we’re asking is, when grain prices soared in 2007 and ’08, were they reflecting a brand-new set of market fundamentals based on growing world demand and biofuels? Or was it merely a bubble which, once burst, would see prices sink back to pre-2006 levels, whether China’s median income is growing or not?
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To find out, I asked James Rude, economist at the University of Alberta, if 2007 was a bubble. His reply: “yes and no.”
Rude says the new demand from the biofuel sector and from emerging markets has indeed provided support for higher crop prices. At the same time, however, the biofuel business operates on cycles of its own. It’s heavily dependent on subsidies, he points out, and its profitability can evaporate overnight based on wavering fuel prices and grain costs.
Nor are emerging markets so reliable. We had thought they might be forced to come to us to feed their people. Instead, says Rude, China and India have implemented policies in recent years that have left them nearly self sufficient in wheat and other grains.
While demand from these countries may be outpacing their agricultural capacity, China and India are modernizing and they are adopting new technologies that are helping them grow their grains and oilseeds instead of having to buy them.
“Has anything in grain markets fundamentally changed? No!” says Rude. “Demand for grain is not overly responsive to price movements, and advances in technology continue to drive down real grain prices.”
Rude believes the historical trend of lower real grain prices is likely to continue. At best, he says, the trend line may have moved up slightly, so the rate of decline that farmers have to deal with may not be quite as steep as it otherwise would be. But prices are still heading down.
In real terms, Rude says, nothing has changed. If growers hope to make a dollar from grain and oilseed production, they’ll have to make it by continuing to make it by ensuring their productivity rises faster than their prices fall.
Not everyone agrees, including Purdue economist Christopher Hurt. He believes there has been a fundamental change in demand. “We have identified five reasons why we feel why we will not go back to a time of poor grain prices,” Hurt tells me, and then he proceeds to rattle them off one after the other like a rehearsed speech.
“I expect the biofuel demand to continue to rise because legislation ensures this increasing demand for corn and soybeans in the United States until 2015,” Hurt says, adding:
“The rate of economic growth in developing countries has been increasing since the mid 1900s. This leads to increased demand for goods, including grains.
“The only constraint to economic growth in the world is high energy prices, but agriculture has tied itself to the energy market with biofuels. Energy is not cheap now so even current energy prices support corn and soybean prices. Support in the prices of these crops supports prices in other crops as farmers switch acres to corn to maximize profits.
Have grain prices fallen too low?
“You also have to recognize we have been in a very major world recession. This has eroded demand and pushed grain prices down in 2009. However, there has never been a permanent recession and as we come out of this one, grain prices will improve. We are probably at the lows right now.
“Finally, 2009 has been a year of record production for both soybeans and corn which has pressured prices. We will not have record yields every year.”
New biofuel and emerging-market demand will limit the buildup of grain stocks that kept a lid on grain prices in past, Hurt says. The chance of surplus grain production is low, so we are not going to see large supplies which drive down prices.
So, Hurt summarizes, “2008 prices overstated grain values. 2009 prices are understated. We are going to go through a period of adjustment, but prices should level off between the highs of 2008 and lows of 2009.”
Most analysts — but not all — point to low world grain stocks when they try to explain 2007’s
run-up in grain prices. David Dawes with the Food and Agricultural Organization (FAO) questions this argument. In a February 2009 paper, Dawes points out that while world stocks of rice, wheat, and corn declined rapidly after 2000 and in 2006 reached their lowest level in 20 years. Most of this depletion was the result of the drawdown of stocks in China.
With its drive to become self sufficient in cereal grains, China had grown production to such an extent by 2000 that its stocks-to-use ratio was close to five times higher than what the FAO believed was needed for stable prices and consumption.
Even after drawing down its stocks, China still had a close to a 40 per cent stocks-to-use ratio in wheat in 2007. This compares to the recommended FAO ratio of 17 to 18 per cent.
During this same time period, the world’s major wheat exporting nations had stocks-to-use ratios of over 20 per cent, also above what the FAO considers worrisome.
In December 2008, Heady and Fan, economists with the International Food Policy Research Institute, identified evaluated 10 possible causes of surging commodity prices in their paper Anatomy of a crisis: The causes and consequences of surging food prices.
Heady and Fan were blunt. “We more or less unequivocally reject rising demand from China and India as an important cause.”
Financial speculation and securitization of grain is also widely blamed for grain price increases. Heady and Fan acknowledge that speculation and non-commercial ownership of grain increased exponentially during this time period, but they also believe speculation may be more of a result of price volatility rather than the cause of it.
So, what did cause the price run? Heady and Fan suggest weather-related production shortfalls probably played some role. After all, production in much of Australia, the U.S., Russia and Ukraine was down significantly prior to the price spike.
Globally, however, wheat production dropped by only 1.3 per cent in 2006, a drop that was smaller than the world had lived through repeatedly over the last 20 years when prices remained relatively stable.
Furthermore, global grain output actually increased 4.7 per cent in 2007, even while prices continued to rise.
Heady and Fan do agree that demand for biofuels had some impact on grain prices. The ethanol industry has absorbed 70 per cent of the increase in global corn production from 2004 to 2007. As acres were switched into corn to meet this demand, the prices of other crops also increased.
More important, say Heady and Fan, were rising world oil prices which accounted for up to 30 per cent of the price jolt. But oil prices were only one of the causes, mixed in with a rare brew of economic and market conditions, including hoarding by countries trying to protect themselves again rising grain prices, low interest rates that encouraged investors to move from financial markets to commodities, and the 22 per cent depreciation of the U. S. dollar in the five-year period before the price spike.
Were 2008 grain prices too high?
2008’s prices should have been even higher, says Tim Semler, farm business management agent with the North Dakota State University Extension Service.
Semler’s reasoning is reflected in the accompanying chart, which shows that grain prices adjusted for inflation have steadily declined for 50 years.
In fact, Semler says, the erosion of the market has been going on even longer than that. In order for farm gate prices to have reached parity with 1910, his state’s farmers would have had to average $10.60 per bushel for their corn, $7.37 per bushel for their barley and $13.95 per bushel for their canola in 2008.
There’s a lesson in the fact that farmers didn’t get those prices, Semler says. “Farmers have to look at their expenses and really evaluate whether they need new equipment. They have to ask themselves if outbidding their neighbour in renting or purchasing more land is driving up their costs.”
The 1974 and the 2008 spikes stand out on historical price charts. These charts also clearly show the relatively quick fall of real grain prices after 1974, when they sank back to the longterm downward trend line.
The big question is if history is repeating itself, will we see a return to the historical trend line, as Rude predicts, or is Hurt right when he forecasts a leveling off of that trend to lower real prices?
For farmers, the hard swallow comes when you look at what the two economists agree on. Both say that the odds are stacked against prices rebounding to their 2008 highs. CG
