On demand-driven winds and ag market storms

Agricultural market uncertainties galore

In any public event on agricultural market developments, uncertainty about their future price prospects is a standard theme of late, driven by the direct and indirect impact of the Russian invasion of Ukraine, COVID-related supply chain disruptions, as well as the costs of the green transition and uneven world economy growth. Price volatility is, an inherent feature of agricultural markets, the result of the discontinuity in the supply of crop production, as most crops are harvested once a year (often subjected to adverse weather and trade restrictions), and the continuity in the demand for food products, which stems the need to supply the processed products of these crops on a daily basis to cover food needs.

Increasingly so, other exogenous factors, from energy upheavals to war impacts, have added uncertainty concerns to weather-driven volatility. Most of the focus on these factors is about their impact on the supply side. And while developments potentially affecting the demand side of agricultural markets, from diets to food waste, have received more attention recently, there are two basic factors that are often left at the level of a reference in passim.

Two such factors I want to address here that are seemingly unrelated at first - consumer food price inflation prospects and population growth impacts. Rarely attracting the attention that they need, they are nonetheless pivotal in the debate about food security and the necessary policy considerations.

Food prices move with agricultural prices – but not always…

Most people have certainly not heard of Engel’s Law, yet every household would have witnessed it in practice as the share of food in household expenditures kept declining decade after decade. It is this development that has been at the core of economic growth as the increasing share of available family income generated by their economic activity was spent on other items, with a multiplier effect on economic and social growth and the unfortunate side effect of a negative environmental footprint.

The recent surge of inflation, driven in part by energy and food, has put this long-term downward trend of food expenditure into reverse, raising concerns about its future prospects. And although supply drivers and constrains have been exhaustively, though not uniformly, analyzed, pressures on the demand side of agricultural markets have been less so.

In fact, every period of agricultural price boom in that past two decades has been followed by a bust; “high prices are the best cure for high prices” because of the supply response they generate. But such a “cure” is missing for consumers, as at their level, food prices kept growing even in periods of significant decline in farm prices and indicate a rather striking recent change on inflationary pressures.

Combining FAO’s Consumer Food Price Index and the World Bank’s Food Price Index reveals two major changes on food inflation. First, a recent dramatic acceleration; second, the stickiness of food prices at consumer level; the law of price gravity applies for farm-gate prices, but not at the shelf!

Graph 1 highlights the three agricultural price spikes of this century, while the summary in their variation and duration is presented in Graph 2. 

Graph 1. Farm and food price developments

Graph 2. The diverging paths of price booms and busts

In every farm price boom in this century (at monthly rates ranging between 3.6% and 5.6%), farm prices reversed to a decline, with monthly rates of change between -0.6% and 6.2%, with the decline of the most recent period standing at -2.8%.

The month-to-month increase in food consumer prices was always low in every boom period, ranging from 0.6% to 1% (in the most recent period); but every time farm prices declined, food consumer prices kept increasing, from a monthly rate of 0.3% in the two earlier periods of farm price declined to 1.8% recently.

The above mark a significant change that needs to be monitored and analyzed. The share from price of food going back to the farmer is significantly lower today than the relative share in the 1950s. Even if prospects for a reversal in the long-term downward trend of agricultural prices exist (conditional on what I state at the end of the article), prospects for the continuation of the declining share of food expenditure in the household budget are more doubtful as, increasingly, all intermediate stages of food production put upward pressure on food prices.

Therefore, higher food costs, prospects for higher energy costs driven by the green transition and increasing income inequalities put households in the developed world at a risk of changes in consumer behaviour that are driven by forces that are exogenous to both their existing and the often desired change in their tastes and preferences. Underestimating the potential impact of this trend puts at great risk all strategies aiming at sustainable growth.

Who trades all this wheat?

Among the factors that explain the recent upward trend in food inflation is the impact of the war in Ukraine, with the Russian invasion generating a major and dramatic shock in Ukraine’s capacity to export, especially in wheat. I have already focused on the pivotal role of wheat for food security in a previous LinkedIn article. Here I expand this discussion to link it with future global market prospects, as these appear in the most recently available projections for agricultural markets, those of the USDA (USDA Long-Term Projections, February 2023). First, let’s look at the update of the graph 3, depicting major changes in the world wheat market, (a graph I used in a previous LinkedIn article, but present updated here because of the need to make it more comparable with the USDA projections).

From the “traditional exporters” (a term reflecting the past century) US has given up its previous role as export leader in wheat, while all EU, Canada and Australia increased exports. Minor changes took place in Latin America, where the export surplus of Argentina roughly covers the deficit of the rest of the region, or in China and India, where growth in wheat yields led India to a small surplus and China to a decline in its imports.

But the big story was elsewhere; Africa and the Rest of Asia saw their wheat deficit more than double. Just 25% of this deficit was covered by collective export growth of the traditional old big-4. Between 1996 and 2021, 75% of the increase in the net trade wheat deficit of Africa and the Rest of Asia was covered by Russia and Ukraine, thus the more significant impact of the war in Ukraine on wheat than in other markets.

 Graph 3. What has changed in wheat in 25 years

Now let’s look at population growth, a major driver for global food demand. The usual focus here is on the impact of economic growth on strong demand in emerging economies, and thus on meats, maize and soyabeans. Focus on population patterns, on the other hand, shift the focus on food security concerns, and thus on wheat. It is in this market, which is much more diverse both on the supply as well as on the demand side, that major changes in population growth risk having the greatest impact because of the composition of present trade and the risk in the future one.

Graph 4. Where population will grow in the future

The implications for wheat from population growth as shown in the graph above are self-evident. Africa (mainly, expected to add a population roughly equal to the current population of the US in the next ten years) and to a lesser extent the Rest of Asia will grow fast, while India will grow at a lower rate than in the past (0,7%, but still this easily add another 100 million in ten years) and China almost not at all.

Where does this pressure leave wheat trade? In rough round numbers, USDA expects the world to import 20 million more metric tonnes of wheat in 2032 than in 2022. 90% of these additional imports are expected to come from Africa, the Middle East and South-East Asia. Traditional exporters increase their exports (including the US, that is seen as reversing a long-term downward trend in area allocated to wheat), Argentina’s growth is not enough to cover the increasing deficit of the Rest of Lain America, Ukraine is expected to lose some 50% of its present export capacity, Russia is becoming the world’s largest wheat exporter, and the deficits of Africa and Rest of Asia grow, though somewhat less than in the past.

(However, we would need to find 30 million metric tonnes more in exports if the impact of the Russian invasion is expected to reduce Ukraine’s export capacity by 10 million metric tonnes. This USDA assumption is explained as linked to uncertainties of the war. I presume that it reflects the destruction in current producing regions of Ukraine and the long-term cost of bringing them back into production in a successful liberation of these regions).     

Graph 5. How could net wheat trade look like in 2032? 

A question stemming from USDA’s outlook is whether this can realistically materialize at the supply side. (For example, the EU’ Agricultural Outlook of past December has the Union’s wheat exports stable during the next decade.) I will try to address this in future articles, but Graph 6 summarizes wheat yields and their growth in the past 25 years.

It is evident that not all parts of the world have the same potential. The EU and China have the highest wheat yields, sometimes almost double the yield of major exporters, while Ukraine, with the highest yield of the rest, is still almost a third below the two. It is also unclear what this potential will be in the future as too many parameters remain unknown and too many assumptions, sometimes contradicting each other, are made in the public debate.     

Graph 6. How can all this expected wheat growth materialise? 

What implications?

The above analysis of two very diverse demand factors aimed at highlighting how two seemingly unrelated factors could test the capacity of agricultural supply to respond to increasing food security concerns amidst climate change priorities. How this could be done I have addressed in the past and will continue to address in future articles.

As a reminder of how population pressures were addressed in the past, productivity, science and trade come in mind. None of these is perfect – productivity growth requires to incorporate the environmental footprint in its measurement, scientific progress needs to address increasingly negative public perceptions about its dependence on certain interests, and trade needs a reminder that it comes with winners and losers, and the former need to introduce measures that compensate and accompany in transition the later. Yet though imperfect, all three are necessary. To become also sufficient in addressing the global need to produce more with less, we need to confront head-on the difficult questions of who is afraid of productivity, of science and of trade in the EU context?

 (…to be continued…)