I’m sure everyone has heard the news by now, rising food prices are “threatening the poor worldwide” and causing riots around the globe. The cause of these high food prices? Well, biofuels of course, and ethanol in particular. Recent news articles have lambasted the ethanol industry.
Time magazine calls ethanol “The Clean Energy Scam”. A recent article titled The Great Biofuel Famine said: “biofuel policies will significantly contribute to the early, avoidable deaths of between 10 and 20 million people in the year 2008 alone.” Former president Bill Clinton, at the Progressive Governance Summit in England, made this terribly misguided statement:
“What’s really hurting the food markets is America moving into ethanol. People there are moving into corn and you have pasta riots in Italy related to what some people are doing in farming in America.”
A recent editorial in the New York Times titled, The World Food Crisis, chastised the “rich world” for “exacerbating” the rise in food prices by “supporting the production of biofuels.” In this same editorial, it’s interesting to note that the Times Editorial Board characterizes food prices as “controllable” and fuel prices as “uncontrollable”. In reality, fuel prices are just as controllable as food prices – all you have to do is produce more oil. But the Times does not support drilling for oil because it causes more global warming, so higher fuel prices are fine by them. After all, higher fuel prices force people to use less, and less use means saving the planet. What they won’t admit though, and as I’ll demonstrate in just a little bit, the increased cost of fuel is the primary driver of soaring food prices. Ethanol biofuel is just a bit player in the whole scheme of things.
So is all this criticism warranted? Is the diversion of corn into ethanol production actually what’s driving the increases in food prices? In part, yes. But it’s only a small role, as we shall see.
In order to get a clear picture of the effect ethanol is having on prices, I’ll go through, on-by-one, some of the food items that are heavily dependent on corn. We’ll have a detailed look at what’s really driving prices – but be forewarned, what I have found might surprise you. I’ll also look at the law of unintended consequences: the argument that the price of some foods, even though they are not derived from corn, are rising because farmers are planting less acres of a crop in order to plant more corn for biofuels. Wheat is a prime example, and it’s where I’ll begin my analysis.
The prime ingredient of a loaf of bread is wheat flour. The price of wheat flour has increased considerably because the price of wheat has more than doubled in the last few years. This in turn has caused an increase in bread prices. Perception amongst consumers is that the price of wheat is mostly to blame. But is this true? Is the price of wheat flour driving store prices, or is their some other factor involved – like the cost of fuel?
According to the U.S. Department of Labor’s Bureau of Labor Statistics, the price of bread has risen 32 cents since 2004. That equates into a 32% increase in just a few years, which is a lot, and it is definitely being felt in the consumers pocketbook. But is the 32% increase because of the higher cost of wheat? In order to find out, let’s do some calculations.
From the Kansas Wheat Commission, we know that a bushel of wheat will make approximately 70, one-pound loaves of white bread. We also know, from The United States Department of Agriculture’s Economic Research Service (ERS), that the average price a farmer received for a bushel of hard red winter wheat in January, 2008 was $7.60 per bushel. If we take $7.60 per bushel and divide that by 70 loaves of bread, we know that we have 11 cents of wheat in a loaf of bread. That’s the farmers share of the price of a loaf of bread.
Now, if we go back to 2004, we know from the (ERS) that the average price of a bushel of hard red winter wheat was $3.43 per bushel. Take the $3.43 per bushel and divide that by 70 loaves of bread, we know that we had 5 cents worth of wheat in loaf of bread in 2004. We can now see that even though the price of wheat has more than doubled, we have only 6 cents more wheat in today’s loaf of bread as compared to 2004. That’s only a 6% rise in price! But the price of bread has went up 32%! Where is the other 26 cents going?
I don’t have a definitive answer to that last question but I do know that a large part of the extra 26 cent increase is because of the price of fuel. It takes a lot of energy to process the wheat into flour, package it, and then ship it to the retailer. This is undoubtedly a major expense on the part of the processor.
One other thing to consider is the way margins are figured at the retail level. I’m sure everyone has seen where a retailer has been quoted as saying that his percent markup hasn’t changed so the increases are not his fault. In this case, the retailer is not being entirely truthful. Let’s use the price of bread as an example.
Let’s assume that in 2004, the retailers cost of a loaf of bread was $0.80. In order for him to make 30% from the sale of the bread, he takes $0.80 and divides that by 0.7 to get his 30% markup. This makes his sale price $1.14 per loaf, so he’s making 34 cents per loaf. Now let’s say his cost for a loaf of bread today is $1.00 even. He takes the $1.00 and divides that by .7 to get his 30% markup, so his new selling price is $1.43. He’s now making 43 cents per loaf instead of 34 cents. In other words, the retailer has increased his profit by 9 cents for each loaf sold.
It’s important to note that I have no problem with a retailer making more money. A retailers expenses go up just like everybody else, and he needs to cover those expenses in order to stay in business. But I do have a problem when a retailer is being less than truthful about where the price increases are occurring. The claim that their retail margins have not increased is pure nonsense.
This article from the Washington Post tells us that beef prices are on the rise, and that greater demand for corn is squarely to blame. The Post illustrates this by saying: “… cattle ranchers have to pay more for animal feed that contains corn. Those costs are reflected in cattle prices, which have gone from about $82.50 per 100 pounds a year ago to $91.15 today.” Wow, almost a $10.00 increase in just a year, all because of the high cost of corn! But is this true? Is the farmer passing the increased feeding costs through to the retailer? I think not! I’ll explain why.
Thankfully, the USDA tracks monthly retail meat prices along with the farm sale price of cattle and hogs. From this data we can calculate the difference between what the farmer receives when he markets the animal and the final sales price of the meat at the grocery store. This is referred to as “the spread”, and I’ve illustrated this in the following chart:
Figure 1. Retail Value and Net Farm Value of Beef. Retail value is defined as the average value of the selected cut of meat at the grocery store, measured in cents per pound of retail weight. Net Farm Value is defined as the gross farm value minus the value of byproducts; represents the value of the meat to the farmer.
Notice in Figure 1 that the gap between Retail Value and Net Farm Value looks to stay relatively the same (looks can be deceiving) throughout the 1990’s and then beginning somewhere around 2002, the gap starts to widen. This is our first indicator that something is amiss. The chart clearly indicates that in the recent past, retail prices are rising faster than farm prices. By how much it’s difficult to tell, because you have to eyeball the difference between the two prices, but it’s readily apparent the spread is growing.
Next, to illustrate this further, I subtracted the Net Farm Value from the Retail Value which gives us the difference in price between the farmer and the retailer. Now we can see how quickly retail prices have outpaced farm prices:
Figure 2. Retail Value minus Net Farm Value
I think one would have to agree that the results in Figure 2 are simply stunning! Since 1990, the retail price of beef has been growing faster than the farm price, and in the early 2000’s the price difference has accelerated greatly. This is clearly an indicator that increased corn prices are having little to no affect on the price of meat at the grocery counter. By calculating the difference between the retail price and the farm price, we know that the majority of the increase in the price of beef is occurring after the animal leaves the farm. In other words, the enormous price increases are occurring either at the wholesale level or the retail level, or a combination of the two together.
The take-home message here is that the increase in the price of beef has little to do with the increased price of corn. The majority of the increases we have seen to date are occurring after the animal leaves the farm and reaches the meat packing plant. The reason for this is obvious – the price of energy has skyrocketed. As it is with wheat flour, it takes a lot of energy to process the meat, package it, and then transport it to the marketplace.
I’m not going to go into as much detail about the rise in pork prices as I did with beef prices because the story is the same – the majority of the price increase is occurring after the animal leaves the farm. I have illustrated this in the two charts below:
Figure 3. Retail Value and Net Farm Value of Pork.
Figure 4. Retail Value minus Net Farm Value
Again it’s not too hard to see that the farmer is not passing the increased cost of his corn feed on to the consumer. In fact, the farmer can’t pass on the extra costs because, as this article so skillfully points out, farmers are “price takers”, not price makers. Farmers do not establish their sales price, the commodities market sets the price for them. It’s a take it or leave it proposition. The farmer either has to take the price offered or not sell his product, it’s as simple as that.
Poultry (Meat & Eggs)
Although the available data for poultry prices is limited, it appears that the increased cost of corn is having an effect at the local grocery. While my knowledge of the poultry industry is virtually zero, I suspect the reason why corn prices are affecting poultry prices more than beef or pork is because poultry products are not commodities. It appears that most of the poultry wholesalers also raise their own birds. Because the wholesaler sets the price to the retailer, they are able to pass along the increased costs of raising the birds. The following chart illustrates this relationship nicely. With the exception of eggs, the price increases are not originating at the retail level.
Figure 5. Retail to consumer spreads for poultry and eggs = Difference between what the retail grocery store pays for the product (wholesale price plus a delivery charge) and what the store charges the consumer.
Milk & Cheese
I don’t think there’s a household in the United States that doesn’t consume milk in one form or the other. Because of this, hardly a day goes by that I don’t here a complaint about the price of milk.
So what’s behind the price increases? Is the price of corn the dominating factor?
The answer to those two questions is complex, but in short, corn is only a small factor in today’s milk prices. The real reason milk prices have went through the roof is because of the laws of supply and demand. Demand is up, and according to the International Herald Tribune, it’s because people are becoming more affluent in the Asian countries:
“But the biggest force driving up milk prices is the same one that has driven up prices for conventional commodities like iron ore and copper: a roaring global economy. Rising incomes in emerging economies from China and India to Latin America and the Middle East are lifting millions of people out of poverty and into the middle class.
It turns out that, along with zippy cars and flat-panel TVs, milk is the mark of new money, a significant source of protein that factors into much of any affluent person’s diet.”
The Tribune goes on to note that:
… The average person in China now consumes more than six gallons of milk a year, up from more than two gallons in 2000.
But there’s more to the story than just demand from China. As it turns out, supply is down sharply. There are a couple of important factors that have affected worldwide milk supplies: drought in Australia and recent record low milk prices that forced dairy farmers to reduce the size of their herds.
Australia is the third-largest dairy exporter in the world. Recent droughts have reduced Australia’s dairy production by almost 1 billion litres, which has reduced worldwide supplies. With the recent La Nina rains in Australia, the situation has improved, but it will take some time for their dairy industry to recover and ramp up production.
Also, few people remember that just a few short years ago, milk prices were very low and the dairy industry was losing a lot of money. Profits were so bad that many referred to the situation as “dire”. This caused many farmers to liquidate their herds, as these numbers from the state of Washington show:
Source: Washington Dairy Products Commission
Most experts agree that milk prices will ease a bit in the future, but it’ll probably be another year or two before that happens. In the meantime, we should urge media outlets such as The Daily Green and Senators such as Charles Schumer to (actually) brush up on Econ 101, and stop advocating terribly misguided policy changes which will do nothing to fix high food prices. There is no reason to hamstring the ethanol industry because ethanol is not the main cause of the problem.