ST. LOUIS – The global crisis caused by high grain and food prices has little to do with supply and a lot to do with demand.
The government predicted Thursday that U.S. farmers this year will produce their second-biggest corn crop since 1944. Yet all that won't likely be enough to halt food-price inflation.
Pushing grain prices up, possibly for years to come, are growing sources of consumption: demand from an expanding Asian middle class; increased use by the U.S. ethanol industry; and speculation in futures contracts for grain and other commodities.
Farmers intend to plant 92.2 million acres of corn this spring, 5 percent more than last year, the Agriculture Department estimated Thursday. Prices of corn and soybeans rose after the report. Analysts warned that even with more corn acreage, prices won't drop back to their lower levels of six months ago.
The government said earlier this year that corn reserves were at their lowest level in 15 years. Financial markets have been left jittery. Relatively slight declines in supply, from droughts and other short-term disruptions, can send prices jumping.
"Stocks are going to remain very tight," said John Sanow, a grain markets analyst with Telvent DTN in Omaha.
Grain prices have reached their highest points since the food crisis of 2008. The price of corn doubled since last summer, from $3.50 to more than $7 a bushel. Those high prices are encouraging farmers to plant more corn — but not enough to lower prices.
The price of corn had fallen this week to about $6.60 a bushel. But after Thursday's report, it shot up to $6.93 a bushel.
Some of the increase in corn planting comes at the expense of this year's soybean crop. Farmers intend to plant 76.6 million acres of soybeans. That's down 1 percent from last year. Soybean prices rose 3 percent to close at $14.10.
It can take months for grain prices to filter through to U.S. groceries. That's because ingredient costs account for only about 10 percent of the price of the processed food Americans buy. The government estimated earlier this year that overall food prices would rise a little more than 3 percent this year.
There are limits on supply. Traders fret that farmers will expand the corn crop by planting on acreage previously set aside for conservation. That land isn't highly productive, so crop yields there could be disappointingly low, KeyBanc Capital Markets Akshay Jagdale said in a report.
If yields look sluggish this summer, and if bad weather affects the Midwest, prices could climb again, Jagdale said.
Crop prices have always risen and fallen in cycles. What's different now is that today's higher prices are expected to stay high, possibly for years, because of the growing sources of global consumption.
With supplies low relative to demand, any short-term supply disruptions can cause a spike in prices.
"We're in a dangerous situation," said David Hallam of the U.N.'s Food and Agriculture Organization. "When you do get supply shocks for whatever reason, whether it's bad weather or whatever, it's quite likely there will be a bigger reaction."
Farmers have managed to produce record harvests of the worlds' staple crops. But demand has for soybeans has risen 3 percent faster than supplies. For wheat, it's grown 3 percent faster. Corn supplies grew a tiny 0.5 percent faster than demand.
The result is that corn reserves have sunk to about 14 percent of the amount expected to be used this year. Soybean reserves are at 23 percent, wheat at 27 percent.
Helping push up demand is the growing middle class in Asia, especially China. As incomes have risen, so has demand for beef and for soybeans to feed animals. In China, the annual demand for soybeans has rocketed from about 27 million metric tons in 2000 to about 69 million metric tons this year.
For years, investors didn't figure that grain demand in the developing world rise high enough to push grain prices up, said Don Coxe, an investment advisor and chairman of Coxe Advisors LLC.
"The view was that we fed our own people, and we did send stuff to the underdeveloped countries ... but this was just getting rid of our surpluses," Coxe said.
But increasingly affluent Chinese and Indians can now afford milk and pork. That requires huge amounts of grain. About seven pounds of vegetable protein are needed to make one pound of beef protein, Coxe said. Each pound of pork requires six pounds of vegetable protein.
Contributing to demand for corn is the U.S. ethanol industry. The 2005 Energy Policy Act mandated increasing portions of ethanol that must be blended into gasoline sold in the United States.
The number of ethanol plants more than doubled between 2005 and 2010. Ethanol plants are expected to consume about 40 percent of the total U.S. crop. That compares with just 14 percent in 2005.
This month, corn traded above $7 a bushel. Many traders say it could surpass the record high of $7.65 a bushel it reached in 2008.
In a normal market, such high prices would reduce demand from ethanol plants. The more expensive corn gets, the less profit they make.
But the government mandate guarantees that ethanol demand will stay strong. It calls for nearly 14 billion gallons of renewable fuel to be produced this year. Next year, the mandate jumps to more than 15 billion gallons.
Financial speculation is also helping keep grain prices high. John Sanow, a grain market analyst with Telvent DTN, notes that speculators often cause exaggerated price swings because they trade on momentum. As prices rise, investors snap up futures contracts for grain, driving prices higher.
Financial deregulation opened the door for pensions, hedge funds and other big investors to buy more contracts in the commodities market. That made grain markets far more volatile, said Scott Irwin, an agriculture economics professor at the University of Illinois.
Some of the price fluctuation may ease as a result of the new financial overhaul law. The law calls for limits on speculative trading of commodities futures. The restrictions are aimed at financial firms that seek to profit on swings in market prices. Agricultural companies, airlines and others that trade futures to hedge against price changes won't be affected.
Irwin notes that low crop reserves contribute to price volatility. When reserves are at adequate levels, a decline in grain supplies tends to cause prices to rise modestly. But when reserves are unusually low relative to demand, short-term supply disruptions can cause prices to jump exponentially, Irwin said.
In part, that's because unlike with other goods, rising food prices generally don't cause people to buy less food. Rather, they typically cut spending on other things so they can keep the diets they're accustomed to. Prices tend to stay high until demand finally slackens.
"It's, in essence, how painful you have to make food costs to get someone to eat less," Irwin said.
U.S. consumers are relatively shielded because raw ingredients account for just a small fraction of the price of the processed foods most Americans eat. It can take months for the price of corn to show up in the price for corn flakes. Grocers and food processors are also loath to pass on costs that could reduce sales.
Still, U.S. food prices are expected to increase between 3 percent and 4 percent this year, the Agriculture Department says.
For developing countries, the impact is dire. Consumers there can spend 70 percent of their take-home pay on food. That raises the risk that higher prices will cause political instability.
That's what happened in 2008, when food riots erupted in countries like Haiti. More recently, high food prices contributed to the unrest in Tunisia that sparked revolts in Egypt, Libya and elsewhere in the Middle East.
"They're exposed to what is happening in the world (grain) markets," said Hallam of the FAO.
AP Business Writer Marcy Gordon contributed to this report from Washington.
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