Mitigating food price fluctuations: Is it possible?

Achmad Syafriel , Analyst | Wed, 04/16/2008 12:31 PM | Business

As long as there is no significant increase in supply, soft commodity prices will not ease soon.

We saw competition between the demand for food and the demand for biofuel emerge last year. With oil prices staying high and volatile, many countries were encouraged to seek alternative fuels.

There were many options to chose from, from using coal to geothermal as an alternative fuel. However, biofuel (a mix between fossil fuel and vegetable oil) was seen as the most feasible option for many countries at the time considering its low price, almost non-existent or very low emission, and it being considered a renewable resource.

The European Union pioneered the use of biodiesel (biofuel mix of diesel oil with rapeseed oil and CPO) through a regulation requiring biodiesel use of up to 5.75 percent of total fuel consumption by 2010 and 20 percent by 2020 for all member countries.

This move has been followed by many countries, including the United States. Starting this year, the U.S. government plans to expand the country's bioethanol (mix of gasoline with ethanol from corn) production to 9 billion gallons by the end of the year and to a further 36 billion gallons in 2022.

The decision to develop biofuel in many countries has had a significant impact on the balance between supply and demand for soft commodities in the global market. Demand from the food industry for soft commodities used as biofuel feedstock, such as corn, rapeseed and CPO, was already high even before biofuel demand came into the equation.

After biofuel programs were delivered, according to the World Bank, the United States used 20 percent of its corn production to produce ethanol while Brazil used 50 percent of its sugarcane production to produce ethanol.

The EU, as the pioneer, used more than half of its rapeseed oil production and reached 68 percent of the total for biodiesel production.

The implications do not stop there -- it has had a huge impact on soft commodity prices. CPO reached its historical high at US$1,395/MT in Rotterdam while corn reached its highest level at $6.16 in Chicago.

To benefit from high prices, farmers tended to plant more commodities used for biofuel than commodities used only for food. For example in the U.S, more farmers planted corn than soybean. Therefore, soybean supply dropped and the price surged.

In fact, the production of commodities used for staple foods such as rice and wheat declined due to many factors. Less area for agricultural commodities planting and bad weather were major factors causing lower staple food production around the world.

The situation worsened globally. Realizing food prices were climbing due to supply shortages amid continuing strong demand from food and biofuel industries, many major commodity producing countries secured their domestic supply.

According to the United States Department of Agriculture, many major rice suppliers have placed a ban or quota on their exports. Vietnam has placed a ban on rice exports. India imposed limited ban on non-basmati rice exports. Export from China is expected to drop 300,000 tons as China placed a tax and quota system on exports.

Indonesia, besides being the largest CPO producer, is also the second largest consumer of CPO. To secure its domestic supply for cooking oil production, Indonesia is imposing a progressive export tax rate on CPO. The higher CPO prices in Rotterdam, the higher export tax rate.

Currently Indonesia is imposing a 20 percent tax rate on CPO exports after the average price in Rotterdam reached $1,200/MT in March.

Imposing a high export tax and placing an export ban or quota might be seen as the right measure to secure domestic supply, but these measures reduce supply to the global market.

Prices are consequently increasing since demand is still strong.

Note, there is no country in the world that is self-sufficient in every commodity.

Indonesia, for example, is self-sufficient in CPO but still needs to import approximately 1 million tons of soybean and 500,000 tons of rice to fulfill total domestic consumption. Hence, Indonesia will bear the huge import cost from both commodities.

As a result, high inflation is just around the corner.

In summary, before deciding to impose export tax or to place quota or ban export, every country should recalculate the wider impact.

The only option to mitigate food price fluctuations and secure domestic supply is to increase the production of important commodities by planting more and increasing productivity.

Without significant increase in supply, nothing can be done by any country or government to mitigate food price fluctuations since prices are no longer in their hands.

The writer is a research analyst at Bahana Securities

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