The Future of Food Prices
In the immediate aftermath of Russia’s invasion of Ukraine, there was a sharp price rise in a number of agricultural commodities (see Exhibit 1). The reasons for this were in line with those behind the price rises in certain metals and natural gas. Russia and Ukraine are both major commodity exporters and when the invasion began, there were widespread expectations that supply would dry up.
This did in fact play out. Supply was constrained, which forced prices up, particularly in those commodities where Russia and Ukraine account for a large proportion of global exports such as wheat, barley and corn (see Exhibit 2).
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Agricultural commodity prices have, however, eased since then. The FAO Food Price Index, which tracks the monthly change in international prices of a basket of food commodities, dropped for the fifth consecutive month in August. Its level is now at its lowest in seven months (see Exhibit 3).
Wheat prices saw the biggest drop amongst commodities. This was driven by improved harvest prospects in Canada, the US and Russia in addition to the resumption of exports from the Black Sea for the first time in almost five months. Alongside this, vegetable oil, dairy, meat and sugar prices fell.
Despite the drop over the summer, the FAO Food Price Index is still above its value a year ago. Moreover, we don’t believe these high food prices are going away anytime soon, and there is a high likelihood that these agricultural commodities see their prices rise over the remainder of this year and 2023.
The supply and demand dynamics that pushed prices up earlier in the year have not gone away. Whilst the supply issues arising from the Russia and Ukraine war have eased, there were problems before then, which drove prices higher in 2021. They remain unchanged.
On the demand side, the global food crisis is a continuing problem. With an increasing population, the demand for food will be higher than ever. More important is the supply side, which we expect will become more constrained over the winter period and into next year. There is a real possibility that this worsens beyond 2023 and the supply/demand imbalance deteriorates.
For one, how long the Russia and Ukraine war will last is unknown. It could get worse, and this could impact many agricultural regions across the countries via the associated destruction of crops, equipment and machinery. These disruptions will cause prices to rise, but it can also affect the price on various other commodities, for instance palm oil, because it is often used as a substitute for other vegetable oils. A price rise on certain commodities will also deter farmers from producing those commodities where profit margins are lower, such as wheat.
Supply chains are still fragile on the back of the effects of the pandemic. As an example, the supply disruption in the fertiliser market will mean lower fertiliser deliveries, which will impact crop yields. The higher cost of fertilisers (see Exhibit 4) are also resulting in lower crop yields.
Additionally, unpredictable weather patterns will continue to affect key crop-producing countries, increasing supply uncertainty. We’ve already seen this happen with shifting food patterns when the mean temperature rises, and precipitation patterns change. Worst of all, the relationship between the temperature and crop yields is not linear. Even a modest rise in the average temperature will have a very negative impact on the output.
Extreme weather events are also likely to happen more often, and to a greater severity with climate change expected to worsen in the coming years. We’ve already seen droughts, floods and tropical cyclones, and it’s only going to get worse. Exhibit 5 shows how exposed cropland is to just one of these extreme weather events (drought) across various regions.
There are also political factors that could contribute to rising food prices, mainly from a supply angle. What we have been seeing lately is a host of export bans (see Exhibit 6) from various nations in a bid to improve their respective country’s food scarcity problems. Most export bans that were implemented this year will be in effect until the end of 2022. While these bans are short-term, the food crisis only looks to worsen. Supply could remain constrained, which could force many nations to extend export bans or re-implement them at some stage. This is all the more likely given the uncertainty around the war between Russia and Ukraine, and it is not helped, when Russian President Vladimir Putin on 7th September 2022 called for a review of the UN-brokered deal, allowing Ukraine to export agricultural commodities.
As these bans persist, the supply into the global market will fall and this will naturally cause prices to rise. This is further exacerbated by a greater reliance on smaller producers, focused domestically. This will result in a greater susceptibility to climate change effects and unforeseen weather patterns, which will create greater price volatility in the future.
So, we are in an environment where, in the next year or two, higher fertiliser prices, supply disruptions and export bans could have a major impact on the supply of many agricultural commodities and thus drive prices much higher. And this is not even taking into account the impacts of climate change.
This all means that resource intensity needs to be reduced. Alternatively, the agricultural industry needs to be made far more sustainable than it already is. But this is not something that can be achieved overnight, let alone over the next few years. This all points to increased demand and tighter supply in the agricultural commodities market, which will keep prices elevated, if not trend upwards, at least in 2022-23 and quite possibly for much longer.
20 September 2022