The Role of Biofuels as a Possible Major Factor in the Food Crisis 2007-08


Seminar Paper, 2011

22 Pages, Grade: 1,3


Excerpt

Table of Contents

1 Introduction

2 The Anatomy of the Price Hike

3 Possible Causes of the Food Price Crisis 2007-08
3.1 Strong growth in demand
3.2 Financial Speculation
3.3 Depreciation of the Dollar
3.4 Escalating Oil Prices
3.5 Trade Shocks: Adverse Weather, Export Bans and Import Surges
3.6 Biofuels

4 Quantifying the Impact of Biofuels on Rising Food Prices

5 Reasons Behind the Escalating Demand for Biofuels

6 Concluding remarks

References

Appendix

1 Introduction

Agricultural commodity markets usually do not receive a significant amount of me- dia attention as producers in the developed countries are not substantially affected by volatility in the markets due to widespread subsidies and price support. Wealthy con- sumers do not recognise world market changes because the share of expenditures spend on food is generally decreasing with higher income and inflation transmission related to food commodities are typically low. This fact did not hold in 2008 when global food prices peaked at record-high levels only comparable with the disastrous first global food crisis of 1974 (Headey and Fan 2010). Between 2005 and 2008 the prices of most major cereals almost doubled or tripled, causing violent food riots all over the world. World Bank President Robert B. Zoellick emphasised in mid-April 2008, at the peak of the price surge, that “a doubling of food prices over the last three years could potentially push 100 million people in low-income countries deeper into poverty” (WB 2008).

This price rise took place in a very short period of time and especially the rapid in- crease between January 2007 and April 2008 (and the immediate decline afterwards) needed an explanation. A lot of rash statements were made meanwhile and immedi- ately after the food crisis, coming from the media, politicians and lobbies. Most of the non-academic commentaries lacked differentiation and evidence in the attempt to explain the reasons and factors which caused the price spike. Western policy makers insisted on explaining that the developing and emerging countries themselves were responsible for increasing prices “due to poor agricultural policies and changing eat- ing habits in developing nations” as argued by German Chancellor Merkel (Reuters 2008). The media and different pro-poor lobby groups used biofuels or speculation as scapegoats for the entire price rise while the academic literature discussed the weight of these factors and added others like global economic growth, higher energy prices, declining stocks, adverse weather events and decline in agricultural investment (El- liot 2008). This paper aims to summarise the scale of influence that different factors had during the price surge, dealing especially with biofuels as a possible major cause of the crisis. Therefore, it is necessary to first examine the characteristics of the price surge. Secondly, the role of every single suspicious factor will be evaluated, and fi- nally, the reasons behind the appearance of the most important factor will be investi- gated.

2 The Anatomy of the Price Hike

The world has seen relatively stable food prices between the early 1980s and early 2000s with prices of key cereals even declining in real terms over such a long period. Food prices reached their lowest values directly at the outset of the rise taking place from 2002 onward (see Appendix A.1 for the chart). Among most of the publications dealing with recent food price movements there is consensus that this downward trend had reversed 10 years ago. International food commodity prices went up mod- erately between June 2002 and June 2006, reflected in a jump of the FAO Food Price Index (FFPI)1 from 85.3 to 120.2 (see Appendix A.2 for chart). From this time for- ward the process of increasing prices accelerated drastically. From June 2006 until June 2008 the FFPI climbed another 93.3 points (177.6 per cent change) with the peak at 213.5.

This tremendous development in international agricultural markets becomes more illustrative if we look at various important grain prices during the price surge. Ac- cording to Mitchell (2008) wheat prices increased 127 per cent, rice prices increased 170 per cent and maize prices almost tripled from January 2005 until June 2008 (see Appendix A.3 for chart). For the sake of clarity and the aim of this paper to state the effects of different factors, especially biofuels, contributing to this increase it is worth mentioning the timing of the different price rises. In agricultural markets dif- ferent grain prices are highly interlinked across each other because of substitution effects such as shifting land or demand substitution. Therefore it is important to re- tain the fact that maize prices rose first, directly followed by wheat and then rice (Headey and Fan 2010).

After reaching the peak, prices of every staple grain (and other commodities) plunged down immediately with the same speed as they rose before but stopped at a much higher level. The FFPI reached the lowest point in February 2009 (Appendix A.2) with the same level as mid-2007. From then on, prices have been rising steadily to this day, especially maize, with alarming pace since July 2010. At the date of writ- ing, the FFPI reached a slightly higher level than the peak in 2008. It becomes clear that not only short-term factors led to the crisis. Structural medium- and long-term changes are taking place, causing an immense upward trend in global food prices.

3 Possible Causes of the Food Price Crisis 2007-08

In recent years there has been a lot of scientific work done in the field of recent food price developments and the food crisis of 2007-08. Most of them agree on the list of factors that played a part in increasing food commodity prices but there is limited academic work dealing with the quantification and the specific causalities of the dif- ferent factors. Agricultural commodity markets in general and commodity price for- mation in particular are a complex system of many different events and causalities because it is a global phenomenon (both the demand and supply side) with many determinants being interconnected. On account of this problem, Headey and Fan (2010) state that “the more one assesses this crisis, the more one concludes that it is the result of a complex set of interacting factors rather than any single factor.” None- theless, it is worth assessing the contribution of different factors because besides exogen ones some factors are considered as being policy-driven such as the rapid expansion of biofuels production, export-import-policies and speculation in futures markets. Understanding the role of these factors in the food price crisis and potential policy implications for the future is the main aim of this writing.

3.1 Strong growth in demand

One of the major explanations for surging food prices is the fact that a lot of develop- ing and emerging countries experienced a strong economic growth in conjunction with an increase in population. This progress can be exemplified by looking at the largest populated country in the world, China. Real GDP in this region rose by 9 per cent per annum between 2004 and 2006 (Flammini 2008) and the widely known fact that Chinese consumers are changing their consumer behaviour towards more meat and dairy products is reflected by empirical evidence. Between 1990 and 2005 meat consumption increased by 240 per cent and milk consumption tripled (von Braun 2007). This change implicates an escalating demand for grain as a feedstock.Leibtag (2008) estimates that 7 kg of maize are needed to produce 1 kg of beef. Some experts argue that this shift in demand accounts for a large share of the food price crisis but it remains highly questionable if one looks at other facts. First, this trend occurred slowly and can not alone be responsible for such a quick increase in global prices. Second, China and India are mostly unimportant players within global commodity markets. Imports of important agriculture goods in East Asian countries remained constant during the last 20 years and India and China can be called self-sufficient being merely net-exporters of cereals and can hardly be blamed for the rapid global food price increase (Flammini 2008).

3.2 Financial Speculation

While various media reports suggested that financial speculation in commodity fu- tures markets had initiated the price spike most of the academic commentaries con- cluded that at the very most, this could only be a reaction to the opportunity of tight markets. It is true that new players, such as index funds and other speculative inves- tors debuted around the same time while prices began to rise significantly because regulation had gradually been loosened and with the housing bubble bursting in 2007, investors grasped the opportunity to shift portfolios towards agricultural future markets. Thus, it could be inferred that growing activity from non-traditional partici- pants led to increasing prices and rising volatility in the markets. This deduction does not hold well if one looks at the incentives of financial intermediaries. Speculation only becomes attractive if there is already substantial volatility in the markets and other factors contribute to changing expectations (Headey and Fan 2010). Therefore, financial speculation can hardly be the cause of this crisis because it is not creating the environment which increases prices. Speculation can only be seen as a symptom of changing market conditions, such as tight markets and price volatility (Collins 2008).

3.3 Depreciation of the Dollar

Another phenomenon appeared around the same period of time as food prices in- creased. Between January 2002 and June 2008, the U.S. dollar depreciated about 35 per cent against the euro (Mitchell 2008). During the last decades, there has been a non-ambiguous link between a weak dollar and higher commodity prices because crude oil and grains are priced in U.S. dollar and a depreciation of the dollar usually leads to higher demand for U.S. agricultural commodity exports and higher oil prices (more on the oil price influence below). Essentially the same relationship emerged in the recent decade when the value of U.S. agricultural exports increased 54 per cent from 2002 to 2007 (Abbott et al. 2008). Mitchell (2008), being tough enough to es- timate different factors contribution to the food price hike as we see later, concluded from this relationship that the decline of the dollar has increased food prices by about 20 percent. Hence, this widely accepted result can only explain a small fraction of the total rise.

[...]


1 Other indices exist for commodity food prices (World Bank food price index, IMF Commodity Price Index), but for simplicity and comparability only FAO Food Price Index is used as an index

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Details

Title
The Role of Biofuels as a Possible Major Factor in the Food Crisis 2007-08
College
University of Freiburg  (Institut für Volkswirtschaftslehre und Finanzwissenschaft I)
Course
The Economics and Politics of Global Agriculture and Trade
Grade
1,3
Author
Year
2011
Pages
22
Catalog Number
V168272
ISBN (eBook)
9783640852239
ISBN (Book)
9783656058557
File size
622 KB
Language
English
Tags
Biofuels, Food Crisis, Food Price Crisis, Food vs Fuel, Renewable Fuels, Biofuel, Commodity, Food Prices, 2007, 2008, 2007-2008
Quote paper
Ronny Röwert (Author), 2011, The Role of Biofuels as a Possible Major Factor in the Food Crisis 2007-08, Munich, GRIN Verlag, https://www.grin.com/document/168272

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