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Controlling Price Volatility in Food

by 5m Editor
9 August 2011, at 12:00am

Concerns over volatility in the food and agriculture market stem from fears over price rises and behind this, fears over food security, writes ThePoultrySite editor in chief, Chris Harris.

While some producers can benefit from rises in prices, consumers, especially poor consumers, are severely adversely affected.

Most agricultural commodity markets are characterised by a high degree of volatility.

However, a recent report from the Food and Agriculture Organisation at the UN has called for global leaders to take action to ease the fluctuations in prices and calm the fears over food security around the world.

The report – Price Volatility in Food and Agricultural Markets: Policy Responses included contributions by FAO, IFAD, IMF,OECD, UNCTAD, WFP, the World Bank, the WTO, IFPRI and the UN HLTF – was presented to the recent G20 summit of ministers laid down a series of measures to calm the markets.

Producers are more concerned about low prices, which may threaten their living standards as well as their longer term ability to continue, when income is too low to provide for the farm family or for the operational needs of the farm.

The FAO said that when looked at in the long term, there is little or no evidence that volatility in international agricultural commodity prices is increasing.

However, volatility has been higher during the last decade than during the previous two decades.

Since 1990, the implied volatility for major crops has increased significantly and the period since 2006 has been one of extraordinary volatility, according to the report.

Prices rose sharply in 2006 and 2007, peaking in the second half of 2007 for some products and in the first half of 2008 for others. For some products, the run-up between the average of 2005 and the peak was several hundred percent. On the rice market, the price explosion was particularly pronounced.

Prices then fell sharply in the second half of 2008, although in virtually all cases, they remained at or above the levels in the period just before the run-up of prices began.

Market tensions emerged again during 2010 and there have been sharp rises in some food prices.

By early 2011, the FAO's food price index was again at the level reached at the peak of the crisis in 2008 and fears emerged that a repeat of the 2008 crisis was underway.

The FAO says that higher international prices may not always result in better prices for producers and countries that insulate their own markets export instability onto international markets, especially if they are major players in terms of consumption or production.

The degree of processing of final consumption goods also affects price transmission.

Lack of domestic infrastructure and generally undeveloped or inefficient market structures can have a significant affect on prices at they have also to reflect higher transportation and transaction costs.

Developing country markets often lack the capacity to absorb domestic shocks, and can be subject to high domestic price volatility.


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"Trade can help ease the fluctuations in domestic markets but the trade has to be free from market-distorting prohibitions and obstacles"

There are three major reasons why agricultural commodity markets have high volatility.

First, agricultural output varies from period to period because of natural occurrences such as weather and pests.

Second, there is little flexibility in supply and demand as regards price to cope with sudden shocks in the market. Prices have to vary quite strongly, especially if stocks are low, to regain an equilibrium.

Third, because production takes considerable time in agriculture, supply cannot respond much to price changes in the short term, though it can do so much more once the production cycle is completed.

From this last spring, world price levels as reflected in various measures, including the FAO's world food price index, once again reached the levels of 2007/08, giving rise to concerns of a repeat of the earlier crisis.

Several of the same factors known to have contributed to the 2007/08 crisis are also present – weather-related crop losses, export restrictions, high oil prices, and a depreciating US dollar, against a background of a continuing tight supply-demand balance.

However, the situation is slightly different as harvests in 2010 were above average in countries such as Africa and stocks were high so price rises have be redistributed among the commodities.

Meats, sugar and dairy products are all affected, and these are commodities that are less important in the food bills of the poorest nations, where a cereal diet still prevails.

Growing population and income in emerging and developing countries will add significantly to the demand for food in the coming decades.

By 2050 the world's population is expected to have reached about nine billion people and the demand for food to have increased by between 70 per cent and 100 per cent.

The demand for food and feed crops for the production of biofuels is another significant factor.

During the 2007-2009 period, biofuels accounted for a significant share of global use of several crops – 20 per cent for sugar cane, nine per cent for vegetable oil and coarse grains and four per cent for sugar beet.

Projections encompass a broad range of possible effects but all suggest that biofuel production will exert considerable upward pressure on prices in the future.

Agricultural commodity prices are becoming increasingly correlated with oil prices.

Climatic factors also contributed to the price rises in 2007/2008.

Stronger demand for food crops and animal products in conjunction with slow growth in agricultural productivity and low stocks results in upward pressure on prices.

Recent years have also seen some shift in production patterns, particularly of food and feed grains, and world markets are more dependent on supplies from the Black Sea region and other, newer, agricultural production regions than in the past. Yields in these regions are less stable and supply more variable.

The same underlying factors that are leading to increased demand for food – growth in population, affluence leading to increased demand for animal protein, urbanisation and biofuels – are also increasing pressure on finite resources such as land and water.

A depressed US dollar has also had an effect on the market as most commodities are traded in dollars.

Investment in financial derivatives markets for agricultural commodities increased strongly in the mid-2000s but there is disagreement about the role of financial speculation as a driver of agricultural commodity price increases and volatility.

The FAO says that the extent of potential future increases in prices and volatility cannot be estimated accurately but the risks are sufficiently large to warrant serious reflection about what can be done to mitigate it.

Significantly higher food prices are disastrous for the poor especially in developing countries and food price inflation can also be a serious issue in middle-income countries.

Low or volatile prices pose significant problems for farmers and other agents in food chains, who risk losing their investments if price falls occur while they are locked into strategies dependent on higher price levels.

The FAO report calls for investment in developing countries to help create stability, with most of the investment from private sources.

It also calls for greater investment in research, which in turn requires greater management skills.

Increasing public investment in transport and productive infrastructure, as well as in human capital, is central in stimulating productivity and reducing post-harvest wastage, the FAO told the G20 leaders in the report.

All these responses to increase the resilience of agriculture and stabilise prices require public interventions and government expenditure on agriculture can have a significant positive impact on productivity.

The FAO also called for an improved information system on the food chain with better information on stocks.

It said that monitoring food prices, both on cash and futures markets, is essential in a food market monitoring system.

FAO adds that attempting to stabilise prices by using buffer stocks is potentially very costly and has had a reverse effect in the past.

FAO adds that there are divided opinions about whether speculators on the futures markets, the markets themselves and hedging on the futures markets stabilises or destabilises commodity prices. However, it calls for more transparency in these markets and dealings.

Comprehensive trading data need to be reported to enable regulators and participants to monitor information about the frequency and the volume of transactions to understand what is driving commodity prices.

The FAO said that trade can help ease the fluctuations in domestic markets but the trade has to be free from market-distorting prohibitions and obstacles.

It called for:

  • substantially improved market access, while maintaining appropriate safeguards for developing countries, especially the most vulnerable ones
  • substantially reduced trade-distorting domestic support, especially by developed countries, and
  • the elimination of export subsidies.

The FAO also called for a system of national and international safety nets to handle short-term crises. These, it says, are necessary because food price surges, as well as increased prices of inputs such as fertilisers, reduce the incomes of poor and vulnerable households, and put stress on family budgets.

Further Reading

- You can view the full report by clicking here.


August 2011