What’s Going on With These Darn Prices! Managing the Opportunities (Kevin Bernhardt, UWEX) August 2008

View From 10,000 Feet – Global Situation (Kevin) View From the Top of the Oil Rig – Oil prices and Biofuels (Alan) View From the Farm gate (Kevin)

Farm & Risk Management Team © 2008 Sources: Websites The Oil Drum: Association for the Study of Peak Oil: Oil Market Report: Now and Future: WTRG Economics: World Bank Group: Farm Foundation: USDA Economic Research Service: Trading Charts, Inc: CHOICES: Foreign Agricultural Service:

Farm & Risk Management Team © 2008 Sources: Written Articles Global Agricultural Supply and Demand: Factors Contributing to the Recent Increase in Food Commodity Prices. USDA/ERS, July / / Bahn, Henry. “Commodity Prices Rock World Markets: Structural Shift or Short Term Adjustments?” Choices, AAEA, 2 nd qrt (2). Westhoff, Pat. “Farm Commodity Prices: Why the Boom and What Happens Now?” Choices, AAEA, 2 nd qrt (2). Lawrence, John D., James Mintert, John D. Anderson, and David P. Anderson. “Feed Grains and Livestock: Impacts on Meat Supplies and Prices.” Choices, AAEA, 2 nd qrt (2). Irwin, Scott H., Philip Garcia, Darrel L. Good and Eugene L. Kunda. “Recent Convergence Performance of CBOT Corn, Soybean, and Wheat Futures Contracts.” Choices, AAEA, 2 nd qrt (2). Mark, Darrell R., B. Wade Brorsen, Kim B. Anderson, and Rebecca M. Small. “Price Risk Management Alternatives for Farmers in the Absence of Forward Contracts with Grain Merchants.” Choices, AAEA, 2 nd qrt (2). Abbott, Philip C., Christopher Hurt, and Wallace E. Tyner. “What’s Driving Food Prices?” Issue Report from the Farm Foundation, July Fortenbery, T. Randall and Hwanil Park. “The Effect of Ethanol Production on the U.S. National Corn Price.” Univ. of WI-Madison Dept. of Ag and Applied Econ: Staff Paper no. 523, April 2008.

Farm & Risk Management Team © 2008 Sources: Other Extension Outlook Conference, Kansas City, Aug 18-19, Fortenbery, Randy. Presentation to WI Ag Consultants, March 2008.

Farm & Risk Management Team © My Motivation (Nominal Corn Prices) Source: USDA

First, A Quick Reminder of Economic Basics P Q P* D S

Farm & Risk Management Team © 2008 Law of Price Determination Demand: If the demand for a good increases, then ceritus paribus the price for that good will increase and visa versa. D S P Q P D' P'

Farm & Risk Management Team © 2008 Law of Price Determination Supply: If the supply for a good increases, then ceritus paribus the price for that good will decrease and visa versa D S P Q P S’ P' Individual Supply = MC

Farm & Risk Management Team © 2008 Law of Price Determination D S’ P Q P’ S P D'

Farm & Risk Management Team © 2008 Prices – A Perfect Storm

Farm & Risk Management Team © 2008 Demand Population Income Changing Tastes and Preferences Prices of Complimentary and Substitute Goods Value of the Dollar Trade

Farm & Risk Management Team © 2008 Supply Anything that changes the physical capacity to produce – Technology (productivity gains) – Weather – Factors of production (water, labor, etc) Changes in input prices Trade (domestic) Changes in units of production – Institutional (govt) – Switch to other kinds of production – More or less land in production

Farm & Risk Management Team © 2008 Food For Thought The world is not ceritus paribus, It’s Dynamic – Multidimensional mess of constantly changing factors, substitutions, and interrelationships. – Add to that the wild card of market psychology. – Long-term trends messed up by short term shocks – The world’s producers and consumers will respond  High prices over time will lead to more supply which will lead to a fall in prices.  However, the structure of the factors of supply and demand, how they change, the volatility of their change, and the importance (elasticity) of change may be different  It’s not the first time!

Farm & Risk Management Team © 2008 Supply Growth Rate in Productivity slowed – R& D funding – Non-farm uses for land – Constraints on factors of production (water) – Climate Change??

Farm & Risk Management Team © Past gains from Yield not Area - R&D Funding is down - Why fund R&D with surpluses?

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008 Supply Growth Rate in Productivity slowed – R& D funding – Non-farm uses for land – Constraints on factors of production (water) – Climate Change?? Impact on Price

Farm & Risk Management Team © 2008 Supply Change in stock holding policies – 80’s and 90’s were an era of:  Surpluses  Stability  Free Trade So why go through the expense of holding stocks?

Farm & Risk Management Team © 2008 World Wheat and Course Grain Ending Stocks

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008 Supply Change in stock holding policies  By itself, limited impact  Exacerbates impact of any short falls Impact on Price

Farm & Risk Management Team © 2008 Supply Weather Shocks – 2006  Russia and Ukraine  Australia  South Africa – 2007  SE Europe  Russia and Ukraine  Turkey, Australia, Argentina, etc. Impact on Price Historically, two successive years of lower global production occurs about once per decade.

Farm & Risk Management Team © 2008 Supply Higher Oil Prices – Direct Affect: Higher energy costs for transportation, drying, etc. – Indirect: Higher fertilizer costs and fuel surcharges on other inputs Leads to increased marginal costs – Shifts in practices, shifts to alternative uses,  Lower production Shorter supply and higher prices Impact on Price Likely have not felt the full impact of this yet.

Farm & Risk Management Team © 2008 Supply Recap Productivity has slowed World stocks are tight: Policy World stocks are tight: Weather shocks Increasing Input Prices CRP and etc. Switch in production Impact on Price

Farm & Risk Management Team © 2008 Demand Population – Growth rate is slowing, but in absolute number of mouths to feed the world is growing at about 75 million per year  That’s ¼ of US population per year  That’s almost 1 billion more people in next 12 years

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008 Where is Population Growth Source: World Bank Group:

Farm & Risk Management Team © 2008 Where’s the Population Pop. (bil)% of WorldRank World6.667 China India Indonesia Bangladesh Nigeria EU U.S Source: U.S. Bureau of Census

Farm & Risk Management Team © 2008 Population Distribution - China

Farm & Risk Management Team © 2008 Population Distribution - US

Farm & Risk Management Team © 2008 Population Distribution - India

Farm & Risk Management Team © 2008 Demand Population Impact on Price

Farm & Risk Management Team © 2008 Demand Income – Growing at a faster rate – Growing especially in middle income countries and in Asia

Farm & Risk Management Team © 2008 Gross National Income per Capita At what point does the elasticity for food demand change? Source: World Bank Group:

Farm & Risk Management Team © 2008 Gross National Income per Capita High Income people don’t eat more food when they get more money – they buy boats! Source: World Bank Group:

Farm & Risk Management Team © 2008 Gross National Income per Capita With more income this group buys food and often more animal protein. Source: World Bank Group:

Farm & Risk Management Team © 2008 Gross National Income per Capita Source: World Bank Group:

Farm & Risk Management Team © 2008 More Income  Changing Diet

Farm & Risk Management Team © 2008 World Meat & Poultry Consumption (1000 MT) Source: USDA

Farm & Risk Management Team © 2008 Internet Users (per 100 people) Source: World Bank Group

Farm & Risk Management Team © 2008 Demand Income – Growing at a faster rate – Growing especially in middle income countries and in Asia – More people with higher incomes not only demand more and different food, but also more energy. – Income growth can slow, even go negative, but at some point elasticity for food demand changes. Impact on Price

Farm & Risk Management Team © 2008 Demand Decline of the U.S. dollar

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008 USD:Euro 46

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008 Demand Decline of the U.S. dollar – You are holding lots of dollars – Because of the value of the dollar, US goods are relatively cheap – So what do you do?  Buy U.S. commodities

Farm & Risk Management Team © 2008 Corn and Soybean Exports (TMT) Source: USDA/FAS PS&D data

Farm & Risk Management Team © 2008 Beef and Pork Exports (TMT) Source: USDA/FAS PS&D data

Farm & Risk Management Team © % dollar depreciation since 2002 – At 2002 levels oil price at $75/b (Hurt) High dollar reserves coupled with dollar depreciation – $6.00/bu corn becomes $3.30 corn

Farm & Risk Management Team © 2008 Demand Decline of the U.S. dollar Impact on Price

Farm & Risk Management Team © 2008 Demand Oil Prices!!! – Increased Income  Bicycle to car  Increased demand for oil Increased input cost on Agriculture Ethanol is profitable + Increased demand for corn Changing T&P

Farm & Risk Management Team © 2008

Farm & Risk Management Team © 2008

Farm & Risk Management Team © Through Aug 2007

Farm & Risk Management Team © 2008 Forecasted Oil Exports

Farm & Risk Management Team © 2008 Demand Oil Prices!!! Impact on Price

Farm & Risk Management Team © 2008 Demand Hedge and Index Funds Impact on Price

Farm & Risk Management Team © 2008 Demand Prices of Complimentary and Substitute Goods – If pork is profitable, then demand for feed will be greater – Lots of give and take here Impact on Price

Farm & Risk Management Team © 2008 Recap Productivity has slowed World stocks are tight: Policy World stocks are tight: Weather shocks Increasing Input Prices CRP and etc. Switch in production Population Per capita income US dollar decline Oil prices (ethanol demand) Hedge and Index Funds Price of other goods Impact on Price

Farm & Risk Management Team © 2008 Prices – A Perfect Storm

Farm & Risk Management Team © 2008 Food For Thought The world is not ceritus paribus – The world’s producers and consumers will respond  High prices over time will lead to more supply which will lead to a fall in prices.  High profitability will lead to technological innovation  High prices will lead consumers to substitute, conserve, etc. Facing the guillotine is a great way to focus the mind (source unknown)

Farm & Risk Management Team © 2008 What About Tomorrow? Productivity has slowed World stocks are tight: Policy World stocks are tight: Weather shocks Increasing Input Prices CRP and etc. Switch in production Population Per capita income US dollar decline Oil prices (ethanol demand) Hedge and Index Funds Price of other goods Impact on Price What changes are permanent - Long vs Short term trends -What changes are permanent - Long vs Short term trends

Source: USDA-FSA

Farm & Risk Management Team © 2008 CRP Contract Expiration (Acres) Contracts expire on September 30 Source: USDA-FSA

And Here’s Alan