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

What’s Going on With These What’s Going on With These Darn Prices!Darn Prices!

Managing the OpportunitiesManaging the Opportunities(Kevin Bernhardt, UWEX)(Kevin Bernhardt, UWEX)

August 2008August 2008

View From 10,000 Feet – View From 10,000 Feet – Global Situation (Kevin)Global Situation (Kevin)

View From the Top of the Oil Rig View From the Top of the Oil Rig – Oil prices and Biofuels (Alan)– Oil prices and Biofuels (Alan)

View From the Farm gate (Kevin)View From the Farm gate (Kevin)

Farm & Risk Management Team

© 2008

Sources: Websites

• The Oil Drum: http://www.theoildrum.com/story/2006/10/5/215316/408• Association for the Study of Peak Oil: http://aspo-usa.com/ • Oil Market Report: http://omrpublic.iea.org/ • Now and Future: http://www.nowandfutures.com/index.html • WTRG Economics: http://www.wtrg.com/ • World Bank Group: http://ddp-ext.worldbank.org/ext/DDPQQ/member.do?method=getMembers• Farm Foundation: http://www.farmfoundation.org/ • USDA Economic Research Service: http://www.ers.usda.gov/ • Trading Charts, Inc: http://futures.tradingcharts.com/ • CHOICES: http://www.choicesmagazine.org/magazine/issue.php • Foreign Agricultural Service: http://www.fas.usda.gov/default.asp


© 2008

Sources: Written Articles

• Global Agricultural Supply and Demand: Factors Contributing to the Recent Increase in Food Commodity Prices. USDA/ERS, July 2008. http://www.ers.usda.gov/Publications/WRS0801/

• Bahn, Henry. “Commodity Prices Rock World Markets: Structural Shift or Short Term Adjustments?” Choices, AAEA, 2nd qrt 2008 23(2). http://www.choicesmagazine.org/magazine/issue.php

• Westhoff, Pat. “Farm Commodity Prices: Why the Boom and What Happens Now?” Choices, AAEA, 2nd qrt 2008 23(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, 2nd qrt 2008 23(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, 2nd qrt 2008 23(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, 2nd qrt 2008 23(2).

• Abbott, Philip C., Christopher Hurt, and Wallace E. Tyner. “What’s Driving Food Prices?” Issue Report from the Farm Foundation, July 2008. http://www.farmfoundation.org/news/templates/template.aspx?articleid=404&zoneid=26

• 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.


© 2008

Sources: Other

• Extension Outlook Conference, Kansas City, Aug 18-19, 2008.

• Fortenbery, Randy. Presentation to WI Ag Consultants, March 2008.


© 2008

6

0

0.5

1

1.5

2

2.5

3

3.5

1860 1880 1900 1920 1940 1960 1980 2000

My Motivation (Nominal Corn Prices)

Source: USDA

First, A Quick Reminder of First, A Quick Reminder of Economic BasicsEconomic Basics

P

Q

P*

D S


© 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.

DS

P

Q

P

D'

P'


© 2008


• Supply:If the supply for a good increases, then ceritus paribus the price for that good will decrease and visa versa

D

SP

Q

P S’

P'

Individual Supply = MC


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D

S’P

Q

P’S

P

D'


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Prices – A Perfect Storm


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Demand

• Population• Income• Changing Tastes and Preferences• Prices of Complimentary and Substitute

Goods• Value of the Dollar• Trade


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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


© 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!


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Supply

• Growth Rate in Productivity slowed– R& D funding– Non-farm uses for land– Constraints on factors of production (water)– Climate Change??


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- Past gains from Yield not Area - R&D Funding is down - Why fund R&D with surpluses?


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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


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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?


© 2008

World Wheat and Course Grain Ending Stocks

050

100150200250300350400450500

197

9/80

198

2/83

198

5/86

198

8/89

199

1/92

199

4/95

199

7/98

200

0/01

200

3/04

200

6/07

Ending Stocks


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Supply

• Change in stock holding policies By itself, limited impact Exacerbates impact of any short falls

Impact on Price


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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.


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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.


© 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


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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


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Where is Population Growth

0

1000

2000

3000

4000

5000

6000

7000

2006

World

Low & middle income

East Asia & Pacific

Source: World Bank Group:


© 2008

Where’s the Population

Pop. (bil) % of World Rank

World 6.667

China 1.330 19.9 1

India 1.148 17.2 2

Indonesia .238 3.6 6

Bangladesh .154 2.3 9

Nigeria .138 2.1 11

EU .491 7.4 4

U.S. .303 4.5 5

45.1

Source: U.S. Bureau of Census


© 2008

Population Distribution - China


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Population Distribution - US


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Population Distribution - India


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Demand

• PopulationImpact on

Price


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Demand

• Income– Growing at a faster rate– Growing especially in middle income countries

and in Asia


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Gross National Income per Capita

0

1000

2000

3000

4000

5000

6000

7000

8000

1962 1967 1972 1977 1982 1987 1992 1997 2002

World

At what point does the elasticity for food

demand change?



© 2008


0

5000

10000

15000

20000

25000

30000

35000

40000

1962 1968 1974 1980 1986 1992 1998 2004

High income

High Income people don’t eat more food when they get

more money – they buy boats!



© 2008


0

200

400

600

800

1000

1200

1400

1600

1800

2000

1962 1969 1976 1983 1990 1997 2004

Low & middle income

With more income this group buys food and often

more animal protein.



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0

200

400

600

800

1000

1200

1400

1600

1800

2000

1962 1969 1976 1983 1990 1997 2004

East Asia & Pacific



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More Income Changing Diet


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World Meat & Poultry Consumption (1000 MT)

0

50,000

100,000

150,000

200,000

250,000

300,00019

60

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

2008

Source: USDA


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Internet Users (per 100 people)

Source: World Bank Group


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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


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Demand

• Decline of the U.S. dollar


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USD:Euro46


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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


© 2008

Corn and Soybean Exports (TMT)

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

1980 1985 1990 1995 2000 2005

CornSoybeans

Source: USDA/FAS PS&D data


© 2008

Beef and Pork Exports (TMT)

0

200

400

600

800

1000

1200

1400

1600

1800

1980 1985 1990 1995 2000 2005

BeefPork20082008

Source: USDA/FAS PS&D data


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• 45% 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


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Demand

• Decline of the U.S. dollarImpact on

Price


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Demand

• Oil Prices!!!– Increased Income

Bicycle to carIncreased demand for oil

• Increased input cost on Agriculture• Ethanol is profitable

+ Increased demand for corn Changing T&P


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56Through Aug 2007


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Forecasted Oil Exports


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Demand

• Oil Prices!!!

Impact on Price


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Demand

• Hedge and Index Funds

Impact on Price


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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


© 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


© 2008

Prices – A Perfect Storm


© 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)


© 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 permanentWhat changes are permanent- Long vs Short term trends- Long vs Short term trends

Source: USDA-FSA


© 2008

CRP Contract Expiration (Acres)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

2007 2008 2009 2010 2011 2012 2013

US TotalPlainsCorn Belt

Contracts expire on September 30

Source: USDA-FSA

And Here’s And Here’s AlanAlan

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