Rising food prices will reap bitter harvest

British shoppers should brace themselves for “massive” food price rises in 2013, says the aptly-named Mark Price, the Managing Director of Waitrose. Is he correct, or is this just another retailer trying to soften up public opinion before imposing gouging price hikes?

It strikes me that Price most certainly is right and his statement deserves more comment and consideration. For it is almost inevitable that many crucial foodstuffs will become considerably more expensive during 2013, not least due to recent weather patterns. More fundamentally, the food price rises we’ll see over the coming year will also reflect longer-term non-cyclical trends, not least the burgeoning world population.

During 2013, in fact, rising food prices are likely not only seriously to impact the global economy, but could well spark violence and political upheaval, not least in the Middle East. The importance of the trend Price has highlighted, then, goes way beyond the tills of upmarket British supermarkets.

It’s certainly the case, though, that UK food production looks weak, as heavy rainfall in 2012 meant many crops were ruined and farmers couldn’t plant as much as they wanted for 2013. Despite a very dry first quarter, 2012 was this country’s second-wettest year/ since records began in 1910.

While it was the year-end winter flooding that caught the headlines, the impact of heavy rainfall from last Spring onwards will continue to be felt in the inflation numbers well into 2013. While UK food price inflation accelerated to 4.6pc in November according to the British Retail Consortium, up from 4.0pc the month before, these numbers are likely to get much higher over the next few months.

Despite the on-going sluggishness of the UK economy, dipping in and out of recession in recent years, the Bank of England has overshot its 2pc CPI inflation target for 36 months in a row. During 2013, rocketing food prices won’t do anything to help the Bank control inflation.

While the UK’s problem has been too much water, several of the world’s leading food exporters have been suffering from too little. During the summer of 2012, America endured its most widespread rain shortfall since the 1950s, with four-fifths of its agricultural land experiencing “drought”, according to the US Department of Agriculture. That matters – not least as America is the world’s biggest wheat exporter. Russia and Ukraine, themselves both top-ten global wheat exporters, are also enduring bad 2012/13 harvests due to drought. As a result, for the third time in six years, we face another food crisis, as tight global markets push up the prices of key agricultural commodities.

While wheat and maize prices are close to or above the peaks of 2011, they’re still below 2008 levels. Corn and soya bean prices, though, have recently hit new record highs. Remember, also, that the global economy remains on go-slow. Food prices will get a lot higher as and when the world finally emerges from the sub-prime debacle and overall demand is firing on all cylinders.

Even if that doesn’t happen this year, and I don’t think it will, higher food price inflation is already “baked-in” due to the delayed impact of the bad 2012/13 global harvest, as food inventories are run down. That, in turn, will obviously impact meat and dairy prices too, given the importance of arable crops as feedstock.

According to the United Nations’ Food and Agriculture Organization, the global cereal market is set to “tighten considerably” in 2013. Wheat stocks are expected to be “drawn down sharply, especially the stocks of major exporters”, with projected wheat demand “exceeding production … given the smaller wheat crop”. The outlook for the demand and supply balance of all coarse grains is “extremely tight”, says the FAO, with stocks “falling to historic lows”. Meat prices, meanwhile, are “close to record highs” and international prices of dairy products “are rising in the face of limited export supplies”.

Agricultural commodity markets are, by their very nature, cyclical. Bad weather leads to lower crops, which brings price rises. Higher prices then encourage farmers to plant more the following year, so causing prices to fall. In recent years, though, soft commodity prices have been oscillating around a steadily increasing upward trend. This is hardly surprising in the context of a fast-rising global population – which has ballooned from 6,000m to 7,200m since 2001, a 20pc rise in little more than a decade. Dietary changes in developing economies, as increasingly wealthy workers eat more meat, and crop diversion to biofuel production, have also helped push food prices up.

What’s less widely understood, though, is the extent to which food price inflation is driven by higher oil prices. Crude is used in practically every aspect of industrial-scale food production, from planting, irrigating and reaping, to transportation, then food processing and packaging. On top of that, petrochemicals are a principal component of many of the fertilizers and pesticides now so vital to modern agricultural activity.

Brent crude averaged $112 per barrel during 2012 – the highest ever annual average price in both nominal and inflation-adjusted terms. The previous record annual average was $111, set in 2011. It is deeply significant, in my view, that oil prices have stayed so high even though the world economy is still far from buoyant. The reasons – ranging from massive fuel demand from the “emerging giants” of the East, to severe well depletion across many of the world’s leading crude producing nations – have been well-rehearsed in this column over several years.

It’s worth pointing out, though, that high oil prices not only feed directly into food production costs, so generating higher food prices. More expensive food, in turn, then feeds back into global oil markets, helping to push up further the price of crude oil. It was rising food costs, after all, which sparked the Arab Spring back in late 2010, and throughout 2011, so causing the political turmoil which spooked global markets and helped keep crude prices firm.

It is extremely difficult to predict if the Middle East will see the kind of serious political unrest or military activity in 2013 that could structurally affect world oil prices. Of course, such conflict is possible. Even if Syria calms down, though, if Israel avoids war with its neighbours and US relations with Iran are defused, the impact of the Arab Spring still looms large on global oil markets.

Just a few years ago, big Gulf oil exporters such as Saudi Arabia and UAE could balance their budgets with annual crude prices averaging $50 a barrel. Domestic conflict, though, has meant many Arab governments have been forced permanently to raise welfare spending, to mollify restive populations.

Riyadh and Abu Dhabi now need oil at close to $100 a barrel to balance their budgets. As such, the politics of the OPEC oil exporters’ cartel have been changed markedly. Gulf governments used to want to keep oil prices down to help their Western allies. Now their priorities have shifted, with such administrations needing high crude prices to help them generate the revenues needed to keep their own populations in check.

Throughout 2013, high oil prices will feed into higher food prices. And high food prices, in turn, will, help maintain expensive crude. Is this really the moment, then, for the Bank of England to start diluting its commitment to targeting inflation, as has recently been mooted? I don’t think so. Not unless inflation and currency debasement are central to the UK government’s strategy for dealing with its debts.

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