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Implications of High Commodity Prices

Matt McKinney reported in yesterday’s Minneapolis Star-Tribune that, “Fortune smiled on rural Minnesota in 2007, as median farm income soared 73 percent in a year, to $105,000, on runaway demand for corn, milk, wheat and soybeans.

“A University of Minnesota survey of 2,600 farms concluded that it was the most profitable year for the state’s farmers since 1973.

“‘We’re in one of those golden ages of agriculture,’ said Dale Nordquist, associate director of the Center for Farm Financial Management at the university, which does the annual survey.”

Mr. McKinney noted that, “The agricultural boom comes as Congress nears completion of a farm bill that will likely continue huge subsidies to farmers, no matter how successful their current crops. This year alone, the government expects to pay $13 billion to farmers who grow one of five major commodities, including corn, soybean and wheat.

“Skyrocketing farm income will bolster subsidy critics who say they are unnecessary and wasteful.

“And it comes as the general public has become acutely aware of rising food costs as prices have jumped in recent months for milk, eggs and others staples.”

With respect to food prices, an update posted this week at the USDA’s Economic Research Service (ERS) Online (“Food CPI, Prices, and Expenditures: Analysis and Forecasts of the CPI for Food”- Briefing Room), indicated that, “In 2008, the Consumer Price Index (CPI) for all food is projected to increase 3.5 to 4.5 percent, as retailers continue to pass on higher commodity and energy costs to consumers in the form of higher retail prices. Food-at-home prices are forecast to increase 4.0 to 5.0 percent, while food-away-from-home prices are forecast to increase 3.0 to 4.0 percent in 2008. The all-food CPI increased 4.0 percent between 2006 and 2007, the highest annual increase since 1990. Food-at-home prices, led by eggs, dairy, and poultry prices, increased 4.2 percent, while food-away-from-home prices rose 3.6 percent in 2007.”

A more specific breakdown of changes in food prices by category is available at this ERS webpage.

And a news release issued yesterday by the American Farm Bureau Federation stated that, “Retail food prices at the supermarket increased in the first quarter of 2008, according to the latest American Farm Bureau Federation Marketbasket Survey. The informal survey shows the total cost of 16 basic grocery items in the first quarter of 2008 was $45.03, up about 8 percent or $3.42 from the fourth quarter of 2007.

“Of the 16 items surveyed, 11 increased, four decreased and one stayed the same in average price compared to the 2007 fourth-quarter survey. Compared to one year ago, the overall cost for the marketbasket items showed an increase of about 9 percent.

“A 5-pound bag of flour showed the largest retail price increase, up 69 cents to $2.39.”

With respect to international food price pressure, Associated Press writer Joe McDonald reported yesterday that, “Asia faces a sharp rise in food costs, due partly to surging demand for crops used in biofuels, and governments should do more to shield the region’s poor from economic shocks, a U.N. commission said Thursday.”

The article noted that, “‘Rapidly rising food prices will be the key challenge in the coming year,’ Shuvojit Banerjee, an economist for the commission, said at a Beijing news conference. ‘With the march towards biofuels apparently unstoppable, the region has to prepare for sustained inflation through higher food prices.’”

Mr. McDonald indicated that, “China has banned use of food crops for fuel and has imposed curbs on grain exports to increase domestic supplies and cool inflation.

“Banerjee appealed to other governments to follow Beijing’s example.

“‘We would advise governments to be very cautious about biofuels’ until the region can take advantage of technology being developed to make fuel from non-food crops, he said.

“On Wednesday, Indian Finance Minister P. Chidambaram said the use of food crops for biofuels is hurting the poor and called it ‘a sign of lopsided priorities of certain countries.’

“‘It is outrageous and it must be condemned,’ he said in a lecture in Singapore.”

In addition to impacts on the cost of food, higher commodity prices and commodity price volatility are also impacting grain elevators in the United States.

(The Associated Press reported yesterday that, “Wheat for May delivery dropped 19 cents to $10.14 a bushel; May corn added 3.25 cents to $5.555 a bushel; May soybeans declined 24.75 cents to $13.2725 a bushel).

Lauren Etter and Scott Patterson reported in yesterday’s Wall Street Journal that, “A fault line is emerging in the U.S. farm economy, as rising grain prices and the credit crunch combine to squeeze grain elevators, a crucial business link between farmers and markets.

“Grain elevators that collect grains from farmers and sell them up the food chain have seen their costs of doing business balloon as prices of corn, wheat, soybeans and other grains have soared to record levels. At the same time, lenders chastened by the subprime mortgage crisis have grown increasingly reluctant to extend money to tide the elevators over.”

The Journal authors explained that, “Farmers looking to lock in profits now are entering contracts with elevators to sell grains that won’t be harvested for two to three years. To offset their risk that prices will fall, elevators typically then sell a futures contract on an exchange like the Chicago Board of Trade. Whenever the price of the grain goes higher than what is in that contract, the elevator has to make a margin call — or post an additional amount of money to keep the account current.

“These margin calls have become a crushing burden. Before the recent grain boom, a midsize elevator might have had to make a daily margin call of about $200,000 on a day when a grain market rallied. Now, it isn’t uncommon for that same elevator to have a daily margin call of $1 million or more. Many elevators, lacking that much cash on hand, then turn to their banks for help. But even though the farm economy is strong, rural and agriculture lenders have stopped lending additional money in some cases as elevators have exhausted their credit limits.

“Many grain elevators are ‘at their ropes’ end financially,’ says Michael Swanson, an agriculture economist at Wells Fargo, a big lender to farm country. But as grain prices continue to rise, ‘a lot of lending institutions will call into question whether they can write another $50 million check for another margin call. The credit crunch is very real.’”

Nancy Cole, in an article posted on Sunday at the Arkansas Democrat Gazette Online, also explored the issue of market volatility and grain elevators; she noted that, “The size of recent commodity price increases has been unprecedented, said Tim Daven, president of Commodity Risk Management, a Little Rock-based commodities trading firm. ‘Normally, the markets won’t move over 50 cents or a dollar a year, $2 at the max,’ he said. ‘But in the last five or six months you’ve seen $2 and $3 and $5 moves in some of the grains.’ Because of such volatility, the commodities exchanges have raised their margin requirements multiple times, making futures contracts even more expensive, Daven said. The increased demand for credit by grain elevators and cotton buyers to meet margin calls ‘comes at a very bad time, when the credit markets are already in shock from the mortgage crisis,’ he said. Some of these market intermediaries have borrowed the maximum amount that their banks are willing to lend to them. ‘It’s stressing their balance sheets,’ said Drue Ford, chief credit officer of AgHeritage Farm Credit Services in Little Rock. ‘They’re running maybe the same amount of units through their facilities, but it costs so much more,’ he said.

“Such stress could reach a breaking point in some cases, McKenzie [Andrew McKenzie, an agricultural business professor at the University of Arkansas at Fayetteville] said.”

The current market environment has turned additional focus on the upcoming Prospective Plantings report, which will be released on Monday by the USDA’s National Agricultural Statistics Service (NASS). The NASS report will be one of the first key indicators of the potential size of U.S. crops for the 2008 growing season.

Chris Flood reported yesterday at the Financial Times Online that, “US farmers have rarely been so spoiled for choice when it comes to choosing which crops to plant. Corn, wheat, soyabean, oats, rice, barley, hay, canola and sunflower prices are all at or near record levels.

“Which crops farmers will plant this year should become clearer on Monday when the US Department of Agriculture publishes its Prospective Plantings report, based on a survey of 86,000 farm operators in the first two weeks of March.

“The report will set the tone for trading in agricultural markets this year because it will provide an insight into the crops that have emerged as winners and losers in this year’s battle for land.”

The FT article noted that, “The question is how farmers’ planting intentions will affect supply dynamics and prices at a time when global grain inventories have shrunk to multi-decade lows.”

Mr. Flood also reported that, “Record prices have created strong incentives for producers to increase croplands with some hay and pasture lands expected to return to active crop production and further acres being released from the government’s Conservation Reserve Program.

“‘Total corn, soyabean and wheat acres increased 6.4m acres last year [and] we expect a further increase of 6.1m acres this year [inclusive of double crop plantings],’ says Lewis Hagedorn of JPMorgan.”

Reuters writer Carey Gillam reported yesterday that, “Market experts say all signs point to a sharp decline in overall U.S. corn seeding this spring, which could spell a significant tightening of supplies that would resonate at home and abroad, impacting everyone from consumers to cattle feeders.

“‘We have tight stocks worldwide and strong demand, so when there is an acreage or production shortfall you end up with more extreme and violent moves in prices. This is the risk that we face,’ said agricultural economist Bill Lapp.”

Recall however, that a recent analysis by University of Illinois Agricultural Economists Gary Schnitkey and Darrel Good (“Corn Versus Soybean Returns in 2008”), stated that, “How many acres of corn and soybeans will be planted this year is of great interest and could impact relative corn and soybean prices. Most projections indicate fewer corn acres and more soybean acres will be planted in 2008 as compared to 2007.

“Relative profitability of corn and soybeans may impact acreage decisions. Given current cash bids for fall delivery, our analysis suggests that corn will be more profitable than soybeans in 2008 on many farms in Illinois…”

In other commodity price developments, Diana B. Henriques reported in today’s New York Times that, “Economists note there should not be two prices for one thing at the same place and time. Could a drugstore sell two identical tubes of toothpaste, and charge 50 cents more for one of them? Of course not.

“But, in effect, exactly that has been happening, repeatedly and mysteriously, in trading that sets prices for corn, soybeans and wheat — three of America’s biggest crops and, lately, popular targets for investors pouring into the volatile commodities market.”

The Times noted that, “Whatever the reason, the price for a bushel of grain set in the derivatives markets has been substantially higher than the simultaneous price in the cash market.

“When that happens, no one can be exactly sure which is the accurate price in these crucial commodity markets, an uncertainty that can influence food prices and production decisions around the world.”

Ms. Henriques indicated that, “‘We do not have a clear understanding of what is driving these episodic instances,’ said Prof. Scott H. Irwin, one of three agricultural economists at the University of Illinois at Urbana-Champaign who have done extensive research on these price distortions.

“Professor Irwin and his colleagues, Prof. Philip T. Garcia and Prof. Darrel L. Good, first sounded the alarm about these price distortions in late 2006 in a study financed by the Chicago Board of Trade. Their findings drew little attention then, Professor Irwin said, but lately ‘people have begun to get very seriously interested in why this is happening — because it is a fundamental problem in markets that have generally worked well in the past.’

“Market regulators say they have ruled out deliberate market manipulation. But they, too, are baffled. The Commodity Futures Trading Commission, which regulates the exchanges where these grain derivatives trade, has scheduled a forum on April 22 where market participants will discuss these anomalies and other pressure points arising in the agricultural markets.”

Farm Bill

DTN writers Jerry Hagstrom and Chris Clayton reported yesterday that, “Senate Budget Committee Chairman Kent Conrad, D-N.D., told DTN on Thursday he would be satisfied with a $4.05 billion farm disaster program that farm bill negotiators appear likely to add to the new farm bill.

“Last week Conrad was among those who said a plan to provide only $2.24 billion for disaster aid was ‘unacceptable.’

“The new allocation for disaster aid was revealed in a new farm-bill framework agreement that DTN obtained on Thursday. According to the document, the chairmen and ranking members of the House and Senate agriculture committees are considering a new framework agreement under which the money for the new weather-related disaster aid program would rise to $4.05 billion, while the increases for conservation, specialty crops and energy programs would be lower than in the proposal crafted last week.”

The DTN article noted that, “In a telephone interview, Conrad said he believes the framework means that the farm bill can be finished by April 18. But Conrad also warned that the negotiators are still waiting for cost scores for some programs from the Congressional Budget Office. Conrad said the agreement ‘doesn’t mean everyone is wildly enthusiastic. But everybody a little unhappy means we’re getting close to a reasonable conclusion.’

“The new framework also increases funding in commodity programs by as much as $1.68 billion, largely through boosts in loan rates and target prices. Still, the proposal projects $4.35 billion in savings from timing shifts in payments for commodity programs and crop insurance.”

Meanwhile, a news release issued yesterday by Senator Charles Grassley (R-Iowa), stated that, “As farm bill conference committee negotiations continue, Senators Chuck Grassley and Byron Dorgan have urged consideration of ‘Dorgan-Grassley II,’ a possible payment limitations compromise.

“In a letter to Senate Agriculture Committee Chairman Tom Harkin and Department of Agriculture Deputy Secretary Chuck Conner, the Senators wrote that ‘in recent days, farm bill negotiations have clearly pointed to the continuing difficulty in finding acceptable financing mechanisms that meet the demands for farm bill funding. We believe that a sizeable amount of the gap might be found in adopting the four-point program.’”

With respect to the “four-point program,” the letter stated that, “The four-point proposal could correctly be called Dorgan-Grassley II. It attempts to get us closer to a politically acceptable compromise by:

“-Reducing payment limitations and income limitations only when prices are above target price, which should be acceptable to Chairman Peterson who has been willing to sacrifice all payments in years of high commodity prices;

-Softening the impact of reduced limits on cotton, rice and peanuts in recognition of the differences between northern and southern agriculture;

-Incorporating the Administration proposal to lower Adjusted Gross Income limits, but with a feature to increase the savings by reducing payments on cash rented land owned by high income landlords; and

-Responding to the findings of the GAO and USDA Payment Limitations Commission by incorporating the primary control and actively engaged in farming provisions of Dorgan Grassley I.”

And a recent item posted at The Economist Online stated that, “With farm incomes high and commodity prices at record peaks, this season looked ripe for reform. Instead, the House passed a bill that failed to cut subsidies significantly and bought off potential opposition from urban Democrats with spending on a range of social and environmental programmes. Mr Bush has been trying to put his foot down.”

In conclusion, The Economist item stated that, “They will have to make up their minds on the farm bill by April 18th. After that, the White House says, current policy will need to be extended another full year so that farmers can plan for their harvests.”

Keith Good