Seismic price shifts, changing global diets put the squeeze on food processors

It doesn't take but a cursory glance at most agricultural commodity prices to know something seismic is occurring, and food processors are caught in the middle of thin margins and big cost increases.

Some startling incongruities in agricultural commodities in recent months:

• Bumper crop harvests are followed by a record rise in trading prices—e.g., wheat jumping 25 percent in one day, combined with world grain reserves depleted to a 60-year low, and less than a 50-day supply on hand.
• After four successive years of record harvests, China imposes a 20-percent export duty on wheat, barley, and oats. India imposes export taxes as well.
• Russia and others embargo wheat shipments, while the Chinese are losing farmland to urbanized development. And while better wages in China are driving up demand for protein-rich diets, the government is leasing land in the Philippines to plant crops.

In a classic supply-and-demand scenario—with demand rapidly trending toward outstripping supply on a long-term, global basis—food processors are caught in the middle of thin margins and big cost increases.

Compounding the changes in global diets, food and energy markets are merging to a degree with government mandates for biofuels to reduce dependence on oil. Congress recently enacted the 2007 Energy Act (superseding the 2005 act) boosting targets, and pushing ethanol into second place this year for claim on the U.S. corn crop.

“The bottom line is a convergence of the energy and agricultural sectors,” says Joseph Dancy, adjunct professor, oil and gas law at Southern Methodist University Law School and manager of a $20-million private mutual fund, of which he's moved 30 percent into agricultural commodities in the last six months.

“Outside of market analysts, I don't think most people realize yet how large a move in grain prices there has been. Price charts look like moon shots,” claims Dancy.

It's good news, Dancy adds, for fertilizer, farm equipment, and irrigation system manufacturers. “But food processors are on a roller coaster," he says. "They will have to get more efficient—and they're pretty efficient now. They will have to decrease margins and raise prices—probably both.”

Change in world diets also is a huge driver on demand.

“As income in developing countries goes up, people want to move up the food value chain,” says Ned Schmidt, publisher of Agri-Food Value View, a commodities newsletter based out of Boca Raton, Fla. “This isn't going to end anytime soon.”