BLOG POST: Urban Food – The huge hidden upside to low oil prices

BLOG POST: I'm Shrikant Ramakrishnan, Global Business Development Director at Plantagon. This week I'm presenting some thoughts on the connection between food and oil. The ideas and thoughts presented here are my personal views and need not subscribe entirely to Plantagon.

The connection between food and oil is systemic, and the prices of both food and fuel have risen and fallen more or less in tandem in recent years. Modern agriculture uses oil products to fuel farm machinery, to transport other inputs to the farm, and to transport farm output to the ultimate consumer. Oil is often also used as input in agricultural chemicals. Oil price increases therefore put pressure on all these aspects of commercial food systems. 

To put things in perspective, it was not so long ago—in June 2014, to be exact—that Brent crude, the global benchmark for oil, was selling at $115 per barrel. Energy analysts then generally assumed that the price of oil would remain well over $100 deep into the future, and might gradually rise to even more stratospheric levels. Such predictions inspired the giant energy companies to invest hundreds of billions of dollars in what were then termed “unconventional” reserves: Arctic oil, Canadian tar sands, deep offshore reserves, and dense shale formations.

The current rout in oil prices has obvious implications for the giant oil firms and all the ancillary businesses -- equipment suppliers, drill-rig operators, shipping companies, caterers, and so on -- that depend on them for their existence. It also threatens a profound shift in the geopolitical fortunes of the major energy-producing countries. Many of them, including Nigeria, Saudi Arabia, Russia, and Venezuela, are already experiencing economic and political turmoil as a result. (Think of this as a boon for the terrorist group Boko Haram as Nigeria shudders under the weight of those falling prices.) The longer such price levels persist, the more devastating the consequences are likely to be.

A Perfect Storm

Generally speaking, oil prices go up when the global economy is robust, world demand is rising, suppliers are pumping at maximum levels, and little stored or surplus capacity is on hand. They tend to fall when, as now, the global economy is stagnant or slipping, energy demand is tepid, key suppliers fail to rein in production in consonance with falling demand, surplus oil builds up, and future supplies appear assured.

Oil prices just keep falling and crashing into things on their way down. It seems like every day another country gets a bill for damages: Saudi Arabia, Nigeria, Russia, the UK. While the global economy’s biggest players are reeling, there is a less visible group of people who stand to benefit tremendously: those without enough to eat.

The security of the world’s poor is inseparable from the price they pay for food, especially the grains that constitute most of their diet. Oil prices are a significant factor in determining the price of other commodities, including food. Tractors and other farm machinery require fuel, as does the manufacture of fertilizer. Once crops are harvested, oil prices dictate the transportation costs to get them to market, whether that’s down a highway or over an ocean.

For the last decade volatility in food prices has made food security more complex than ever. Price spikes in 2007 and 2008 led to civil unrest in many developing countries. In 2011, that volatility led Oxfam to describe the global food system as “broken.”

Global grain prices have returned to levels from before the price shocks, and some believe they are beginning to stabilize. (Futures prices are also way down.) Three changes are mainly acting to moderate prices:

1. Demand for biofuels has plateaued. For most of the last decade, the grain market has been sapped by the growing US market for ethanol. Refineries have since hit the so-called “blending wall.” They can’t mix any more ethanol into gasoline without modifications to vehicle engines.
2. Farmers are growing more. In response to the price shocks of the last decade, “the world’s farmers have ramped up production way ahead of the growth of population,” Wiggins said. As a result, many countries are now sitting on substantial stockpiles of grain.
3. Oil prices have fallen. This pushes down both the costs of production as well as distribution.

The lingering question is whether those savings on agricultural commodities will translate into lower prices at local food markets. Local markets in developing countries are often insulated from global markets by significant barriers: physical distance, limited infrastructure, etc. This is somewhat less true in port cities, which have more immediate access to international markets. However, inland communities are largely out of luck when it comes to buying up cheap imports.

However, there is another avenue for the global market to influence local prices. Research by several economists suggests that price savings arrive mostly through transportation costs.

Transport is what connects markets. It is expensive to ship food from farms to cities or from ports to rural markets. This is especially true in large countries with poor roads. A shift in oil prices may affect local food prices more through fuel costs than through any effect on production costs. In fact, according to Dillon and Barrett’s research, the farther a consumer is from a port, the more that transportation costs factor into their local food prices and thus the more they could save from cheap oil.

The transmission of cost savings through the supply chain is slow. International commodities traders lower their prices first. Domestic wholesalers will follow suit, but usually not until they’ve cleared out existing inventory. Local markets are the last to reduce prices. Even in the most optimistic scenario, the effects of a drop in oil prices may not reach rural consumers for months or years.

Even with perfect data, which we often don’t have, effects of oil prices on other commodities are virtually impossible to measure in real-time. Economists rely on past trends to estimate the impact of falling prices. Separate reports by the World Bank and the other independent bodies have found that a halving of oil prices typically leads to a decline in commodity grain prices of more than 10%. The poorest people in the world spend more than half of their money on food. If they saw a 10% savings on their local food prices, it would be the equivalent of 5% growth in real income. Of course, not all of that savings is likely to carry over, but it gives some sense of the scale of the changes.

Using a model created by the International Food Policy Research Institute, economists estimated that a halving of oil prices from 2011 levels would result in a 14% decrease in the number of malnourished people in the world. Again, this scenario is for oil prices falling to half of their 2011 peak, but oil prices have actually fallen by 75%. Projections based on economic models should always be greeted with healthy skepticism, but it is another indication that the aggregate effects of falling oil prices could be substantial.

Unfortunately, food prices are also affected by everything from weather to local labor conditions. John Baffes, an economist at the World Bank, said that in food-insecure African nations, “two-thirds of the price…depends on factors that are unique to those countries.” For example, many African countries maintain monopoly control over oil imports. They may choose to deposit the savings from lower oil prices into the government treasury, rather than pass them on to consumers. Other countries have agricultural taxes or subsidies that manipulate local prices.

And then there are the low-income countries that are major exporters of oil, such as Nigeria and Angola. The decline in oil prices is a massive blow to those economies. Any drop in food prices is likely to be offset by lost oil revenues and unstable currencies.

Even in stable, oil-importing economies, low food prices may not bring uniformly positive changes. Some studies of the 2007–2008 crisis have found that higher food prices were actually better for the rural poor. According to Wiggins, this is especially likely to be true in India and the rest of Asia, where the poor are more likely to be farm laborers than subsistence farmers.

“Higher rice prices can actually net improve the lot of the farm laborer household, because even though they are paying high prices they are getting so much more work and better wage rates,” Wiggins said.

Cities, on the other hand, are much more dependent on deliveries of food, both from domestic farms and from imports. As a result, urban consumers are likely to see more consistent benefits.

If there is anywhere where the drop in prices will make an immediate difference, it’s probably in Southern Africa. There, El Niño has disrupted weather patterns and forecasters are predicting one of the worst harvests in decades. Countries such as Malawi and Zimbabwe are expected to require substantial imports of food this year. A drop in oil prices is a poor substitute for rain, but lower import prices should at least help those countries to weather the crisis.

2016 Global Food Security Index Overview – A DuPont: Economist Intelligence Unit initiative

1. Food security has improved around the globe over the past five years, but hunger and food insecurity still persist. Governments, multilaterals and the private sector should remain proactive in addressing food-security challenges around the world.
2. For the first time since the launch of the GFSI in 2012, Europe has experienced an improvement in its food security.
3. Between 2015 and 2016, more countries experienced declines in their scores for national nutritional standards than improvements.
4. Thirty-five of the GFSI's 40 most food-secure countries in 2016 are coastal countries.
5. Developing economies that prioritize investment in agricultural storage and transport infrastructure increase their capacity to ensure food security for burgeoning populations.
6. Political instability exacerbates food insecurity.
7. Countries’ economic development and rising personal incomes improve the structural avenues to support food availability and affordability and strengthen governance.

Shrikant Ramakrishnan,
Global Business Development Director
Plantagon International AB

DISCLAIMER: This is a blog. That fact means nothing. It is not a peer-reviewed journal, a final archive of my writing, a sponsored publication, or the product of gatekeeping and editing. That does mean something…it means that while the ideas and thoughts are often vital and personal, the writing and views need not subscribe entirely to Plantagon. It is essentially as it came from the keyboard: spontaneous, unproofed, unrevised, and corrected afterward only when necessary to address mistakes that grossly effect the intent. Where such changes have been made they are explicitly noted… In your response section, try and be polite please.