Is food price volatility about to return with a vengeance?

Food manufacturers have got used to low food price volatility during 2013. That all changed in the first few months of 2014 as adverse weather, disease and geopolitical concerns has affected the outlook for food production from Brazil to Ukraine. Is food price volatility about to return with a vengeance?

To recap agricultural prices have risen sharply since the start of 2014. First, the weather. Drought in Brazil has raised fears that crop yields for coffee, sugar and soybean farmers will be severely reduced, while drought in West Africa has reduced the output of cocoa. Second, disease. The coffee leaf rust disease has affected output of coffee in Central America while the Porcine Epidemic Diarrhoea virus has decimated large amounts of pigs in the US. Finally, geopolitical concerns have returned. The on-going tension between Ukraine and Russia has heightened concerns that wheat and corn exports from the region will be affected.

Chart: Food price volatility
2014-04-25_2220
Source: FAO

Related article: Food price volatility lowest for seven years

To an extent all of these factors represent one off adverse events that have just happened to coincide. Putting the situation in Ukraine to one side the potential for disruption has focused attention on the power of climate change and its potential to disrupt supplies and ultimately lead to increased uncertainty and price volatility. Indeed all of the previous spikes in food price volatility seen since 2007 were at least partly caused by changing weather patterns and the appearance of drought in particular. This latest bout of volatility at least represents a continuation of this trend. The increasing likelihood of El Niño appearing later in 2014 is another factor likely to food price volatility more pronounced later in the year.

However, in comparison to previous spikes in 2007/08 and 2010/11 it has not been accompanied by volatile oil prices. Changes in the oil price before and after the financial crisis and the implementation of quantitative easing were transmitted through the food chain via the link between oil prices and biofuel demand for corn and the increased cost of transportation and fertiliser.

Another factor suggesting that the current spike in volatility will be more subdued than the past is the strong stocks position. According to the FAO global cereal stocks for 2013/14 are anticipated to increase by 15% to 582 million tonnes. The expansion in world cereal stocks would result in the global cereal stocks-to-use ratio reaching 23.9%, well above the historical low of 18.4% set in 2007/08.

Finally the de-financialisation of commodity markets over the past year or so may be part of longer term trend that could see commodity volatility be more subdued. According to research from the UN the correlation between US equities and corn, cattle and wheat fell to less than 0.05 in January, compared with almost 0.3 in 2008 with the pullback of investment banks from commodity trading and the reduced level of interest from investors in commodities in general weakening the link between commodities and other financial markets.

Related article: Oil prices caught in a vice

Overall, volatility is likely to remain elevated during 2014 and beyond, certainly when compared with historical norms. However, unless the global stocks position deteriorates and the oil price breaks out of its vice then volatility is unlikely to return to the heady days of 2008 to 2012.

What are the 50 things you need to know about commodities?

I  am currently writing a book about commodity markets aiming to provide some insight into how commodity markets affect all out lives. Below is my list of what I think are the top 25 things that I think consumers, business owners and investors need to know about commodities.

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50 things you need to know about commodities
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Materials Risk 50 things you need to know about commodities

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I am currently writing a book about commodity markets. Here is my list of 25 things I think consumers, business people and investors need to know about commodities. Please vote and add your suggestions for 25 other important things. Register for email updates at www.materials-risk.com to get 50% off the book once its published.

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  1. 1  What is a commodity?

    What is a commodity?

    The intrinsic properties of a commodity introducing agricultural, industrial and energy commodities.

  2. 2  What determines the price of a commodity?

    What determines the price of a commodity?

    Supply, demand and costs in an opaque market

  3. 3  The commodity super-cycle

    The commodity super-cycle

    Commodity prices don't just go up.

  4. 4  The resource curse

    The resource curse

    Too much of one thing can be bad for economies.

  5. 5  What is the impact of volatile commodity prices?

    What is the impact of volatile commodity prices?
  6. 6  How can you protect yourself from volatile commodity prices?

    How can you protect yourself from volatile commodity prices?

    Hedging, substitution and adding value

  7. 7  The weather and commodity prices

    The weather and commodity prices
  8. 8  Climate change and commodities

    Climate change and commodities
  9. 9  Resource nationalism

    Resource nationalism
  10. 10  The future of mining: planets, seabeds and landfills

    The future of mining: planets, seabeds and landfills
  11. 11  Malthus

    Malthus

    Why he was wrong and why he might still be proved right

  12. 12  Recycling and the circular economy

    Recycling and the circular economy

    Is there a better way?

  13. 13  The financiailisation of commodities

    The financiailisation of commodities

    Commodity markets and your portfoliio

  14. 14  Cartels and commodity markets

    Cartels and commodity markets

    Why are commodity markets prone to cartels and oligopolistic behaviour

  15. 15  Commodity prices, innovation and investment

    Commodity prices, innovation and investment

    Shale gas and the incentive that high prices brings

  16. 16  Food vs fuel

    Food vs fuel

    Biofuel demand and food prices

  17. 17  How are commodities moved?

    How are commodities moved?

    Pipelines, ships

  18. 18  Emerging markets and commodities

    Emerging markets and commodities

    Urbanisation, population growth and changes in diets

  19. 19  Commodities of the future

    Commodities of the future
  20. 20  Commodity prices, interest rates and the dollar

    Commodity prices, interest rates and the dollar
  21. 21  The allure of gold

    The allure of gold
  22. 22  Commodity production and the its impact on the environment

    Commodity production and the its impact on the environment
  23. 23  What is the impact of high commodity prices?

    What is the impact of high commodity prices?
  24. 24  Commodity substitution

    Commodity substitution
  25. 25  Are we facing a resource crunch?

    Are we facing a resource crunch?

    Or why the stone age didn't end because we ran out of stone.

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Risk of disruption to European gas supplies put at 30%

In regards to sending Russian military forces into Ukraine, Vladimir Putin said on Thursday “I very much hope that I am not obliged to use this right,” Amid the intensifying crisis in the region Roubini Economics now puts the risk of a formal Russian military invasion of Ukraine at 50% and the probability of a meaningful gas disruption at 30%.

Its worth noting that Russia didn’t even suspend gas supplies during the depths of the Cold War and with Russia likely to face increased competition from new gas supplies in Europe and North America it is in their interest to keep gas supplies flowing. Using this logic a probability of 30% attached to supplies being completely cut off appears too high. Putin may see things differently though. “We sell gas in European countries which have around 30-35 percent of their gas balance covered by supplies from Russia. Can they stop buying Russian gas? In my opinion it is impossible,” Mr Putin said.

In the scenario that gas supplies to Europe are completely suspended analysis from Energy Aspects suggests that European gas prices could more than double if supplies were cut off for two months and Europe then had to attract LNG supplies to fill the gap. Gas prices rose to almost 62 pence per therm in March after Russia took over the Crimea before falling back to 48 pence per therm. Today gas prices are around 52 pence per therm.

Bear in mind that even if your country doesn’t import much in the way of gas from Russia (Spain and the UK), gas prices will still rise sharply as traders in the continents gas market worry about where supplies will come from. Indeed, competition for LNG will also have a knock-on effect on Asian gas buyers, consultants Nexant estimate that gas prices there could rise by almost 20%.

A more likely scenario is that Russia cuts gas supplies to Ukraine. Mr Putin warned the EU a week ago that Russia would turn off the tap to Ukraine if it didn’t pay its bills. Indeed Putin has now gone further saying that Moscow is ready to wait for one month to Ukraine to pay its gas debt. The deadline falling one week before Ukraine’s May 25 elections. Although this would indirectly cut off around 15% of Europe’s gas imports the impact on gas prices would be significantly less, not least because Europe is moving towards summer.

2014-04-17_1155

Related article: Could unrest in Ukraine have a sting in the tail for commodity prices?