Commodity prices – and resulting food prices – are rising sharply, driven by a combination of factors that include high oil prices spurring biofuels growth, a weak dollar and world production and consumption trends, according to an analysis by Purdue University agricultural economists.

In a Farm Foundation commissioned report, the Purdue economists – Phil Abbott, Chris Hurt and Wally Tyner – highlight key factors gleaned from examining 25 recent studies plus their own analysis. Their conclusion: A complex combination of factors is fueling agricultural commodity price increases and rising food costs.

Tyner, an expert on energy and policy issues, says the price of oil is an important factor that has increased the demand for biofuels. "About $3 of the corn price increase is due to the higher oil price and $1 to the ethanol subsidy," he says.

As high oil prices spur demand for biofuels, the increased corn production stimulates demand for fertilizer, diesel, propane and other agricultural inputs. Prices for these inputs have also risen due to the "demand pull" from more corn being produced and subsequently the "cost push" due to the fact that petroleum products are key ingredients in many of these inputs.

The weak dollar – another key factor – is linked to the rise in all commodity prices. "The link between the U.S. dollar exchange rate and commodity prices is stronger and more important than many other studies imply," says Abbott. "Whatever impacts the dollar will influence food prices."

An expert on international trade and macro factors, Abbott points out that oil and agricultural commodities are priced in dollars. When the U.S. dollar falls, as it has for the last six years, then these goods become cheaper for others in the world to buy, which increases demand.

"The dollar has depreciated 45% from its peak in 2002 through 2007," says Abbott. "Over the same time, the value of agricultural exports had increased 54%, and are projected to go much higher."

When asked how long these current high prices would last, the economists indicated two factors might be most significant. "Based on this analysis, high commodity prices will persist as long as high oil prices remain and as long as the dollar stays weak," says Tyner. "Lower oil and a stronger dollar would bring pressure on commodity prices to fall."

Many studies point to the pace of global consumption being higher than global production as an important driver of commodity prices. In eight of the past nine years, consumption has grown faster than production. Unlike many who see China and India as major contributors to rising food commodity prices, the Purdue economists argue that is not the case. "It's countries who trade that set the price. China and India are agriculturally self-sufficient and largely do not trade agricultural commodities," says Tyner.

When it comes to the price of oil, however, Tyner says that's another story. "While China and India are not the root cause of food demand, the opposite is true for oil, as China especially has a huge and growing appetite for oil."

Weather and crop diseases have also affected food prices over the past couple of years. Because consumption has exceeded production since the turn of the century, stocks are at record lows. When supplies are low, even small disruptions in production can put further pressure on tight inventories, Hurt says. Last year's drought and this year's late planting and flooding have affected, and will continue to affect, commodity prices.

"Under normal circumstances of large grain inventories these events might not have a large impact, but now prices will have to rise even higher to ration usage," he says.
The economists also said decreased investment in agricultural research has led to lower production growth, which has reduced stocks and set the stage for commodity price increases. "When we had crop surpluses in the 1980s and 1990s, research on crop productivity started to wane. It will take some time for new investments to bear fruit," Hurt says.

One factor the economists did not think was critical was the role of speculators in commodity markets. They indicate that the market is more volatile and trading heavier, but based on existing research, there is little to support the idea that price levels have increased because of speculation.

Read the "What's Driving Food Prices?" report.