Food Inflation Set to Rise Further
There was a clear consensus emanating from the annual U.S.D.A. Agricultural Outlook Forum, which I attended in Arlington, Virginia last week: most in attendance believed that food prices will continue their assent of last year (4%) and perhaps rise by another 3.8%-4% in 2008. U.S. food price inflation will be the result of increasing cost pressures from higher agricultural input prices. These prices, in turn, are the result of strong global demand, continued weakness in the U.S. dollar, the push for renewable energy, low stock-to-use-ratios and global weather that has not been conducive to crop growth in certain regions.
Global Plusses and Minuses
Despite the general concern about rising agricultural commodity prices, there was some good news from the conference, particularly from Paul Schickler, a general manager with DuPont who spoke of technology advances that have been made in plant genetics. He stated, for example, that advances in seed production have led to an increase of 30% in corn harvest yield since the start of the decade. However, the demand side has increased commensurate with supply. Population has increased 13%, income has increased 35% and meat consumption has risen 25% over those same 8 years.
Globally, the two main drivers for the agricultural commodity boom are the appetites from emerging markets and the push for increased use of bio-fuels. That's not news, but what is new this year is that China, Russia and India have made policy moves that should bolster U.S. prices in 2008. These countries have raised export duties while simultaneously lowering import duties on many agricultural commodities in an attempt to satisfy the demand inside their own booming economies. For example, starting January 1, 2008 China raised export duties 25% on wheat flour and starch and added a 10% charge to outgoing rice, soybean and corn flour shipments. India, meanwhile, removed a 36% import duty on wheat flour until April 2009 and Russia raised export duties on wheat from 10% to 40%!
Ag as an Energy Resource
Meanwhile, despite the fact that rising corn prices are making ethanol increasingly un-economic, the U.S. is upping the ante on bio-fuels. The mantra from the USDA, which dreams of creating an energy-independent America, was that we must break the economy's addiction to oil. This explains the 60 ethanol plants currently under construction to go along with the 140 already in existence here. Indeed, last year's 6.5 billion gallons of ethanol produced in the U.S. is projected to reach 8 billion in 2008. And the goal of this government agency is to take 1.2 million traditional gas vehicles off the road next year while helping to increase the production of ethanol from cellulose, as well.
Worthy goals, perhaps, but of paramount importance at this conference were Robert Dinneen, President and C.E.O. of the Renewable Fuels Association and Dr. Roger Conway of the Office of the Chief Economist from the U.S.D.A. Their contention was that it takes only .7 gallons of fossil fuel to produce a gallon of ethanol.
Here there exists much debate. According to the International Monetary fund, for example, it takes .82 gallons of fossil fuels to create a gallon of ethanol -- some yield!
Yet the story might be even worse. According to David Pimentel of Cornell, it takes 29%, more fossil fuel to create a gallon of ethanol than energy yielded from the resulting fuel, a net energy loss! Cellulose and wood biomass seem even less efficient, requiring 45% and 57% more fossil fuel energy than they yield, respectively!
Included in Dr. Pimentel's analysis are the costs associated with producing the crops including fertilization, irrigation, transportation and processing. Not included in his assessment are the costs for Federal and State subsidies or the costs associated with any resulting environmental pollution.
This professor and ecologist was quoted as saying, "The government spends more than $3 billion a year to subsidize ethanol production when it does not provide a net energy gain, is not a renewable energy source or an economical fuel." He has also stated that ethanol production leads to natural gas and oil imports and U.S. deficits. And these doubts don't come from someone who's biased against alternative fuels; Dr. Pimentel endorses the use of wind power and photovoltaic cells in lieu of ethanol fuel.
How Best to Invest in Agriculture
Economics be damned, we're apparently going to keep flushing money down the ethanol toilet, which will continue to put upward price pressure on grain prices at precisely the wrong moment in history, but so be it -- we must simply focus on how best to invest in this trend, then.
Along these lines, I wanted to highlight one other interesting set of comments, these from C. Larry Pope, President and C.E.O. of Smithfield Food, whose honesty and candor was quite refreshing to hear. In reference to the current market situation he stated it was "...an unsustainable condition for livestock producers," pointing out, "input prices have never been higher." He continued, saying, "There will be a dramatic reduction in meat production and food inflation is set to rapidly increase much higher...it has to happen."
While I have written in the past about how to invest in this agriculture theme -- by owning growers, seed and ag chemical companies -- what he said further underscored my contention that investing in livestock companies is a very ineffective way to participate in rising agricultural commodity prices.
This also explains why we avoid including companies such as Tyson (TSN), for example, in the Delta Global Agriculture Portfolio on which we advise (CDGACX); such producers are hurt by rising grain prices.
Attending this year's conference, then, only strengthened my beliefs in both the bull market in agriculture and in the right way to invest in it. Regardless of whether you agree that the use of food for fuel makes sense, it is imperative not to underestimate the devotion from our government to pursue that endeavor. Investors should continue looking to invest in agricultural commodity producing companies and those that help increase crop yields, as the most likely ways to profit from ongoing food price inflation.