Food prices will rise above historical averages, but by how much?

by Jay Sjerven
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WASHINGTON — Conflicting forecasts for food price inflation this year and in the next five years were presented at the U.S. Department of Agriculture’s Agricultural Outlook Forum 2008 held Feb. 21-22. The U.S.D.A. projected consumer food prices to rise between 3% and 4% in 2008, compared with an advance of 4% in 2007 and of 2.4% in both 2006 and 2005. The recent 10-year average year-to-year food price rise was 2.6%.

After above-average annual price advances projected for the current year and to a lesser extent for 2009, the U.S.D.A. forecast through 2017 indicated a return to annual food price advances at levels slightly lower than the anticipated rate of general inflation.

But William Lapp, a former food industry executive and principal of Advanced Economics Solutions, Omaha, said the U.S.D.A. grossly underestimated the potential for food price inflation. Mr. Lapp, who was the featured speaker at the grains and oilseeds luncheon on the final day of the outlook conference, projected food prices to increase 7.5% per year from 2008 through 2012.

The U.S.D.A. forecasts for 2008 were presented by Ephraim Leibtag of the Economic Research Service. The agency’s forecasts for beyond 2008 were contained in "U.S.D.A. Agricultural Projections to 2017," a compendium of baseline agricultural and economic forecasts that was issued a week before the outlook conference.

Mr. Leibtag pointed out U.S.D.A. food price inflation projections for 2008 varied by food category. The widest price advances from 2007 were forecast for fats and oils and for cereal and bakery products. Cereal and bakery product prices were projected to rise 5.5% to 6.5% in 2008. In comparison, cereal and bakery product prices rose 4.4% in 2007 and 1.8% in 2006. Fats and oils prices this year were projected to rise 6.5% to 7.5% from 2007 levels. Fats and oils prices in 2007, in turn, were up 2.9% from 2006.

Narrower price gains from 2007 were forecast for meats, dairy products, eggs and both fresh and processed fruits and vegetables.

Mr. Leibtag pointed to several factors accounting for the projected above-average rise in food prices in 2008, including higher commodity prices, higher energy and transportation costs, increased U.S. agricultural exports because of the weak dollar and rising labor and health care costs. Mr. Leibtag said providing resistance to even greater food price advances in 2008 were increased competition from nontraditional retail formats, better inventory and management cost saving technologies, globalized trade with resultant year-round product availability and demand from consumers for convenience, quality and low prices.

Mr. Leibtag used corn as an example to illustrate sharply higher commodity prices don’t necessarily translate into equally higher food inflation. For the purposes of illustration, Mr. Leibtag compared the effect on food prices when corn prices rise 50% to $3.39 a bu from $2.28. He said an 18-oz box of corn flakes contains about 12.9 oz of milled corn. A 50% corn price rise to $3.39 a bu would be expected to raise the price of a box of corn flakes by about 1.6c, or 0.5%. He added a 2-liter bottle of soda contains about 15 oz of corn in the form of high-fructose corn syrup. A rise in corn price to $3.39 a bu from $2.28 would be expected to raise soda prices by 1.9c per 2-liter bottle, or 1%.

He extended the illustration to include impact of the corn price hike to $3.39 a bu on meat prices. He noted it takes 7 lbs of corn to produce 1 lb of beef, 6.5 lbs of corn to produce 1 lb of pork and 2.6 lbs of corn to produce 1 lb of chicken. One pound of chicken requires 10.6c worth of corn (at the $2.28 corn price), or about 5.2% of the $2.05 per lb average retail price for chicken breasts, Mr. Leibtag said. Using the average price of corn in the illustration and assuming producers do not change their animal-feeding practices, retail chicken prices would advance 5.2c a lb, or 2.5%. Using the same assumptions, retail beef prices would go up 14c per lb, or 8.7%, while pork prices would rise 13c per lb, or 4.1%.

"Higher corn prices pass through to retail prices at a rate less than 10% of the corn price change," Mr. Leibtag said. "Given that foods using corn as an ingredient make up less than a third of retail food spending, overall retail food prices would rise less than one percentage point per year above the normal rate of food price inflation when corn prices increase by 50%. Even this increase may be partially tempered by changes to corn use in food production."

Mr. Leibtag said food price inflation in the current year was projected to be above the historical average but will be only moderate or even mild compared with trends in some earlier decades. He said food price inflation averaged 8.1% per year in the 1970s, 4.6% per year in the 1980s, 2.8% per year in the 1990s and 2.7% a year so far in the 2000s.

In its 10-year food price inflation forecast contained in its baseline projections to 2017, the U.S.D.A. stated, "Relatively large price increases are expected in 2008 for fats and oils and for cereals and bakery products, reflecting higher prices for vegetable oils and wheat. Consumer prices for red meats, poultry and eggs exceed the general inflation rate in 2009 as the livestock sector adjusts to higher feed costs due to the expansion of corn-based ethanol production. Smaller increases in meat prices are then projected as production growth resumes."

The U.S.D.A. baseline forecast food price inflation to drop to 2.9% in 2009, 2.5% in 2010 and 2.2% in 2011, a level where it stays for most of the rest of the projection period through 2017. After this year’s spike, cereals and bakery product price inflation was expected to decline to 1.8% in 2009 and hold at or below 2.4% per year through the baseline period. After this year’s surge, fats and oils prices were expected to rise 2.3% in 2009 and hold at or below a rise of 2.4% per year through 2017.

A different opinion

Mr. Lapp acknowledged the U.S. consumer has faced little or no food inflation pressures since the early 1980s. But food inflation began to accelerate in 2007. He did not see the recent increase in food price inflation as a spike tied to short-term supply/demand conditions.

"Rather, we appear to be entering a period for food inflation very similar to what was seen in the 1970s," he said.

Mr. Lapp said during the 1970s, average prices of most food inputs surged to new plateaus, including corn jumping from its post-WWII average of $1.24 a bu to a new plateau near $2.50 a bu. Food prices rose by an average of nearly 9% between 1972 and 1981, including increases of 20% in 1973 and 12% in 1974, he said.

"Food inflation has been benign since 1982, as there have been commodity price spikes but no sustained increase in commodity inputs," Mr. Lapp said. "The response of food industry participants to short-term price spikes during the past 25 years has been to protect market share at the expense of margins. Thus, since 1982, there has been little correlation between food inflation and these short-term price spikes."

But with the sustained increase in prices seen today, food inflation may no longer be expected to remain in check, and food industry participants will raise prices in the coming years to maintain margins, Mr. Lapp said.

"We have experienced a sharp and, I believe, sustained rise in commodity prices in recent years to a new plateau," Mr. Lapp said. "During the next five years we will see higher food inflation as the impact of higher commodity prices will be passed on to consumers." Mr. Lapp forecast an annual rate of food price inflation of 7.5% through 2012.

Mr. Lapp said his company recently conducted a survey of purchasing executives on their opinions on food price inflation. Mr. Lapp said more than 90% of respondents said 2007 was their most challenging year and more than 90% believed 2008 will be equally challenging or more challenging than 2007. More than 90% of purchasing executives believed the rise in food costs will be sustained. Around 75% indicated they had begun to reflect higher costs in consumer prices and said more price hikes will occur in the next year. Among the causes of the increased food input prices, more than 70% of the executives mentioned global economic growth and a weak U.S. dollar, but more than 90% indicated ethanol was a primary driver of the rise in food input prices.

This article can also be found in the digital edition of Food Business News, March 4, 2008, starting on Page 30. Click here to search that archive.

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