Ingredient costs impacted by state of farm economy

by Morton Sosland
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Maintaining a close watch on ingredient prices, as many executives in food manufacturing do these days, regardless of whether or not they have purchasing responsibilities, is mostly centered on how changes may result in revised manufacturing costs. This is especially the case as a result of the dramatic impact sharp market fluctuations in recent years have had on food profitability. As easy as this single-minded focus is to understand it would be much more valuable if this attention could be combined with equal awareness of how agricultural producers are doing in the same supply-demand arena that is central to the well-being of food companies. After all, it is a broad array of farmer decisions about production and marketing that account mainly for the wide fluctuations in ingredients challenging the well-being of food companies.

Current ingredient markets provide some excellent examples of how food ingredient costs in the past have been directly impacted. In reality, food manufacturers are this year paying the price for what cost relief they might have enjoyed in 2009. Cutbacks in plantings and poor weather directly account for current flour levels, while the dramatic drops in hog and cattle numbers in response to disastrously weak markets in 2008 and 2009 are the force behind this year’s advances in beef and pork prices. Sugar and dairy products have many of the same elements as these prices in posting upturns. All are principally the result of farmers’ unwillingness to invest in production at prices then ruling in markets.

Before anyone is tempted to wonder how the present situation differs from what has happened many times in the past when low farm prices have been followed by a costly rebound, the added weight this time reflects the way the recession of 2008 and 2009 exerted a more dramatic impact on the rural economy than any recent business downturn. As many food manufacturers are only too aware, this recession caused reductions in consumer food spending, both in dollar and unit sales. Cutbacks were especially severe for food service, which in turn caused a fall in demand for protein foods. Livestock prices suffered. Weakness in a wide range of ingredients resulted from a business downturn that, unlike many of its predecessors, cut specifically into consumer spending on food.

Similarly, agricultural producers felt depressed prices and dismal prospects as export demand responded to what quickly became a global recession. Just like domestic demand, global buying slowed, cutting back the agricultural export pace during the entire year. Livestock export reductions were led by a 45% drop in dairy shipments. The value of wheat and corn exports both shrunk.

Tight credit, in the not too distant past hardly a problem for most farmers, loomed large in the setbacks agriculture recently has faced. Credit standards for agricultural loans were tightened at many banks, collateral requirements were increased and loan terms have been curtailed to lower risks. So-called guaranteed loans became the preferred avenue to obtaining credit. These moves coincided with a marked increase in farm loan delinquencies and a slowing in repayment rates. Recent surveys show farmers expecting financial conditions to deteriorate further, as reflected in less capital spending.

Gross crop revenues in 2009 fell 10.6% from the previous year, and real net farm income was estimated by the Department of Agriculture down to $52 billion, contrasted with $80 billion in 2008. Of course, the latter was a boom year for agriculture and 2009 mimicked the bust that hit the overall economy. Any satisfaction that might have been registered by food manufacturers over the easing in ingredient prices is quickly giving way to disappointing market rebounds.

Experience of the past several years emphasizes the extraordinary impact that setbacks as well as booms in agriculture exert on ingredient prices. The case may be made that these influences, measured by how they moved ingredient prices recently, rival fundamental supply-demand as factors in determining ingredient costs.

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