Long-Term Commodity Prices: Moderate Strength

By Yelto Zimmer, Senior scientist at the Thünen Institute of Farm Economics

As commodity prices soared from 2008 to 2012, global concerns mounted that the expanding population and rapid economic growth were out Yzimmerstripping our capacity to feed the world as it heads for nine billion in 2050. Now, prices have fallen – in some cases by as much as 50 percent. “A New Paradigm for Global Agriculture Commodity Markets?” explains why both the demand and supply sides suggest long-run price levels are likely to average only modestly above those of the pre-boom period.

  1. Demand-side growth is slowing: After increasing by an average of 2.2% between 1970 and 2007, global annual growth in food demand is projected to ease to 1.4% between 2007 and 2030 and to 0.8% between 2030 and 2050. Causes include slower population growth; an increase in the elderly population, who tend to consume less food; and an increasing share of the global population whose diets have reached the saturation level and from whom no significant increase in food demand can be expected.
  2. Global supply potentials are higher than many estimate. We still have massive untapped yield potentials. For example, average wheat yields average 40% of the agronomic potential.

Also, land is not in short supply globally: About 1.7 billion acres or 700 million hectares of arable land are still available, without touching the rain forest or other ecologically sensitive areas.

  1. Cost of production and transport are the deciding factors. Globally, it is cost of production of the marginal producer that counts – that is, the producer who represents the production system or site with the highest cost of production, who contributes the last unit of output on the global supply schedule needed to match supply and demand. Further, it is the cost at a port that serves global markets that matters.

A few factors might suggest a higher cost of production as new land is brought into production: It may be lower yielding, for instance. Data from agri benchmark farms indicate low-yielding wheat farms – which account for as much as 80% of global trade – have direct production costs of about $25/ton above high-yield farms. However, in some cases, mechanization and economy of scale compensate. In addition, recent agricultural growth has been in countries where natural conditions for arable production and good yields are excellent—Argentina, Brazil, Mozambique, Angola, and Myanmar, to name just a few.

Some believe adoption of more intensive production practices increases cost of production. Data from agri benchmark farms from all different intensity levels globally do not support that view. We found absolutely no correlation between use of nitrogen fertilizer or crop production products as proxies for input intensity and direct cost, operating cost, or total cost of production per ton.

The possible reason for this: In the long run, farmers not only use more fertilizers but modify the entire production system, using better seed, higher plant population, etc.; i.e., they move to a more efficient production function. Hence, the hypothesis that intensification’s effects on cost of production are the cause for a strong increase in prices is unfounded.

Finally, some believe that higher oil and fertilizer prices led to higher cost of production and hence higher commodity prices. agri benchmark figures from 23 typical farms from all major wheat-producing countries, from 2008-2012, when crude oil prices were near $100/barrel, suggest that the increase in energy and nitrogen prices (which are energy-price driven as well) led to a fairly modest $25-$35/ton higher production costs compared with the pre-2008 period. Of course energy and nitrogen prices have fallen dramatically more recently.

On the other hand, new lands’ longer distances to export harbors and less developed infrastructure mean free on board (f.o.b.) costs inevitably rise. A case study from Brazil suggests this increase could be in the range of $30/ton.

Land rent may absorb some of these increases in cost of production. As the current United States case illustrates, when farm profit margins tighten, land rents and values adjust downward. Figures from two Brazilian agri benchmark farms with similar yields support the view that higher transport costs are reflected in lower land rent: A farm in Parana is relatively close—435 miles (700 km)—to the port at Santos and rent is about $89/acre ($220/ha); one in Mato Grosso is about 1,367 miles (2,200 km) and land rents there are about $57/acre ($140/ha).

The bottom line. Assuming long-run increases in costs of $65/ton, and assuming only about half this increase is compensated by reduced land rents, $180/metric ton might be a reasonable estimate for long-term wheat prices; corresponding corn prices can be assumed in the range of $140/metric ton. That is well below the extreme scenario of $270/ton wheat some have portrayed. And, of course, if crude oil prices stay at or below $60/barrel, the long-term price level would be at least $10/ton lower.

This is not to say supply-side shocks have no effect. During the recent price boom, yields in the United States were below trend for several years, and the major drought in 2012 resulted in very tight supplies. However, as we have seen, stocks have rebuilt rapidly and prices have adjusted accordingly.

We conclude that long-run equilibrium prices might be modestly, but not dramatically, above pre-boom prices and also dramatically lower than some forecasting institutions have suggested.

For More Information

The full working paper is available at www.agribenchmark.org/fileadmin/8-Cash-Crop/Working-Paper/cc-1502-commodity-markets.pdf

agri benchmark methodology: www.agribenchmark.org/cash-crop/publications-and-projects0/methodology.html. Typical farm approach is explained in more detail here: www.agribenchmark.org/fileadmin/Dateiablage/B-Cash-Crop/Misc/SOP-cashcrop-0512.pdf

Yelto Zimmer is coordinator of the agri benchmark Cash Crop Network, senior scientist at the Thünen Institute of Farm Economics; e-mail: yelto.zimmer@ti.bund.de; www.agribenchmark.org.*

*agri benchmark is a global, nonprofit network of agricultural economists, advisors, producers and specialists in key sectors of the value chains who use internationally standardized methods to analyze farms, production
systems and their profitability.
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