We mention these different elements of the food economy to illustrate that the way food raw materials are used is complicated and highly dependent not only on price, but on cultural habits and the mechanisms for processing and distributing food - the so-called "farm to fork" value chain. The agriculture and food economy is not like making cars or refining crude petroleum oil or making computer chips but is instead hugely diverse and determined by interactions of the environment, climate and human psychology. Many of the raw materials are used in conjunction with each other; if the price of wheat rises because of adverse weather in North America, the production of cookies might fall reducing demand for sugar and cooking oil, even those these materials might be in reasonable supply.
In this case generalizing about the food industry, let alone making accurate forecasts is extremely difficult. We try to avoid it, instead taking an approach that tries to explain why prices are where they are currently, that takes a longer term view than the very erratic short-term changes in specific futures contracts (though we report these too) and when things are going one way, we try and explain why they could go another.
Hence the subject of this post: how are high food prices affecting demand for agricultural raw materials and what might happen to take the steam out of the markets?
It may come as a surprise to some that food demand, even in developed, high income countries, can and does adjust down. My anecdote about turning stale bread into rusks (for those that don't know, having never had the need, stale bread baked in a hot oven turns in delicious crunchy biscuits - try them!) is relevant - Americans slashed their food expenses more during 2007 to 2009 recession, by an inflation adjusted 5 percent— the largest decrease in at least 25 years according to a report from USDA’s Economic Research Service. In 2006, before the recession began, total food spending by all US households peaked at $726 billion. By 2009 it dropped to $690 billion - $36 billion out of the food economy right there.
However there is more to the story: the drop in consumption came from food bought in commercial establishments - restaurants, fast-food places - and the folk changing their consumption pattern were the middle-class; typically one expects that food is a relatively small part of middle class income earners overall household expenditure; indeed so it may be, but going out to dine is still considered by many as something of a treat. People are not actually eating less, but they are paying less for the food by consuming it at home. This may not reduce the demand for raw materials, but it may e.g., drop the demand for industrial-sized packages of foodstuffs.
There is another lesson to be had from the data in the chart. The top line represents real total food expenditure from 1990. Despite the (actually quite minor) adjustments down during recessionary periods, the overall trend is slightly upwards and this does reflect somewhat the overall long-run increase in prices; equally, apart from the change just discussed, overall the trend had been towards eating outside the home - more expensive and more highly processed foods.
Think about what constitutes restaurant food: food raw materials that have been grown commercially on a large-scale, processed by large commercial operators, packaged and shipped. In developed countries, of which this US data is representative, this trend suggests the growth of major industries,many not included in "agriculture", along the value chain to the dining table in that expensive restaurant. Agriculture and even primary processing no longer hold the real keys to food demand in such countries but rather provide raw materials that have enormous value added to them before reaching the final consumer. Changes in raw material supply and price certainly affect demand, but through the filter of this much more complex value chain.
Another feature is that the chart lines show little dramatic change or disturbance. The headline writer at USDA makes much of the recent downwards adjustment - indeed we all have to write articles hung on a certain story. But the real truth of food expenditure and demand in the developed world is that it is a remarkably stable demand whatever the circumstances. Your local high-end restaurant may see a fall off in custom and have to lay off some waiters, but the customers can still afford to cram down their 4,000 calories at home and still worry about obesity.
This is NOT the case for the rest of the world, and it may help to get some handle on what I mean by this. World average per capita GDP is roughly $10,000 (IMF data). There are 81 countries (out of 183) where incomes are higher than that figure and we might use these as indicators of where there might be a significant middle class. This is a VERY rough way to look at things because a country like Pakistan has a large population, a large middle-class, but a per capita GDP of only $2,721.
The majority in the >$10,000 group are actually countries which have some kind of significant resource advantage such as Qatar which holds the Number 1 spot with a per capita GDP of over $88,000. But don't expect Qatar to account for much by way of food demand! In fact we count only five countries in this top end group that have both large enough populations and a very significant middle class (USA and Canada - taken as one - UK, France, Germany) to really impact food consumption. So who does?
We might usefully look at a recent report on the emerging middle class by OECD.Note 1 A key finding is as follows, "Today’s rich countries accounted for 22 per cent of the world’s people in 1965, but only account for 15 per cent today, and their share is forecast to shrink to 13 per cent of the world total by 2034 (Ed. my bold). Overall, the world will add 1.6 billion people by 2034. But the population in today’s rich countries will grow by only an estimated 90 million. Ninety-five per cent of the population increase (excluding migration) will be in developing countries."
Similarly in 1965 the global centre of the world was Europe, with the USA and Japan being the two growth super-powers. In the next 20 years this centre of gravity will have shifted to Asia, with India and China producing the largest number of middle-class. The report goes on:
"Globally, the size of the middle class could increase from 1.8 billion people to 3.2 billion
by 2020 and to 4.9 billion by 2030. Almost all of this growth (85 per cent) comes from Asia. The size of the middle class in North America is expected to remain roughly constant in absolute terms.......... Europe enjoys some early growth in the numbers of the middle class, but then sees a fall as populations decline in Russia and elsewhere."
So there you have it: right NOW, a fairly small proportion of the world's population actually accounts for the bulk of food industry demand - commercialized agribusiness and processed food; that population, concentrated mainly in the mature (stagnant?) developed countries, can change the kind of food it eats and where it eats it, but is unlikely to much reduce consumption overall - nor will it increase it - hey, 4,000 calories/day is an obscene amount of food!
By contrast most of the world's population is simply outside this market. Going forwards (if the OECD and other commentators are to be believed) while the proportion of middle-class falls, the total size of this market grows driven by newly rich folk in Asia. These people will switch from rice and vegetables to meat and (probably farmed) fish. These items require much greater supplies of feed and hence a higher push for staple commodities (corn, wheat, soybeans, barley, sorghum etc.).
And of course in the future the issue of feeding the (larger) majority gets more critical.
This blog attempts to be action oriented, and future posts will look at how these dynamics will affect investors in agribusiness and those interested in developing agriculture.
For the moment we can say this: the fact that demand can adjust very rapidly as knowledge circulates in the developed world certainly affects specific sectors and segments of the market. Witness the rapid growth in demand for "super fruit juices" and a slackening in demand for milk and sugar as the population ages and folk become (slightly) conscious of Metabolic Syndrome (or Type II diabetes) as they pass 40 years if age. In this case it is the composition of the food basket that is of real commercial interest.
Raw material costs affect processor margins, so while chicken farmers may benefit from a dietary preference for white meat, they lose from higher feed costs and chicken processors have work to maintain their margins as these costs get passed on. Simply because on-farm agriculture is seen to be doing well from higher prices does NOT mean that agribusiness is benefiting - and we'll be looking at the fortunes of the big publicly-owned food businesses in the next post.
For the majority non-middle-class world, caring little for what they eat or where they do so long as they DO eat (something), the issue is latent demand. Most people on the planet simply do not begin to approach the dietary standards of the middle-class. This demand is notional or "stored' in the sense that it cannot be calculated into the balance sheets of the commercial food industry. However it can be considered by investors capable of tackling frontier economies and building a food supply that is cheap and available. Yet another story in the pipeline.
Note1: This is a highly academic report based on a specific model; treat it with some scepticism. What is noted here is only part of the document which should be read in full to get the complete picture.
