Corn Prices Near Record High,
But What About Food Costs?
Higher corn prices increase
animal feed and ingredient costs for farmers and
food manufacturers, but will consumers undergo the
same sticker shock at the grocery store?
Ephraim
Leibtag
|
|
Higher
corn prices increase animal feed and
ingredient costs for farmers and food
manufacturers, but pass through to retail
prices at a rate less than 10 percent
of the corn price change. |
|
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 1 percentage point
per year above the normal rate of food
price inflation when corn prices increase
by 50 percent. |
|
Even
this increase may be partially tempered
by changes to corn use in food production. |
|
For
more information . . . |
“U.S.
Ethanol Expansion Driving Changes Throughout
the Agricultural Sector,” by Paul
C. Westcott, in Amber Waves, Vol. 5, No. 4,
USDA, Economic Research Service, September
2007.
“The
Future of Biofuels: A Global Perspective,”
by William Coyle, in Amber Waves, Vol. 5,
No. 5, USDA, Economic Research Service, November
2007.
|
You
may also be interested in . . . |
ERS
Briefing Room on Food CPI, Prices, and Expenditures.
|
Record U.S. trade driven by economic
growth in developing countries and favorable exchange
rates, combined with tight global grain supplies,
resulted in record or near-record prices for corn,
soybeans, and other food and feed grains in 2007.
For corn, these factors, along with increased demand
for ethanol, helped push prices from under $2 per
bushel in 2005 to $3.40 per bushel in 2007. By the
end of the 2006/07 crop year, over 2 billion bushels
of corn (19 percent of the harvested crop) were
used to produce ethanol, a 30-percent increase from
the previous year. Higher corn prices motivated
farmers to increase corn acreage at the expense
of other crops, such as soybeans and cotton, raising
their prices as well.
What effect do these higher commodity
costs have on retail food prices? In general, retail
food prices are much less volatile than farm-level
prices and tend to rise by a fraction of the change
in farm prices. The magnitude of response depends
on both the retailing costs beyond the raw food
ingredients and the nature of competition in retail
food markets. Ethanol’s impact on retail food
prices depends on how long the increased demand
for corn drives up farm corn prices and the extent
to which higher corn prices are passed through to
retail. ERS research has traced the effect of higher
corn prices on U.S. retail food prices by analyzing
data on price trends and price response of corn-dependent
foods to cost changes.
Retail Competition Moderates
Food Price Inflation
Retail food prices adjust as the
cost of inputs into retail food production change
and the competitive environment in a given market
evolves. Strong competition among three to five
retail store chains in most U.S. markets has had
a moderating effect on food price inflation. Overall,
retail food prices have been relatively stable over
the past 20 years, with prices increasing an average
of 3.0 percent per year from 1987 through 2007,
just below the overall rate of inflation. The main
exception occurred when sharply higher farm prices
increased retail prices 5.8 percent in 1989 and
1990. Since then, food price inflation has averaged
just 2.5 percent per year.
Retail prices are a function of
both consumer demand and the interaction between
food manufacturers, distributors, and retailers,
with each group having some pricing power in the
supply chain. Ultimately, though, the retailer has
a more complicated pricing decision since it is
selling a wider variety of products to a more diverse
consumer clientele than most manufacturers or distributors.
The challenge for the food retailer is to determine
how best to distribute the costs of providing both
food and services to consumers across a wide range
of products. This pricing challenge removes some
of the direct connection between the costs of a
given product and the retail price charged.
When there are cost shocks in
the food production system due to changes in the
commodity or farm product market, most retailers
respond by passing on a fraction of their higher
costs to consumers. Among factors affecting this
pass-through rate is the level of processing and
value-added services that take place between the
farmgate and the grocery store aisle. Products that
require more processing and packaging are usually
less directly linked to changes in farm prices,
while the price of less processed foods more closely
follows the changes in farm prices. For example,
changes in farm prices for eggs, fresh fruit, and
fresh vegetables show up in more volatile retail
prices for these less processed foods. The price
volatility of pork and beef is also above the average
for all foods. The other food categories average
between 2.3 and 3.4 percent in price change per
year.
Higher Farm Corn Prices,
Slightly Higher Food Prices
Field corn is the predominant
corn type grown in the U.S., and it is primarily
used for animal feed. Currently, less than 10 percent
of the U.S. field corn crop is used for direct domestic
human consumption in corn-based foods such as corn
meal, corn starch, and corn flakes, while the remainder
is used for animal feed, exports, ethanol production,
seed, and industrial uses. Sweet corn, both white
and yellow, is usually consumed as immature whole-kernel
corn by humans and also as an ingredient in other
corn-based foods, but makes up only about 1 percent
of total U.S. corn production.
Since U.S. ethanol production
uses field corn, the most direct impact of increased
ethanol production should be on field corn prices
and on the price of food products based on field
corn. However, even for those products heavily based
on field corn, the effect of rising corn prices
is dampened by other market factors. For example,
an 18-ounce box of corn flakes contains about 12.9
ounces of milled field corn. When field corn is
priced at $2.28 per bushel (the 20-year average),
the actual value of corn represented in the box
of corn flakes is about 3.3 cents (1 bushel = 56
pounds). (The remainder is packaging, processing,
advertising, transportation, and other costs.) At
$3.40 per bushel, the average price in 2007, the
value is about 4.9 cents. The 49-percent increase
in corn prices would be expected to raise the price
of a box of corn flakes by about 1.6 cents, or 0.5
percent, assuming no other cost increases.
In 1985, Coca-Cola shifted from
sugar to corn syrup in most of its U.S.-produced
soda, and many other beverage makers followed suit
(see “High-Fructose
Corn Syrup Usage May Be Leveling Off”
in this issue). Currently, about 4.1 percent of
U.S.-produced corn is made into high-fructose corn
syrup. A 2-liter bottle of soda contains about 15
ounces of corn in the form of high-fructose corn
syrup. At $3.40 per bushel, the actual value of
corn represented is 5.7 cents, compared with 3.8
cents when corn is priced at $2.28 per bushel. Assuming
no other cost increases, the higher corn price in
2007 would be expected to raise soda prices by 1.9
cents per 2-liter bottle, or 1 percent. These are
notable changes in terms of price measurement and
inflation, but relatively minor changes in the average
household food budget.
Impacts Extend to Meats
Through Higher Feed Costs
Given that livestock feed rations
traditionally contain a large amount of corn, a
bigger impact would be expected in meat and poultry
prices due to higher feed costs than in other food
products. Currently, about 55 percent of corn produced
in the U.S. is used as animal feed for livestock
and poultry. However, estimating the actual corn
used as feed to produce retail meat is a complicated
calculation. Livestock producers have many options
when deciding how much corn to include in a feed
ration. For example, at one extreme, grass-fed cattle
consume no corn, while other cattle may have a diet
consisting primarily of corn. For hog and poultry
producers, ration variations may be less extreme,
but can still vary quite a bit. To estimate the
impact of higher corn prices on retail meat prices,
it is necessary to make a series of assumptions
about feeding practices and grain conversion rates
from animal to final retail meat products. To avoid
downplaying potential impacts, this analysis uses
upper-bound conversion estimates of 7 pounds of
corn to produce 1 pound of beef, 6.5 pounds of corn
to produce 1 pound of pork, and 2.6 pounds of corn
to produce 1 pound of chicken.
Using these ratios and data from
the Bureau of Labor Statistics, a simple pass-through
model provides estimates of the expected increase
in meat prices given the higher corn prices. The
logic of this model is illustrated by an example
using chicken prices. Over the past 20 years, the
average price of a bushel of corn in the U.S. has
been $2.28, implying that a pound of chicken at
the retail level uses 8 cents worth of corn, or
about 4 percent of the $2.05 average retail price
for chicken breasts. Using the average price of
corn for 2007 ($3.40 per bushel) and assuming producers
do not change their animal-feeding practices, retail
chicken prices would rise 5.2 cents, or 2.5 percent.
Using the same corn data, retail beef prices would
go up 14 cents per pound, or 8.7 percent, while
pork prices would rise 13 cents per pound, or 4.1
percent.
These estimates for meat, poultry,
and corn-related foods, however, assume that the
magnitude of the corn price change does not affect
the rate at which cost increases are passed through
to retail prices. It could be the case that corn
price fluctuations have little impact on retail
food prices until corn prices rise high enough for
a long enough time to elicit a large price adjustment
by food producers and notably higher retail food
prices.
On the other hand, these estimates
may be overstating the effect of corn price increases
on retail food prices since they do not account
for potential substitution by producers from more
expensive to less costly inputs. Such substitution
would dampen the effect of higher corn prices on
retail meat prices. Even assuming the upper-bound
effects outlined above, the impact of rising corn
commodity prices on overall food prices is limited.
Given that less than a third of retail food contains
corn as a major ingredient, these rising prices
for corn-related products would raise overall U.S.
retail food prices less than 1 percentage point
per year above the normal rate of inflation.
While higher commodity costs may
have a relatively modest impact on U.S. retail food
prices, there may be a greater effect on retail
food prices in low-income developing countries.
As a relatively low-priced food, grains have historically
accounted for a larger share of the diet in less
developed countries. Even with incomes rising, consumers
in such countries consume a less processed diet
than is typical in the U.S. and other industrialized
countries, so food prices are more closely tied
to swings in both domestic and global commodity
prices (see “Rising
Food Prices Intensify Food Insecurity in Developing
Countries” in this issue).
Markets Adjust and Prices
Stabilize
Continuing elevated prices for
corn will depend on the extent to which corn remains
the most efficient feedstock for ethanol production
and ethanol remains a viable source of alternative
energy. Both of these conditions may change over
time as other crops and biomass are used to produce
ethanol and other alternative energy sources develop.
Even if these conditions do not
change in the near term, market adjustments may
dampen longrun impacts. In 1996, when field corn
prices reached an all-time high of $3.55 per bushel
due to drought-related tighter supplies in the U.S.
and strong demand for corn from China and other
parts of Asia, the effect on food prices was short
lived. At that time, retail prices rose for some
foods, including pork and poultry, but these effects
did not extend beyond the middle of 1997. For the
most part, food markets adjusted to the higher corn
prices and corn producers increased supply, bringing
down price.
Food producers, manufacturers,
and retailers may also adjust to the changing market
conditions by adopting more efficient production
methods and improved technologies to counter higher
costs. For example, soft drink manufacturers may
consider substituting sugar for corn syrup as a
sweetener if corn prices remain high, while livestock
and poultry producers may develop alternative feed
rations that minimize corn needed for animal feed.
Adjustments by producers, manufacturers, and retailers,
along with continued strong retail competition,
imply that U.S. retail food prices will remain relatively
stable.
|