A profound, fundamental shift is underway in American agriculture. The impact of a policy that diverts resources from food and shifts them to fuel has already impacted producers and consumers in major ways over the past two years. As this policy continues to be followed, even more significant impacts are yet to unfold.

The most visible impact has been in the grain markets. Corn and soybean meal prices have more than doubled in the past 18 months. Prices are driven by increased demand for biofuels and exports—not by tight supplies. These price increases have taken place in the face of record crops.

The old adage of high grain prices leading to high meat prices is based on sound economics. It doesn’t happen overnight—but it does happen. If it costs more to produce meat, then consumers will sooner or later have to pay more to eat it.

New technology introduced in the hog industry has resulted in a large increase in pork production relative to the size of the breeding herd. Prolonged liquidation in cattle herds has kept beef supplies large. This has masked the impact of higher feed costs in the short run. Producers in both industries have been operating with negative margins.

They will not continue to do this in the long run. Meat supplies will tighten up and meat prices will rise, probably by the second half of this year. The market is anticipating this by keeping big price premiums in the far deferred futures contracts.

The food-versus-fuel dilemma is also being demonstrated in more subtle and less visible ways. A major but often overlooked component in determining live cattle prices is the value of the hide and offal byproducts, often referred to as drop credits.

The value of the hide and offal for a steer recently reached record levels. The major component of the drop credit is the hide, which historically has made up well over half of the total drop value. Interestingly, the value of the hide from a 1,200-lb. steer is nearly $15 per head lower than it was last year.

So what has driven drop credits to new highs? The answer, once again, lies in the use of food for fuel. High corn and soybean meal prices have caused pet food manufacturers to reformulate their product using more animal variety and organ meats. Prices for meat and bone meal, as well as blood meal, have soared as they are tapped to replace soybean meal in pork and poultry rations.

But the biggest gains have come in prices for tallow, both that which is edible for human beings and that which is not. Edible tallow is normally used for cooking oils, and prices have soared with the rise in vegetable oils. Inedible tallow, which is used to manufacture drugs, cosmetics, soaps and other items, has been finding increased demand as a direct fuel source.

The food-versus-fuel situation will bring interesting moral and ethical considerations in the future. Mother Nature has blessed the nation with good growing conditions and excellent crops in the past couple of years, which has allowed for big growth in the biofuels industry. This industry has been heavily subsidized, providing further incentives for growth. When drought results in reduced crop production down the road, what will decide if grain goes into the stomach of an animal or the fuel tank of a car?

The total demand for U.S. commodities has been fueled even further by the weakness in the U.S. dollar. This makes U.S. grains even more sought after as foreign buyers have more dollars to turn into food. Foreign ownership of U.S. production facilities is also on the rise as those longer term assets are more attractive to foreign companies that have more U.S. dollars to turn into U.S. assets. The trend of a lower value dollar seems to be firmly in place for the foreseeable future.

Higher feed costs will result in higher animal prices. Higher animal prices will not, however, translate directly into profitability for cattlemen. Meat will compete for consumer dollars that also must pay increased costs for energy, cosmetics, drugs and even pet food. Risk management and marketing skills will become ever more valuable resources for those who want to continue in the livestock business.