The return of global food inflation is one of the big stories in 2011, and we might as well get used to it because this is the new reality.
Much of the focus has rightly turned to the price of grains. In a 2008 paper, University of Illinois ag economists Darrel Good and Scott Irwin found "compelling evidence that a new era of crop price levels and volatility has begun."
We are now in the third such era since World War II, they noted. During the first era, from 1947 to 1972, corn prices averaged $1.28 per bushel. But structural shifts took hold in 1973: grain purchases by Russia, changes in currency exchange-rate policies and rising energy prices. It’s no coincidence that farmgate milk prices started to increase dramatically at the same time, rising from less than $6 per cwt. at the beginning of the decade to more than $12 per cwt. at the end of it.
That second era, during which corn averaged $2.42 per bushel, ended in 2006, the economists determined. The big structural shift that began in 2007, of course, was mandating the use of corn for ethanol.
"The linkage between energy and corn prices formed so quickly that it is easy to overlook the profound nature of this change," the authors said back in the fall of 2008. "This means that uncertainty in energy markets and about energy policy is directly transmitted into grain markets. And this is on top of the traditional weather and disease risks that are so familiar."
Likewise, it’s no coincidence that milk prices climbed to record highs in 2007. After averaging $12.61 from 1973 to 2006, the All-Milk price has averaged $16.64 in the four years since. USDA projects the 2011 All-Milk price to average $16.50.
Higher grain costs have serious implications for dairy, noted Rabo AgriFinance analyst Tim Hunt at last fall’s World Dairy Summit in Auckland, New Zealand.
First and foremost, expect dairy to trade in a higher band from here on out. Higher grain prices will increase costs for all farmers, so the returns required to attract resources to dairy production must increase as well.
Ultimately, milk prices must reflect the cost of production.
Higher grain prices will also lead to greater volatility in the dairy markets, since corn and soybean prices have historically been more volatile than dairy. And they put greater pressure on margins since grain and dairy prices don’t always move in sync, leaving periodic mismatches in costs and returns.
In addition, they perpetuate the cost advantage of pasture-based milk production regions, Hunt said. And since dairy occupies a premium position among sources of protein, they present a challenge to defend market share against substitutes.
These shifts impact everyone in the dairy supply chain, from farm to fork. And it affects the policies we choose. Noted Hunt: "Farmers, processors and regulators will all need to consider [how this impacts] the market as they develop their strategies for the medium term."