Rising commodities prices: The other side of the coin

The Jakarta Post

Achmad Syafriel, Research Analyst

The biofuel and food processing industries are currently going head to head in competing for agricultural commodities, and to envisage a decline in commodities prices from here on is difficult.

The impact of this could be threefold. First, the man on the street could be faced with rising prices for staple foodstuffs; second, the margins of firms that make consumer products could feel the heat; and, third, environmental implications could result that will have to be dealt with.

With oil prices staying high and volatile, many countries have been encouraged to seek alternative fuels. For example, the European Union has issued regulations that require biodiesel use in all member countries to account for 5.75 percent and 20 percent of diesel consumption for transportation purposes by 2010 and 2020, respectively.

Meanwhile, Indonesia launched a biofuel development program last year to reduce consumption of fossil fuels. Indonesia hopes to substitute 10 percent of its fossil fuel consumption with biofuel by 2010.

Biofuel can be produced from several agricultural commodities, or what are known as "soft commodities". Bioethanol can be made from sugarcane, corn or wheat, while biodiesel is made from crude palm oil (CPO), rapeseed oil and jatropha oil.

Bioethanol is a mix of gasoline and ethanol, while biodiesel is a mix of diesel and methyl ester. They are graded depending on the biofuel content of the particular fuel. For instance, Biodiesel 10 (B10) means the fuel contains a 10 percent methyl ester mix, while Ethanol 60 (E60) refers to a 60 percent ethanol mix.

The increased demand for soft commodities from the biofuel industry comes at a time when the supply is limited.

Traditional soft commodity demand (e.g. for food and soap) is already high. For example, the compounded annual growth rate in traditional CPO demand over the past 11 years up to 2005 has been higher than supply; 7.6 percent versus 7.4 percent.

Similarly tight conditions can also be seen in the case of corn and wheat. Traditional demand for these products had been high even before biofuel came into the equation. Bear in mind that corn and wheat are the staple foodstuffs of the majority of people around the world, with wheat being the main raw material for the production of bread and noodles.

Add to this the possibly of a prolonged drought this year, which has led the U.S. Department of Agriculture to lower its estimate of the level of U.S. corn stockpiles at the end of this year to 752 million bushels from 935 million bushels previously.

At the same time, U.S. President Bush has proposed increasing the U.S. mandate for alternative fuels fivefold to 35 billion gallons by 2017. This higher ethanol demand may require up to 6.5 million more corn acres in 2007.

Farmers in the U.S. may plant less wheat and soybean in order to benefit from rising demand for ethanol. This comes at a time when drought in several wheat producing countries, such as Australia, threatens wheat production.

Global wheat supply will have fallen to 119.3 million tons by the end of May, according to the U.S. Department of Agriculture. In sum, these conditions may lead to rising prices for CPO, wheat and soybeans.

What implications will all this have? Well, for us average people, we may be faced with higher prices for staple foods.

Indonesia is no exception in this regard as the country imports a significant amount of wheat. This is an issue that the government must calculate carefully, as food prices are directly linked to poverty levels.

Second, consumer product firms will face challenges in maintaining margins. The Indonesian consumer is known for his sensitivity to prices. So, with minimal room for pass-through, margin pressure will be felt.

Third, efforts to respond to supply constraints through increased production may have environmental implications. There have been numerous cases around the world where the opening up of new CPO plantations has been at the expense of the rain forests; Indonesia appears to be no exception in this regard.

So far we have only seen the good side of rising soft-commodity prices, i.e., in the form of stronger export growth and increased cash turnover in rural Sumatra. How prepared are we for the adverse consequences?