Oil, Dollar Drive Commodity Prices - Economists

Commodity prices - and resulting food prices - are rising sharply, driven by a combination of factors that include high oil prices spurring biofuels growth, a weak dollar and world production and consumption trends, according to an analysis by Purdue University agricultural economists.

In a Farm Foundation commissioned report released recetnly, the Purdue economists - Phil Abbott, Chris Hurt and Wally Tyner - highlight key factors gleaned from examining 25 recent studies plus their own analysis. Their conclusion: a complex combination of factors are fueling agricultural commodity price increases and rising food costs.

Tyner, an expert on energy and policy issues, says the price of oil is an important factor that has increased the demand for biofuels. "About $3 of the corn price increase is due to the higher oil price and $1 to the ethanol subsidy," he said.

As high oil prices spur demand for biofuels, the increased corn production stimulates demand for fertilizer, diesel, propane and other agricultural inputs. Prices for these inputs have also risen due to the "demand pull" from more corn being produced and subsequently the "cost push" due to the fact that petroleum products are key ingredients in many of these inputs.

Another key factor - the weak dollar - is linked to the rise in all commodity prices. "The link between the U.S. dollar exchange rate and commodity prices is stronger and more important than many other studies imply," says Abbott. "Whatever impacts the dollar will influence food prices."

An expert on international trade and macro factors, Abbott points out that oil and agricultural commodities are priced in dollars. When the U.S. dollar falls, as it has for the last six years, then these goods become cheaper for others in the world to buy, which increases demand.

"The dollar has depreciated 45% from its peak in 2002 through 2007," says Abbott. "Over the same time the value of agricultural exports had increased 54 percent, and are projected to go much higher."

When asked how long these current high prices would last, the economists indicated two factors might be most significant. "Based on this analysis, high commodity prices will persist as long as high oil prices remain and as long as the dollar stays weak," says Tyner. "Lower oil and a stronger dollar would bring pressure on commodity prices to fall."

Many studies point to the pace of global consumption being higher than global production as an important driver of commodity prices. In eight of the past nine years, consumption has grown faster than production. Unlike many who see China and India as major contributors to rising food commodity prices, the Purdue economists argue that is not the case. "It's countries who trade that set the price. China and India are agriculturally self-sufficient and largely do not trade agricultural commodities," says Tyner.

When it comes to the price of oil, however, Tyner says that's another story. "While China and India are not the root cause of food demand, the opposite is true for oil, as China especially has a huge and growing appetite for oil."