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April 1, 2011

Comment: The challenges and opportunities of commodity prices

Commodity price spikes have again made headlines, hitting new "record" levels this year and leaving food manufacturers to grapple with rising input costs while consumers face inflated retail prices. The increasing cost of commodities such as cocoa, grains and sugar does not look set to be a short-lived phenomenon with growth in demand outstripping supply. However, Katy Humphries suggests, this changing dynamic presents food makers with opportunities as well as challenges.

Commodity price spikes have again made headlines, hitting new “record” levels this year and leaving food manufacturers to grapple with rising input costs, while consumers face inflated retail prices. The increasing cost of commodities such as cocoa, grains and sugar does not look set to be a short-lived phenomenon with growth in demand outstripping supply. However, as Katy Humphries suggests, this changing dynamic presents food makers with opportunities as well as challenges.

Rising commodity costs have once again been highlighted this week, providing a central theme during yesterday’s (31 March) Westminster Food and Nutrition Forum in London, where speakers claimed that the current system of food production is not adequate to meet the needs of the growing global population.

Global food production will need to increase by 70% by 2050 in order to meet the needs of a population that is expected to reach about 9bn people. Professor John Beddington, chief scientific advisor to the UK government, insisted that a “radical redesign on the food system is required” in order to feed the world’s population.

A lack of suitable arable land, poor access to water, the negative impact of climate change and rising costs are all issues contributing to the shortage of food commodities. Indeed, according to Dr Camilla Toulmin, director of the International Institute for Environment and Development, this imbalance of supply and demand will result in rising food prices for years to come.

“The price of food is going to go up relative to other things over the next 30-40 years. We are going to have to accept that we live in a finite world and there is only so much clever science can achieve,” she warned.

The profound impact of the changing metrics of supply and demand can already be seen daily in the commodities markets. According to the United Nations Food and Agriculture Organisation’s Food Price Index, world food prices jumped to their highest levels since the index began tracking them in 1990 last month. In February, food prices climbed 2.2% month-on-month, led by increases in dairy and cereal prices.

The increasing commodity costs have put a strain on the profit margins of food manufacturers.

An investor note from Morgan Stanley today suggested that rising commodity costs will increase food manufacturers input costs by an average of 9-11% during this year alone. Food makers will continue to look to pass higher costs down the supply chain to consumers. However, higher costs will likely weigh on the profitability of food makers during the first half of the year as price hikes trail rising costs, analysts at Morgan Stanley cautioned.

Unsurprisingly, the price shock of food inflation has not been welcomed by shoppers. In developed markets, such as the UK, Europe and US, food inflation has caused consternation among consumers, attracting considerable media attention and increasing political pressure on food makers and retailers to keep prices down.

However, it is the world’s poorest people who are being worst hit by rising food prices and in urbanised emerging markets the outcry against food inflation has been far sharper. In recent months, food inflation has contributed to riots across northern Africa and the Middle East that have already toppled the governments of Egypt and Tunisia.

While food makers must look to juggle profit margins in the short term, the long-term challenge is far more profound. More food must be produced on the same land using fewer resources. This must be achieved while also reducing the negative impact that agricultural production has on the environment.

However, as Nestle CEO Paul Bulcke suggested at the Consumer Analyst Group Europe this week, rising commodity prices are not necessarily in and of themselves a ‘bad thing’. The upward trend in commodity prices will, Bulcke suggested, lead to a “renewed interest in agriculture”.

“It’s going to be the heart and base of rural development and the heart and base of wealth creation worldwide,” he argued.

If rising commodity costs mean higher profits being passed along to farmers in developing countries – rather than ending up in the pockets of middle-men and speculators in commodities futures – this could then provide the means and incentive to reinvest in improving agricultural practices. An increased investment in agriculture could then feed through into higher crop yields.

Food companies would benefit from an improved, more reliable, higher quality supply base – which can often prove problematic in the current environment. Meanwhile, those corporations who have expanded in emerging markets and focused product development on meeting the needs of consumers in these regions would benefit from the growing spending power of an increasingly affluent customer base.

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