Crude oil prices may be off the record highs seen recently, but levels over US$60 a barrel are up enough to have a big impact. In the last couple of months company after company, in every sector of the food chain, has warned that fuel costs are going to hit their results. Just what will the damage be? Chris Lyddon reports.

“We expect to feel increasing margin pressure from rising fuel prices,” said Steve Sanger, chairman and CEO of cereal company General Mills, when he presented his company’s first half results last month.

In recent days snack maker Golden Enterprises blamed a move into loss for its first quarter on the effect of increased fuel costs.

Canadian grocer Loblaw cited high fuel costs as one of the reasons for its decision to close its internet grocery business.

Yet another company, of many, to feel its bottom line threatened is supermarket giant Tesco. “We saw significant external cost increases in the first half, mainly from higher oil-related costs and above-inflation increases in business rates” it said when it released its first half results recently. “Although we had budgeted for a large increase in oil-related costs, current oil prices suggest actual costs may be as much as £60m (US$106m) above budget for the full year, a level which will be hard to absorb fully through other cost savings.”

More expensive food?

Somebody is going to have to pay for the extra costs caused by higher oil prices, according to Christine Welberry, spokeswoman for the UK industry’s lobby group the Food and Drink Federation. “From our perspective current high levels of oil prices will feed into high energy costs and high costs of packaging and will affect supplies of ingredients,” she tells just-food. “Higher oil prices will increase our costs, which will then have to be recovered through higher prices for food and drink.”

In agriculture, traders worry that increase fertiliser costs will encourage farmers to cut inputs. The sums still add up for farmers using nitrogen to produce higher quality wheat, but many grain traders are concerned that the farmers won’t see it that way. If they respond by cutting inputs they will lose out, according to Tim Hirst, seeds director of UK grain company Grainfarmers. “Growers should not be deterred by the extra they will be spending,” he told reporters recently. “They still get high returns.”

Another big concern in the commodities markets is the rising cost of freight, John Whitelam, marketing manager at grain marketing company Fengrain, tells just food. The cost of shipping the short distance from the UK to Ireland, for example, had risen by 20% in recent weeks. “Freight rates are getting very difficult,” he says.

Australia’s farmer owned dairy company Dairy Farmers has announced a rise in the price of its products including fresh milk, cheese, yogurt and juice – by between 4% and 8%.

“The high price of oil, which has been caused by a range of international factors, has significantly impacted the national farmer-owned Co-operative’s production costs, such as for packaging and distribution,” it said. Chief executive Rob Gordon said the Co-operative had been absorbing substantially higher input costs, such as that of oil, for several months on the back of continuing efficiency improvements and costs savings. “However, given that oil prices remain at record highs, we now have no choice but to pass on some of the increased input costs,” Gordon said.

Oil is not actually so expensive

But the whole situation may not be as bad as it looks. “The first thing to say is that although oil prices are at record levels, in real terms they are not as expensive as during the oil crisis of the 1970s,” James Walton, senior economic analyst at the Institute of Grocery Distribution, tells just-food.

However, there is a fundamental difference between the oil crisis of the early 1970s brought on by the response of producing countries to political events. “The (1970s) oil crisis was an induced crisis,” he says. “Now we have a structural issue. It is the inability of supply to match burgeoning demand, in particular from China, but also from India and the US.”

There is no way the producers could supply more to balance the market. “Those people who can produce are producing at 100%,” he says. “The capacity issues are not going to go away any time soon.”

Wake up call

It is preparation for the day when the world’s oil supplies finally run out. “There is always the issue that oil supplies are going to be depleted,” Walton says. “It is a bit of a wake up call to the industry worldwide. How we manage when oil gets scarce – it’s some way off, but it’s good to think about it now.”

It will make the industry think about how it uses fuel, he says. The much vaunted ‘food miles’ issue will become more important. “Certain parts of the industry have been exploiting cheap fuel, particularly by importing,” he says.

High oil costs hit the food industry from many different directions. “The cost of packaging goes up. The cost of transport goes up. The cost of fuel goes up. The cost of heating goes up” he says. “It’s cost increases across the board.”

But an important part of the effect of high oil prices on the food industry came from their effect on consumer behaviour. “It also has an impact on consumers,” he says. “It affects their ability to spend money on groceries.”

The effect is not necessarily real. “It also comes as a shock to them,” he says. “I suspect the impact is more psychological than actual.

Walton points out that high oil prices were just one of a number of factors affecting the economy. “It’s one of a number of things which have contributed to the impact on retail sales over the last few months,” he says. But the British food industry at least should be able to deal with it. “The IGD would say that UK grocery Plc is very alert and adaptable,” he says. “Whatever challenges are thrown up by rising energy prices the industry will find a way to adapt as it always has in the past.”