Aug. 9, 2012 at 5:40 PM ET
LONDON -- Attempts by major food importing nations to shelter their populations from the effects of a U.S. drought may make a bad situation worse, five years after the last jump in crop prices provoked rioting in some of the world's most fragile states.
Many governments have watched on the sidelines as drought in the U.S. farm belt sent prices of corn, soybeans and wheat soaring, hoping that the market would eventually ease.
However, their nerve seems to have broken with Mexico, the world's second biggest corn importer which suffered "tortilla riots" in 2007, making a huge purchase last week.
With fears growing that drought will also cut the wheat harvest in the Black Sea region, buyers in the turbulent Middle East are now also pouring on to the markets.
"A cascade effect is not inconceivable and may well be taking place -- wheat prices have shot up nearly 50 percent since the beginning of July," said J.Peter Pham, a director with U.S. think tank the Atlantic Council.
"If such proves to be the case, some of the most fragile states may well be shaken," added Pham, who also advises U.S. and European governments on strategic issues.
In 2007-2008, food prices rose when a jump in oil -- which pushed up production costs such as for chemical fertilizers -- mixed lethally with speculation on commodity markets and export restrictions imposed by some leading agricultural nations.
The resulting food emergency hurt the world's poor worst, provoking unrest from Egypt to Mozambique and Mexico. However, prices soon crumbled spectacularly as the global economy slowed, oil fell again and markets bet on lower demand for commodities.
This time around the problem is simpler, some have argued, blaming the drought in the United States, a leading world producer of corn, wheat and soybeans.
Global grain prices saw a fierce rally in June and July, with corn and soybean prices rising 50 and 20 percent respectively. Wheat also jumped around 50 percent due to the worst drought U.S. Drought in more than half a century.
July was the hottest month in the continental United States on record, beating the devastating Dust Bowl summer of 1936 when drought and bad farming practices of the time led to soil blowing away in vast clouds.
Analysts expect this year's drought, the worst since 1956, to yield the smallest corn crop in five years.
The effects are profound, as corn is not only used directly for making food. It is also fed to livestock for meat production and used to make ethanol, demand for which is strong as governments try to meet targets for moving towards biofuels and reducing reliance on fossil fuels.
Several bodies including humanitarian agencies, governments and food companies concluded that the latest price surge was not as serious as in 2007-2008. For instance, Nestle, the world's biggest food group, said it expected raw material prices to ease in the second half of 2012.
Earlier this year the United Nations food agency also played down the problem, but on Thursday it acknowledged the risks.
"Prices have the potential to increase further," the Food and Agriculture Organisation's senior economist and grain analyst Abdolreza Abbassian told Reuters. "There is potential for a situation to develop like we had back in 2007/08.
The FAO Food Price Index, which measures monthly price changes for a food basket of cereals, oilseeds, dairy, meat and sugar, was up 6 percent from June, after three months of declines.
Wheat output is also looking shaky as drought blights large producers such as Russia, Ukraine and Kazakhstan, and raises the risk that they might impose export bans to hold down prices on their home markets.
Weather woes are also showing up in other significant wheat producers Australia and India.
Governments in large importing countries, which were shaken by unrest last time, had held off from making major purchases of grain as prices bubbled but now they are jumping back in to keep their stocks healthy and their populations satisfied.
The Mexican government, keen to avoid a repeat of the tortilla riots when corn prices jumped, has tried to secure lower corn prices by purchasing in bulk, buying a massive 1.516 million tons last week.
In 2007 tortillas cost on average 5.73 pesos per kilo and today they're 9.76 pesos per kilo, according to data from the economy ministry.
"I don't see social problems because the government is very focused on controlling the price of something that is an integral piece of the Mexican diet. They'll keep protecting the people," said Alvaro Ley, head of AMEG, the Mexican meat fatteners association.
However, dealers say the Mexican tactic could touch off a frenzy of buying by other countries wrongfooted by the U.S. drought. Iran, Algeria and Jordan are all shopping for grain this week.
One notable absentee so far is leading wheat buyer Egypt, which snaps up more than 10 million tonnes a year.
Pham noted that Egypt, which is still experiencing social and political tensions following last year's revolution, gets a quarter of what it consumes from the United States.
"Any upward movement in U.S. wheat prices will have significant impact on the lives of ordinary Egyptians, nearly half of whom subsist on less than two dollars a day," he added.
Economists expect to see fewer changes in diets as a result of the corn and soy-led rally than they did in 2007-08, when consumers in poorer areas of the Middle East, North Africa and Asia found alternative food supplies as rice and wheat soared.
High corn and soybean prices will trickle down to meat consumers in wealthier countries, still reeling from the financial crisis, as crops are used to feed livestock.
"The human implications of this are probably very different than the 2008 run-up in prices," said Pat Westhoff, director of the Food and Agricultural Policy Research Institute.
While the world's poor respond to higher food prices by finding something cheaper or simply eating less, many consumers in wealthier countries can afford to pay more, so demand holds up better. This indicates corn and soybean prices could stay stronger for longer.
Meat and other food producers in Japan, the world's biggest corn importer, will bear the brunt of the rally as the cost of feeding livestock rises, but deflationary pressures in the domestic market mean they cannot proportionately raise prices of beef and pork for consumers.
Feed mills are trying to offset the problem by increasing the use of corn from Brazil, Chinese soymeal in cattle feed and domestically produced and stockpiled soybeans for Tofu, but alternatives are limited.
Hog farmers in China, which accounts for 60 percent of the soybean traded across the world, are already facing higher feed costs with domestic soymeal prices hitting a record high of 4,048 yuan a tonne earlier this month.
Drought is also affecting parts of Europe including Spain, whose wheat harvest is expected to fall by over a quarter this year from 2011. Spain's debt crisis has exacerbated the problem, all but cutting off lines of credit to any other than the largest grains trading houses.
Domestic grain stocks are low and enough to last only until late August, according to Miquel Angel Berges, an analyst at agricultural exchange Mercolleida.
"It could be a major problem as many small and medium-sized businesses don't have the resources to finance themselves... we could see slaughterhouses and meat producers start to close by year-end if we don't see a return to June prices," he said.
Food price pressures are also simmering in parts of Africa. While inflation in much of the region remains below peaks scaled in 2008, there are worrying signs costs related to the crop pipeline might not subside as quickly as they did in 2009.
In South Africa, the continent's biggest economy and corn producer, the inflation measure used by the central bank for monetary policy was 5.5 percent in June compared with 11.6 percent at the same point in 2008.
Almost no economist sees South African inflation racing next year to 13 percent, as it did in mid-2008, but many see food price pressures continuing to erode the household incomes of the country's poor.
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