ANALYSIS-Will cheaper oil reduce your grocery bill?

by Chris Arsenault | @chrisarsenaul | Thomson Reuters Foundation
Friday, 7 November 2014 10:50 GMT

A woman looks at food products at a supermarket in a Tokyo shopping district, July 29, 2014. REUTERS/Yuya Shino

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The cost of oil has fallen by a fifth in recent months, and some consumers are enjoying cheaper food as a result

By Chris Arsenault

ROME, Nov 7 (Thomson Reuters Foundation) - After years of high prices, the cost of oil has fallen by around 20 percent in recent months, and some consumers are enjoying cheaper food as a result.

International food prices have dropped to their lowest levels since August 2010, a U.N. agency announced on Thursday.

Analysts believe falling energy costs are responsible for part of this decline, but caution that the relationship is not linear and varies significantly between markets.

"Colloquially put, if you lower the price of oil, you will lower the price of corn, but it won't necessarily lower the price of corn flakes," said Josef Schmidhuber, a senior economist with the U.N. Food and Agriculture Organisation (FAO).

The relationship between food costs and oil prices "can't be easily modelled" because too many factors are involved, Schmidhuber told the Thomson Reuters Foundation.

"We generally observe a positive correlation between oil prices and food prices," said Maximo Torero, director of markets at the International Food Policy Research Institute.

A 10 percent drop in oil prices, however, will not automatically lead to a 10 percent drop in agricultural prices. "Price transmission does not flow directly," Torero added.

The FAO is predicting a record global harvest this year.

November marked the seventh straight month the world's Food Price Index, a basket of key agricultural products, has fallen.

U.S. crude oil prices have followed a sharper trajectory, tumbling from a high above $107 a barrel in June to a 29-month trough below $80 this week on concerns of an oil glut.

CHEAPER FERTILISER

Transportation costs and fertilisers - determined largely by petroleum prices - have a major impact on food prices. But the extent depends on what you eat, and where you live.

For the United States, fertiliser accounted for 36 percent of the production cost of wheat in 2012, Schmidhuber said, while fertiliser and energy together accounted for 52 percent.

The U.S. fracking boom has contributed to a significant drop in fertiliser costs, along with the general fall in energy prices.

Most fossil fuels obtained by hydraulic fracturing, also known as fracking, are used domestically in the United States, allowing fertiliser manufacturers to benefit from cheaper raw material costs.

Schmidhuber said the trend was likely to persist, providing "a longer-term boost in wheat and corn production".

African farmers, who use less fertiliser than their developed-world counterparts, could see fewer benefits from lower energy costs, he added, although consumers could gain through cheaper transportation.

GOOD NEWS FOR CONSUMERS

In 2007 and 2008, food prices spiked alongside oil prices, leading to unrest in some countries and reassessments of food security plans by policy makers.

By mid-2008, when the crisis was at its height, ammonia and urea prices - ingredients for fertiliser derived from petroleum - more than doubled compared to 2007, Torero said. Oil and corn prices, in turn, were 1.5 to 1.9 times higher.

The global recession that began in 2008 led to lower energy consumption due to decreased economic activity. That, together with the exploitation of new, unconventional energy reserves - particularly shale gas obtained by fracking - precipitated the current drop in oil prices.

The pockets of most consumers, who don't live in oil-exporting countries, are likely to benefit, experts say.

"If energy prices remain lower, the cost pressures on food we have seen in the last decade will abate," said Kenneth Medlock, senior director at the James A Baker III Institute for Public Policy in Texas.

"This is generally a good thing for consumers as it increases their disposable income for other activities, and in less developed countries, cheaper food can go a long way to alleviating other social pressures," he added. (Reporting by Chris Arsenault; Editing by Megan Rowling)

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