The US Midwest is suffering its worst drought in decades. The US Department of Agriculture (USDA) recently dropped its corn yield forecast from 166 bushels per acre, made earlier this year, to 123 bushels per acre. The expected shortage of corn is causing prices to surge.
Corn has multiple uses – it is used as fuel (ethanol), animal feed, or directly as food. Roughly 40% of US corn production goes towards ethanol, 36% towards feed, and the rest towards food.
There are several concerned groups that believe the Environmental Protection Agency (EPA) should relax the ethanol requirement under the Federal Renewable Fuels Standard act, which states that there must be 13.2 billion gallons of corn starch-derived biofuel produced in 2012. The UN has called for an immediate suspension of the US-mandated use of ethanol. In addition, a coalition of beef, pork, and poultry producer associations have called for a cessation of the ethanol requirement.
Whether the EPA will ease the ethanol requirement is not the most important question – the real question is how do we plan to deal with rising agricultural commodity prices and volatility in the long term? The corn shortage might be a one season event, but volatile agriculture and softs prices are here for the long term.
We have an expanding world population that is forecasted to grow from 7 billion to 10 billion in the next 35+ years. As part of this population growth, there is a rapidly growing middle class across China, India, and other parts of Asia. China and India alone are doubling their per capita incomes at approximately 10 times the rate and 200 times the scale achieved by Britain’s Industrial Revolution in the 1800s. This growing middle class wants to eat higher on the protein scale (more meat which needs more animal feed). And it appears we’ve hit a pattern of severe weather events including droughts, floods, extreme temperatures, etc. These long term trends will drive acute commodity price swings – which is, as we’ve said before, the new normal.
All companies in the food supply chain, from upstream to downstream, should be putting plans and commodity risk management systems in place to handle price volatility.
Heavy users of raw materials face a huge challenge. The prices of many of the world’s key commodities reached all-time highs last year, and volatility across the markets was more than enough to create huge problems for companies in the industrial manufacturing and consumer products industries.
It’s easy to find startling examples of price volatility in every category from arable crops and metals to timber, oil, and chemicals. And it’s also easy to see the consequences of such volatility in companies’ bottom lines – time and time again, there are stark reminders that sharply rising raw material costs can impact profitability.
For example, spice and condiment manufacturer McCormick saw first quarter profits hit by 3% because of higher than expected raw material costs. And Swiss agribusiness company Syngenta cautioned that its 2012 results would be impacted for the same reason.
According to a new white paper on Commodities Management from Procurement Leaders, there are several ways to fight back, including hedging, forming strategic supplier alliances, and leveraging advanced technology solutions. The paper provides a good primer on the subject, and discusses how companies including Unilever have successfully controlled skyrocketing raw material costs. Read it now.