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Food Price Rise: An Ethanol Twist

May 14, 2009

The recent food price inflation leading to food insecurity has been one of the immediate and striking outcomes of the recent oil price spikes and the global financial meltdown. This has triggered a chain reaction leading to the diversion of arable land in the form of overseas land grabs, and agreements between commercial food and finance industry. For instance, corns and scare economic resources are being diverted to the production of green bio-fuels such as ethanol and bio-diesel.

According to World Bank (2008) estimates, during 2007-2008, food prices registered a record rise of 54 per cent in general, while wheat and rice 83 per cent and 215 per cent respectively. Similarly, a study conducted by CGD (Center for Global Development), (2008) also came to the conclusion that “From 2000-07, prices for corn, rice and wheat rose by 85, 63, and 124 per cent, respectively. For corn and wheat, most of the rise has occurred since 2005, 66 and 67 percentage points, respectively”.

Our analysis of the commodity markets reveals that three main factors have played a crucial role in destabilizing the equilibrium of the food market globally. First, low stock of food grain, especially when the crisis hit the food markets took away the markets’ capacity to cushion the crisis. According to the US Department of Agriculture (2008) during the last one decade (1998/99-2007/08), the global stock of food grains declined to more than 45 per cent, from 579.7 million metric tones (mmt) to 315.2 mmt, in general, whereas wheat and rice stocks registered steeper decline; wheat stocks declined from 207.9 mmt to 110.1 mmt and rice from 134.4 mmt to 72.2 mmt, during the same period. Second, the recent spikes in petroleum prices from $20 a barrel in 2001 to $147 a barrel in July 2008. This adversely affected the agriculture input prices, including fertilizers, irrigation and the transportation cost. According to the FAO Report (2008) Petroleum and food prices are highly correlated. Since 2006, fertilizer prices tripled and transportation costs doubled. This affected the small farmers’ financial capacity to produce more despite high food prices. The third factor which is believed to have contributed to the spike of food prices is the green fuels – ethanol and bio-diesel. Although in the immediate term the role of bio-fuels in the rise of food prices are not known precisely, its beginning has certainly alarmed the world community in general and food scarce countries in particular. The way green fuels induced major countries to divert their land, resources and surplus corns to the production of bio-fuels, portends a serious crisis in waiting. Even we this apprehension was echoed by the world leaders and experts gathered at World Food Summit, Rome, last year. The Declaration said “It is essential to address the challenges and opportunities posed by bio-fuels, in view of the world’s food security, energy and sustainable development needs…We call upon relevant inter-governmental organizations, to foster a coherent, effective and results-oriented international dialogue on bio-fuels in the context of food security and sustainable development needs.”

Bio-Fuels Drive

Today, many big developed and developing countries that are severely deficient in oil have already started experimenting with bio-fuels. Countries like the US, selected countries in the EU, some Latin American countries like Brazil, Argentina, and Malaysia, Indonesia in Asia and Mozambique in Africa have started diverting their land, corns and resources to produce liquid bio-fuels. According to the International Energy Agency (IEA) currently 1 per cent, i.e. 14 million hectares, of total arable land is diverted to the cultivation of green fuels and it is likely to increase to approximately 2.5 per cent, 35 million hectares by 2030.

Besides arable land ‘diversion’, we notice that huge economic resources are also being diverted to the production and promotion of liquid bio-fuels. According to the World Development Report (2008), in 2006 approximately $10.8-12.1 billion was diverted to produce 40 billion litres of ethanol fuel-- 90 per cent produced by Brazil and the US-- and over 60 billion litres of bio-diesel-- 75 per cent produced in the EU, mainly France and Germany. The quantum of green fuels produced by these countries is only 1 per cent of the total energy consumed by the global transport sector. It is noted that by 2020 these countries have plans to meet 5 to 6 per cent of their transport fuels through bio-fuel sources. This means in order to produce 5-6 per cent of the total energy consumed in transport sector, a total of $50.8-72 billion would be diverted by 2020. Last year a report published by the World Bank denotes the EU has a plan to raise its bio-energy share in the total energy mix from 2 per cent in 2010 to 5.75 per cent in 2015; and among them France has a more ambitious plan; it has set a target to meet 7 per cent energy from bio-fuels in 2010 and 10 per cent by 2015. The US has also set a plan to meet 10 per cent of all car fuel consumption by 2010. In Spain ethanol already accounts for 3 per cent of the total fuel consumption.

Besides land and resource diversion, it is also found that during the last couple of years, major food and vegetable oil surplus countries have used their agricultural output for producing bio-fuels. For instance, US distilleries have used 20 per cent of the maize crop to produce ethanol in 2006/07. While Brazil used half of its sugarcane whereas other countries diverted their Soya, vegetable oil to produce bio-fuels.

Although biofuels offer big market opportunities for agricultural producers that could accelerate rural growth and farm income, its economic, environmental, social and food security impact are well contested. Broadly we notice, that globally a three step formula has been widely practiced by each country: one, inducing consumers through tax cuts; second, providing tax incentives, loan guarantees, direct subsidies, etc to the producers; and third, mandatory consumption quota. All these issues (analyze) the economic feasibility and sustainability of the choice of liquid biofuels. Whether this can be sustained without the scale of support offered by the governments is another question to be explored.

Economic Impact: For instance, the US government provides 200 support measures costing around $5.5-$7.3 billion a year which amounts to $0.38-0.49 per litre of petroleum equivalent to ethanol and $0.45-0.57 for bio-diesel. In case of Brazil, although the use of sugarcane for ethanol goes back to the 1930s, the government continues to provide substantial support despite favourable conditions for sugarcane production. The ethanol producers in the EU and the US also enjoy high tariff protection, besides several incentive packages. Steenblik (2007) calculated that the total support in monetary terms for bio-ethanol and bio-diesel in selected OECD countries totaled around $11-14 billion in 2006.

Now, if we consider the opportunity cost of producing ethanol over oil, we find that producing ethanol is costlier both in money and material. Take the US as an example into, we notice that in the previous year the US which spent $5.5 -$7.3 billion a year to achieve $0.38-0.49 of petroleum equivalent to ethanol and $0.45-.57 to bio-diesel, oil proves economically cheaper. If we compare the same amount ($5.5-$7.3 billion) of expenditure with the Indian case (2007-2008), it would reduce our net oil import bill by 11.4-15.1 per cent, whereas, the same amount of subsidy if used to promote the use of liquid fuels would not be able to replace that quantum of oil. If we compare the expenditures incurred by selected OECD countries for liquid bio-fuels, approximately $10.8-12.1 billion, will easily cover up to 24.4-25 per cent of our total net oil import of the last year. This evidently indicates the economic burden of pursuing a bio-fuels’ strategy.

Another significant impact of green fuel production in recent years has been felt on the upward trend in the price of grains. The World Development Report (2008) records that between 2006 and 2008, maize prices rose from 23 per cent to 60 per cent. This is believed to be the result of a 20 per cent shift from maize to ethanol production by the US, the largest producer of maize in the world. Similar to maize, the prices of vegetable oil has also experienced an upward shift. A report prepared by the FAO (Food and Agriculture Organisation) (2008), reveals that the price of vegetable oil has gone up more than 97 per cent between 2006 and the first three months of 2008, and the greater share of this rise has been attributed to the diversion of vegetable oil to the production of biofuels production, particularly the palm oil, by the leading producers like Malaysia and Indonesia.

Impact of land diversion to the production of bio-fuels is one of the worrying elements for food scare countries. A diversion 2.5 per cent of arable land to biofuel production would certainly impact food security.

Another significant impact of the diversion of grains to the production of bio-fuels has been noted in terms of opportunity cost. It is estimated that to produce 100 litres of ethanol, 250 kg maize is required, a ratio of 1:2.5. In 2006, the US distilleries have produced 40 billion litres of ethanol, which means it has used 100 billion kg of yellow grains. This has made the prices of maize by 33 per cent costlier. During this food crisis, according to the World Bank, about 100 million people might be thrown back into the ranks of the poor. The United Nations has estimated “the total number of food insecure people was probably closer to about three billion, or about half the population of the world”, “wiping out all the gains the poorest billion have made during almost a decade of economic growth”, quoted by Bob Zoellick, the president of the World Bank. Had this maize which not used for producing ethanol, it can be easily reached at conclusion that there would have been no doubling of food emergencies in the world from 15 to 30 a year; no starvation, no food riots in countries like Egypt, Pakistan, Morocco, Yemen, Mexico, Guinea, Mauritania, Senegal, and Uzbekistan, etc.

Evaluating the future drive towards ethanol production, we note that if 80 per cent of the 62 distilleries which is now under construction are completed by late 2008, the demand for grain of these distilleries will climb to 114 million tones, which would be around 28 per cent of the projected harvest of the total US grain. Calculating the impact of this massive diversion of food grains to liquid green fuels production, Professors Runge and Senauer, University of Minnesota, revised their optimistic projections and indicated that by 2025, approximately 1.2 billion people would be potentially imperiled by hunger.

Coming to another fact, in 2006, $12-14 billion has been spent on promoting the use of liquid bio-fuels. Had these amounts been used in procuring food, there would have been spare money with the World Bank to do other pressing issues like health, education, climate pollution, etc. The United Nations officials estimated that on the current scale solving the world’s food problem would cost anywhere from $15 billion to $30 billion a year. It is also found that as a result of high oil prices and escalated transportation cost, many countries stopped sending food grains to the United Nations destinations.

Environmental Impact: The strongest argument made in favour of liquid biofuels is their benign quality; its use potentially reduces greenhouse emissions (GHEs). But there is a trade-off - it also generates feedstocks of biofuels at the cost arable of land, cutting down more forests and draining more peat land to produce feedstocks such as vegetable oils. According to the EU Biofuel Strategy 2006 “this can cancel the GHGs savings “for decades”.

Political Impact: The twin developments - financial meltdown and food price inflation, have persuaded commercial industries and national governments to seek and own overseas farmlands. Countries like China, Japan, South Korea, the UAE, Kuwait, Saudi Arabia in the Arab Gulf have targeted the Central, South and East Asian markets as well as African countries in a big way. For instance, in order to secure food security, China has planned to invest $30 billion in African countries within the next three decades. Similarly Arab countries have also targeted several countries for the same objectives. This has generated an apprehension that the acquisition of overseas farmlands might result in political opposition in the form of local resentments, especially during periods of food shortages against foreigners taking away surplus food. Another significant issue which may become emotive is the problem of wage payment. Foreign companies and governments in their overseas farmland ventures would utilize the services of cheap and abundant labour and resources. What would be the standard wage rate? This is an important aspect because these companies would take away surplus produce and sell at exorbitant prices in international markets. Another valid aspect is the utilization of natural resources such as water, productivity and quality of soil, impact of fertilizers and pesticides on local flora and fauna, etc.

India: Due to energy and environmental concerns, particularly for the transport sector, India has also embarked on a National Mission on Biofuels with the aim of achieving a targeted 20 per cent blending biodiesel by 2011-12. Under the Biofuels Mission, the government has emphasized planting diesel-rich plants such as Jatropha curcas and Pongamia than encouraging starch and sugar-based distilleries which require corn, sugarcane, edible oil which directly threatens national and global food security. Mixing 20 per cent of bio-diesel in petroleum fuel would additionally obtain a saving of 15.2 mmt of oil. On land diversion, the government has developed a policy to encourage the utilization of non-arable, arid and fallow lands. It is estimated that 11 million hectares of land is required to cultivate the Jatropa plant. In India, it is estimated that approximately 68 million hectares of land is affected with soil degradation but at the same is suitable to the plantation of oil-rich plants. Besides targeting wasteland, the government has also used other lands which remain unutilized such as roadside, arid zones, including the integration of these oil-plants into social forestry programmes.

Thus we find that India’s green fuel policy does not contravene the larger objectives of global food security unlike the US, EU, Brazil, South East Asian countries, etc which potentially compromise food security by diverting scarce food grains, land and resources to the bio-fuel production. Nevertheless, the green fuel policy should also not be based on excessive use of animal feedstock as India homes one sixth of the global livestock.