Ethanol Still a Major Source of Inflationary Pressure

The U.S. Department of Agriculture released its “Agricultural Projections to 2020” report this month, and the agency's predictions — at least in the near term — probably won't surprise many meat and poultry producers.

Broadly speaking, USDA expects food prices to rise faster than the general inflation rate for the next two years, “reflecting higher food commodity prices, rising energy costs and improved demand as the economic recovery continues.”

In the livestock and poultry sectors, the agency writes that high feed costs will continue pressuring suppliers to cut back production. Shrinking supplies will translate into rising prices, probably through 2012. After that, improving net returns will offer incentives for producers to expand their herds and flocks, and these increases in supply will help hold future price increases to nominal levels for the remainder of the decade.

The ebb and flow of supply is a familiar one in agriculture. When prices and demand are high, farmers want to ramp up production, but this takes time to do. So, lots of farmers tend to ramp up production all at once, ultimately normalizing supply or creating an oversupply situation. Prices respond.

In this case, however, there is a catch. High feed prices aren't going away. If the USDA's predictions are correct, by 2012, meat and poultry producers will simply have made an adjustment to this new reality after a wrenching five years.

Feed prices no longer respond to that familiar ebb and flow, because the U.S. is now converting a vast amount of corn into ethanol. This same USDA report estimates that 36% of total corn grown in the U.S. will be used in ethanol production during the next decade.

When more corn is grown, there's less acreage allocated for crops like soybeans and wheat, so prices for these other key commodities are pushed higher as well. This is good for row-crop growers. It's bad for almost every other producer in the U.S. food industry, and that's bad for consumers.

Alternative fuels and energy independence are important goals, and an argument against corn-based ethanol is not an argument against those goals. As several environmental activism groups have noted, after accounting for the artificial fertilizers used to grow it, the diesel used to harvest and transport it, and the energy used to ferment, distill and blend it, it takes almost a gallon of fossil fuels to produce a gallon of corn-based ethanol. This system bears little resemblance to the success story in Brazil, where sugarcane-based ethanol is produced much more efficiently.

Plenty of ink has already been spilled on this subject. But, food price inflation looks to be a tough problem that will impact producers, retailers and consumers alike this year and probably next. Keep in mind that a key source of the pressure is an inefficient industry kept viable by federal mandates that are too general, and subsidies that are too generous.