We all have been reading the back and forth on bio-fuels and how they are and alternatively not affecting food prices and supply. The common advocate argument is simple, corn and wheat cannot possibly be affecting the price the rice so there must be something else to blame. Well the problem is one of interdependencies in the food supply and it something that everyone is missing in the debate. I will walk you through how wheat and corn being turned into fuel actually does raise the price of rice.
The Formula is Simple
The easiest way to show how wheat and corn demands for bio-fuels are responsible for the pressure on rice supply is with some math and a basic understanding of commodities and agriculture. The formula can be described as a simple one of total demand less the availability of wheat of corn. I use this very simple formula to describe how this works.
T(Total Demand for Food Staples) - W(Wheat Supply) - C(Corn Supply) = R(Rice Demand) or T-W-C=R
So using this simple formula you can see what happens when you constrain the supply of wheat and corn and what happens to the demand for rice. This can be done with the the relationship based on price as well. As corn and wheat prices rise the demand for rice grows as a cheaper alternative, and with increased demand comes the corresponding price rise. So you now ask how does bio-fuel affect this equation?
Demand for bio-fuels has an effect on two things, total land use being used for wheat and corn, plus reduced supply due to being diverted into fuel processing. By affecting the supply, and alternatively the price, you change the demand for rice which in turn increases the price, that is a very simple concept. Another factor overlooked is increased production of corn reduces wheat supply, which effects rice as well because the production excess is diverted to bio-fuels. The entire system is much more complex than this but this is a simple way of showing the direct relationship between rice prices and bio-fuels.
Percentages and the Crying Game Effect
The bio-fuel industry likes to use the 5% number to explain the portion of corn they use for fuel, except that corn production has increased, and so has the number of ethanol processing facilities, so this percentage as an strict amount of yield has increased dramatically and the number from 2005 is nowhere near what 2008 will be. Remember corn and wheat are traded globally, which means that speculators look at total world demand for the commodity, not just domestic uses. The EU has been shopping for ethanol crops since early in 2007 to meet it's bio-fuel targets, visiting the USA and Canada to attempt to secure supplies for it's legislated requirements. I see the percentage increasing to 15-25% of World Supply being diverted to bio-fuels in 2008 based on all the new legislation in western countries.
This leaves us with what I call the Crying Game Effect, that sudden realization that something is not as attractive and desirable as it first appeared to be. Now of course the environmentalists are all back tracking on the bio-fuel debate with many changing their position. The same is of the public in general, the only problem is that once a Government mandates something and pours billions of public treasure into it, they have to stay the course. So look for the problem to amplify over the next 3 years.