26 Apr, 2012

UNCTAD Warning to Global Aviation: Biofuels Will Worsen Food Price Pressures

Imtiaz Muqbil

In a clear early-warning to the global aviation and transportation industry, the UN Conference on Trade & Development (UNCTAD) has asserted that growing usage of biofuels is already contributing to higher food prices, and indicated that the problem could get worse in future.

The Commodities and Development Report 2012 (UCDR), a new UNCTAD publication launched on April 23 at the UNCTAD XIII quadrennial conference in Doha, Qatar, says “mounting financial speculation in commodities and the increasing diversion of agricultural land to biofuel crops has changed the forces underpinning commodity prices, pushing them through a sustained period of increase.” It says that “a sustained rise in prices for raw natural resources and basic agricultural goods is defying long-standing patterns and appears to be hurting poor nations through rising food and fuel costs more than it is helping them through higher revenues for their commodities exports.”

The report sounds an early-warning alert to the aviation sector specifically and the transportation industry in general. Both are shifting to alternative fuels, with biofuels seen as an important part of the mix. However, the aviation sector’s publicity blitz on biofuels has positioned the shift as part of an effort to alleviate global warming. It has downplayed the long-term impact on land-usage and food prices. The UNCTAD report changes that scenario, making it clear that the shift will not be risk-free and that short-term gain could lead to long-term pain.

It says, “UNCTAD identifies biofuels as a third new twist in the current commodities boom. In the 2003-2004 harvest year, world maize farmers devoted 5 per cent of their crops to producing ethanol, which is marketed as an alternative to fossil fuels and mixed with gasoline. By the 2010-2011 harvest year, the proportion of world maize production converted to ethanol had tripled to 15%. Generous subsidy programmes in the USA, Europe, and Brazil played a role in convincing farmers to use maize and sugar crops to produce biofuels instead of food. UNCTAD estimates that competition from biofuels contributed an estimated 15 to 20 per cent to cereal export prices. More fundamentally, biofuels link cereal markets with energy markets, weakening the influence of demand and supply signals on cereal prices.”

According to the report, this shift in energy usage, although being public touted as an opportunity to create new jobs in alternative fuels, is actually bolstering the bottom-lines of commodity speculators and investors. It says: “One driving force of the change is the massive influx of financial capital that has flowed into commodity futures markets since 2003, the report says. Financial investors differ from producers or traders in that they are not concerned with the physical delivery of products, but rather in buying delivery contracts and later selling them for higher prices, thus repeating speculative profits. As these financial investors have pulled their money out of troubled bond and equity markets, the number of commodity futures contracts traded worldwide has exploded, climbing from approximately 500 million in 2003 to more than 2.5 billion in 2011. Similarly, the worldwide value of commodity derivatives, including both futures and options, rose from just over US$1 trillion in 2003, to more than $8 trillion in 2007, before subsiding to $3 trillion in 2009 and 2010.

“UNCTAD contends that this “financialization” of commodities futures has fundamentally changed the conduct and outcomes of commodities markets in general, for example by changing a producer’s price expectations and reducing his ability to hedge against risk.”

Hence, the report says, “what should be a boon for poor nations, especially the globe’s 48 least developed countries (LDCs) — whose economies often depend heavily on commodity exports – is on balance a negative development because many of these countries are net importers of oil and staple foods, the study says. Since the food crisis of 2008, prices for basic nourishment have been both volatile and high, the report says – and poor families are acutely vulnerable, as they typically spend 50 per cent or more of their incomes on food.

Among the UCDR’s recommendations:

• Steps should be taken to invest in national and regional food reserves to help food-insecure countries;

• The recent shift to “finance-driven globalization,” as it applies to commodities, should be reconsidered, especially in comparison to the standard development model in which profits from commodities exports are used to increase domestic investment that can help diversify and expand the capacities of developing-country economies;

• That fiscal and taxation policies be adjusted so that they help developing countries reap stable, long-term economic benefits from commodities exports; and

• That measures be taken nationally and internationally to improve the situations of small farmers and other small commodity producers in poor countries.

It says: “Thus far, the 2003-2011 commodities price boom has unfolded differently than previous booms. Historically, commodity price cycles involved a short, rapid price increase, followed by a steep decrease, and then a long period of stagnation before the next spike. This boom-bust cycle has frustrated the economic prospects of countries whose development strategies rely on exporting their natural resources or farm products. By contrast, in the current boom, these commodity-dependent developing countries (CDDC) have benefited from relatively sustained price increases since 2003, with only a brief retreat in 2009.”

The report downplays the impact on climbing commodities prices of growing Chinese demand. China has undertaken rapid industrial development over the last two decades, a process that has required large volumes of imported raw materials such as oil, metals, and rubber, as well as food to feed its factory workers. This demand is often cited as the main factor driving the price boom across all commodity products. UNCTAD finds that Chinese demand has indeed dominated the markets for metals such as copper, nickel, and in particular iron ore, for which it accounted for 63 per cent of world imports. But China’s share of world imports of oil (7 per cent) and food commodities (all less than 2 per cent), although significant, is not so high as to drive price movements.

From a development perspective, the report details how the unique characteristics of the current boom have affected CDDCs. A direct effect of high and volatile food prices is reduced food security among the poorest populations. The 2008 food-price crisis pushed an additional 119 million people worldwide into hunger. Many CDDCs are net food importers, so high food prices result in trade deficits for their governments. Food prices have remained volatile ever since, which dissuades farmers from investing in new equipment or land and overwhelms the insurance and hedging facilities available to them.

Many CDDCs also are disproportionately dependent on oil imports. Thus, despite the additional revenues they received from exports of other commodities, these revenues were often outweighed by the increased cost of oil imports. As a result, the countries’ trade balances have suffered despite the boom. For households in developing countries, the rising costs of fuel and food imports are a serious threat, as food represents 50 per cent or more of an average household’s total expenditures – much more for the poorest households.

Apart from paying for increased oil and food import costs, CDDC governments have mainly invested their export windfalls in international capital markets, a startling deviation from the previous export-led development model. During the rapid industrial development of many East Asian and Southeast Asian economies, for example, governments reinvested earnings from exports of oil or agricultural products in industrial or infrastructure projects, or in domestic capital markets. These investments helped diversify their economies, improving their productive capacities and increasing their available capital.

Instead of these domestic investments, CDDC governments have used export earnings to repay foreign debt and to build their foreign exchange reserves. These foreign capital transactions are important for demonstrating solvency and economic stability to foreign investors, but they do not contribute to the productive and capital sectors of CDDCs’ domestic economies.

According to UNCTAD, this trend in which developing countries invest their export earnings in international capital markets is a symptom of a larger shift to a “finance-drive globalization” model. If such a shift has occurred, it has major implications for countries that follow export-led development strategies.

Among other things, the report recommends that the “international governance architecture” as it relates to commodities be studied and reconsidered and that more research be carried out on possible policy and technical solutions to the challenges faced by CDDCs.