What's Pushing Up Crop Prices

Five key factors have fueled the boom, and the outlook is for continuing strong demand.

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While 2007 was a lackluster year for stocks—the S&P 500 inched up just 3.5 percent—the agricultural commodities markets punched the lights out, with wheat futures soaring some 77 percent skyward, soybeans jumping approximately 74 percent, and corn up about 17 percent. Here's a rundown of the key factors behind the boom and a peek at where prices may go from here:

Alternative fuels: Emerging demand for alternative fuels such as ethanol, which is made from corn, has been a key factor in the surging prices of agricultural commodities. The federal government has used incentives to boost ethanol use since the late 1970s. But the renewable-fuels standard of the Energy Policy Act of 2005—which mandated increasing levels of ethanol use—helped trigger a more recent spike in demand. As a result, corn prices more than doubled from December 2005 to December 2007. "Ethanol has been a huge driver of higher corn prices," says Daniel Griswold of the Cato Institute.

Increased demand for biodiesel, which is made from soybeans, has put upward pressure on soybean prices as well. This momentum only intensified as farmers, looking to cash in on ethanol demand, began planting corn on land previously used for soybeans. That led to lower production, driving soybean prices sharply higher. "You've got soybeans and corn bidding for the same acreage out in the Midwest," says Jerry Norton of the U.S. Department of Agriculture. "That's certainly driving up the prices."

Demand for alternative fuels is expected to continue gathering steam, especially in light of the recently signed Energy Independence and Security Act of 2007, which compels fuel producers to use no less than 36 billion gallons of biofuel in 2022—roughly five times as much as is used today.

More meat: Higher global demand for meat—particularly from emerging nations—is another driving force behind the boom in commodity prices. As globalization has boosted the income of workers in industrializing countries like China and India, such populations have been able to afford to raise their protein intake by eating more meat. From 1980 to 2002, total meat consumption in developing countries nearly tripled.

Increased meat consumption has stoked agricultural commodity prices, since more grains are needed to feed livestock, says Ryan Davies, a senior trader at Titan Commodities. "Literally 2 billion people are going from a grain-based society to a meat-based society," Davies says. "It takes a lot more grains to feed a cow than it does to feed a person."

This trend should continue to influence agricultural commodity prices, with the United Nations anticipating global meat production to more than double from 2001 to 2050—that's roughly twice the projected rate of world population growth for that period.

New investors: Large inflows of investment capital have also juiced the run-up in commodity prices. Investors began warming to agricultural commodities in 2001 as a hedge against inflation, says Darin Newsom, a senior analyst at DTN. But as prices marched upward, a growing number of big-ticket investors—such as hedge funds—began shooting for capital appreciation, pulling even more money into the market. The total number of corn futures contracts held, for example, more than doubled from January 2005 to January 2008. "We've seen the agricultural commodities market evolve from more of a risk-transfer platform to more of a recognized investment strategy," Newsom says.

This inflow of investment dollars has boosted prices, increased volatility, and eroded the cyclical nature of agricultural commodities market, Newsom says.

Descending dollar: The weakening U.S. dollar also lifted commodity prices in 2007 by making crops cheaper for foreign buyers. "You have the price of gold going north and the U.S. dollar going south," says William Fordham of C&S Grain Market Consulting. "People don't understand how important a low dollar is to agricultural exports." In addition, the falling dollar has triggered fears of future price appreciation, prompting investors to put more money into commodities to protect against inflation.