Will the boom last?....Maybe.

As I mentioned in my blog entry from November 29^th, the economies in China and India are growing at about 10 percent a year. This growth is likely to continue due to the fact that these nations save 20-30 percent of their annual incomes, which is invested in capital and technology to increase production and sustain growth. Personal income in China averaged $2025 in 2006 (Source: www.worldbank.org); although this may sound very low, purchasing power is increasing. As personal incomes grow, so does the demand for meat. If meat demand increases, grain demand also increases because it takes 3 kilograms of grain to produce 1 kilogram of beef.

These two nations are also increasing the demand for fossil fuel. China ranks second in the world for vehicle sales behind the United States. Sales increased 25% in 2006 and the expectation is that China will be the world's top car market within four years. The increased number of passenger vehicles translates into increased demand for fossil fuel. As oil supplies diminish, fossil fuel demand will have to be offset with alternative fuel sources such as grain-based ethanol.

Hubbert's peak is the bell curve plotting convention oil production. Oil production in the U.S. peaked around 1970 and some feel we have already approached peak production globally. We do not know how much oil is available, but we do know the supply is finite. If we have approached Hubbert's peak on a global level the price of oil will remain high compared to historical levels. A high price for oil helps support the biofuels industry and subsequently the demand for grains in ethanol production.

Biofuel policy has been put in place in the United States, Brazil, European Union and Canada. The United States produces corn-based ethanol and is the world's second largest producer of ethanol. This is a relatively new demand for grain and may in fact be one of the largest reasons that grain prices are at their current level. Corn for ethanol production is competing for production acres with other crops which drives the prices up for all grains, oilseeds and pulses. In 2008, the United States is expected to use 85 million tons of corn to produce ethanol. High grain prices have slowed expansion somewhat. However, the Renewable Fuels Association indicates that current capacity is 7.8 billion gallons and there are another 68 plants currently under construction or expansion representing 5.5 billion gallons of capacity.

Whether the economics of corn-based ethanol make sense or not, the United States has a plan for massive expansion to achieve energy security. On December 19, 2007 the United States announced their "Energy Independence and Security Act" that expanded the renewable fuels standard; it is now set at 36 billion gallons of renewable fuel by 2022. If an oversupply of grain on the world market decreases grain prices, the renewable fuels standard will drive plant construction and the oversupply will be sucked up and prices will return to their high levels.

Given these three major factors it seems plausible that we are not in a "typical" commodity cycle. In this case we could be in for a sustained period of higher and unstable prices. This being said, a major world recession or a major reversal in biofuel policy could result in a rapid accumulation of grain stocks with the more typical fall in prices. If prices are maintained we have to ask whether our stabilization and income support policies are adequate for this new paradigm. A related issue is how the higher prices will impact the livestock industry in both the short run and the long run.