What links oil and food prices

Syllabus: General Studies Paper 3

Context:

Recently, the UN Food and Agriculture Organisation released data showing its world Food Price Index (FPI) averaging 133.2 points in October 2021, the highest since July 2011.

Fuel and food

• One reason why petroleum and agri-commodity prices move in tandem is the bio-fuels link. 
• When crude prices rise, blending ethanol from sugarcane and corn (maize) with petrol or diverting palm and soyabean oil for biodiesel production becomes that much more attractive. 
• Cotton, likewise, turns relatively affordable vis-à-vis petrochemicals-based synthetic fibres. Also, since corn is primarily an animal feed, its diversion to ethanol leads to substitution by other grains, including wheat, for livestock use. That, then, pushes up prices of foodgrains as well.
• The same happens to sugar, as mills step up the proportion of cane crushed for fermenting into alcohol.
• The present global cotton rates of 125 cents-plus per pound were last seen in July 2011. Corn and sugar prices, too, are ruling way higher compared to a year ago.
• But it isn’t the bio-fuels effect alone: Large price increases also tend to rub off on other farm produce through the creation of positive “sentiment”. 
  • International coffee prices have nearly doubled in the last year and, like most other agri-commodities, also strengthened along with crude oil in the last three months.
• Economic activity and stimuli.
• “Sentiment” is, in turn, connected with two things.
  • The first is, demand returning with a revival of economic activity worldwide amid receding pandemic cases and rising vaccination rates.
  • The second is the flood of liquidity unleashed by the US Federal Reserve and other global central banks, to limit the economic damage wreaked by Covid-19. 
    • The US Fed’s total assets (mainly government bonds and mortgage-backed securities that it buys) on its balance sheet has expanded from $4241.51 billion to $8,574.87 billion between March 2, 2020 and November 1, 2021. 
    • All this money, combined with the policy-induced ultra-low global interest rates, has found its way into stock markets, start-up investments and also commodities. 
    • And since restoration of supply chains hasn’t kept pace with the demand recovery (manifested in congestion at ports, shortage of shipping containers/vessels and labourers yet to fully return to plantations) the overall result has been inflation.

Impact on farmers

• The surge in international prices benefited producers, especially farmers. 
  • Kapas (raw unginned cotton) is today selling at Rs 7,500-8,000 per quintal in Rajkot market (Gujarat), well above the government’s minimum support price (MSP) of Rs 6,025 for long-staple varieties.
  • Soyabean growers are similarly realising Rs 5,000-plus per quintal rates in markets such as Ujjain (Madhya Pradesh) and Latur (Maharashtra), against the MSP of 3,950.
• On the flip side, however, farmers are being forced to pay much more for fuel and fertilisers, as their international prices also have shot up. 

Fertilizers

• The situation is worse in fertilisers. 
  • Di-ammonium phosphate (DAP) is currently being imported into India at $800 per tonne, including of cost and ocean freight. 
  • Muriate of potash (MOP) is available for no less than $450 a tonne. 
  • These are close to the prices that prevailed during the world food crisis of 2007-08.
• Landed prices of urea, on the other hand, have crossed unheard-of levels of $900 per tonne. 
• Together with fertilisers, the prices of their intermediates and raw materials such as rock phosphate, sulphur, phosphoric acid and ammonia have also skyrocketed due to a combination of demand-pull (from higher crop plantings) and cost-push (from oil and gas).
• There is a huge challenge for the government to make fertilisers (particularly phosphatic and potassic nutrients) available in reasonable quantities, to enable farmers meet the requirements for their wheat, mustard, potato, onions and rabi pulses crops. 
  • That would matter for food prices down the line — at a time when fuel and fertilisers are also on fire.

Reason behind the fuel price rise

• The price of Brent Crude breached the $85 per barrel mark, reaching its highest level since 2018 on the back of a sharp increase in global demand as the world economy recovers from the pandemic. 
• Key oil producing countries have kept crude oil supplies on a gradually increasing production schedule despite a sharp increase in global crude oil prices. 
• The price of Brent crude has nearly doubled compared to the price of $42.5 per barrel a year ago.
• Recently, the OPEC+ group of oil producing countries reaffirmed that they would increase total crude oil supply by only 400,000 barrels per day in November 2021 despite a sharp increase in prices. 
• The output of the top oil-producing countries – Saudi Arabia, Russia, Iraq, UAE and Kuwait — would still be about 14 per cent lower than reference levels of production post the increase in November 2021.
• OPEC+ had agreed to sharp cuts in supply in 2020 in response to Covid-19 global travel restrictions in 2020 but the organisation has been slow to boost production as demand has recovered. 
• India and other oil importing nations have called on OPEC+ to boost oil supply faster, arguing that elevated crude oil prices could undermine the recovery of the global economy.
• Supply side issues in the US including disruptions caused by hurricane Ida and lower than expected natural gas supplies from Russia amid increasing demand in Europe have raised the prospect of natural gas shortages in the winter.
  • International coal prices have also reached all-time highs as China faces a coal shortage that has led to factories across China facing power outages. 
  • A faster than expected recovery in global demand has pushed the price of Indonesian coal up from about $60 per tonne in March to about $200 per tonne in October.

Overall Impact on India

• High crude oil prices have contributed to the prices of petrol and diesel regularly setting new record highs across the country in 2021. 
• India has seen a faster recovery in the consumption of petrol than of diesel after pandemic-related restrictions with petrol consumption up 9 per cent in September compared to the year-ago period but diesel consumption remaining 6.5 per cent below 2020 levels. 
• Diesel accounts for about 38 per cent of petroleum product consumption in India and is a key fuel used in industry and agriculture.
• S&P Global Platts Analytics noted in a report;
  • Demand for diesel in India was expected to go up in the next few months with the upcoming festive season set to accelerate the economic recovery and push up diesel consumption. 
  • However, predict that India’s total demand for crude oil would only surpass pre-pandemic levels in 2022.
• High international gas prices have led to an upward revision in the price of domestically produced natural gas. 
  • The Petroleum Planning and Analysis Cell (PPAC) set the price of natural gas produced by state-owned ONGC and Oil India under the nomination regime to $2.9 per mmbtu up from $1.79 per mmbtu in the previous six month period. 
  • The PPAC also increased the ceiling price of $6.13 per mmbtu for gas extracted from ultra-deepwater, and high pressure, high-temperature discoveries from $3.62 per mmbtu in the previous six month period.
• The increase in gas prices has put upward pressure on the price of both Compressed Natural Gas (CNG) used as a transport fuel and Piped Natural Gas (PNG) used as cooking fuel. 
• High international prices of coal have added to a coal shortage at India’s thermal power plants by forcing thermal plants to use imported coal that could not pass on the higher price of coal to procurers to stop supplying power. 
• Low coal stocks at a number of coal-fired thermal power plants have led to power outages in a number of states including Punjab and Rajasthan and have forced states to buy power at well above normal prices on the power exchange.

The Indian Express Link:

https://indianexpress.com/article/explained/simply-put-what-links-oil-and-food-prices-7611933/

Question- Rising fuel prices and food inflation are interlinked. Comment.