Bio-era recently released a new report describing our latest thinking about the future of food and fuel markets. In the short term, we could be in for an even bumpier ride than we have seen so far. Over the longer term, new technologies (biological and otherwise) will profoundly alter our ability to produce non-fossil fuels and will thus alter the structure of the economy. But the sheer size of the petroleum and gasoline markets will continue dominate energy markets, and our economy, for many years to come.
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Here is the Introduction:
In recent years, rising prices for agricultural and energy commodities have heightened interest in the economic fundamentals governing these markets. This report presents bio-era’s latest thinking on some of these fundamentals, and how they may be changing in unanticipated ways. Part of what we explore here concerns the interactions between the principal “long forces” affecting these markets, including the forces of climate change, the limits of conventional crude oil supply expansion, and the impacts of continued underlying growth in global populations and economies. Not surprisingly, we foresee these long forces acting in combination to place additional upward pressure on fuel and food prices, and we present a model for thinking about the dynamics at work in what we hope is a simple, but useful, way. In addition, we also consider the growing linkages between agricultural and energy commodities, and how these linkages might affect current and future pricing dynamics within and between these markets. Under one, very specific set of conditions, we believe that price signaling between these markets could lead to a self-reinforcing feedback loop — which if left unchecked — could result in steadily escalating clearing prices. The theoretical effect we describe is akin to an “evolutionary arms race” or a “red queen effect.” Should market circumstances ever give rise to the price dynamic described here, the implications could be far-reaching. Energy and food prices could rise steadily as a result, at great cost to the global economy. Continuing globalization might even be placed at risk. For these reasons, and because these theoretical possibilities have gone largely unnoticed to date, we felt it worth calling special attention to them here.
Here are the "Key Findings":
- Despite seven years of rising real prices for crude oil and a doubling of prices over the past year, global crude oil production has been nearly flat since 2005.
- The production of biofuels--in the form of ethanol fermented from sugars and starches, and biodiesel derived from vegetable oils and animal fats - has increased significantly and is now an important source of supply satisfying year over year increases in global liquid transportation fuel consumption.
- There are two principal connections between the crude oil and petroleum product markets and many of the so-called "soft" agricultural commodities such as grains, sugar, and vegetable oils:
- an input-cost effect on agricultural commodity prices because oil and energy-intensive fertilizers account for a significant share of total production costs for most major crops;
- an output-price effect prices of petroleum products such as gasoline or diesel oil set a floor price for agricultural commodities that can be converted into fuel substitutes.
- The first of these connections--the input-cost effect--is "one-way." The cost of petroleum will influence agricultural commodity prices over time, but the reverse is not true--the cost of agricultural commodities will have little or no effect on the costs of producing, transporting, and refining petroleum.
- The second of these connections--the output-price effect--is increasingly "two-way." As volumes of agriculturally-derived fuels grow, expanding or withholding these volumes from the petroleum product markets directly influences both the price of petroleum products and the price of agricultural commodities.
- The result is competition between food and fuel end-use markets to price at a level sufficient to attract (and/or preserve access to) marginal supplies. Attempting to hold down food prices by restricting or redirecting feedstocks used to produce fuel, may cause fuel prices to rise. Similarly, attempting to hold down or lower fuel prices by increasing conventional biofuels production may increase food prices.
In the absence of a supply response from conventional crude oil, looking ahead, this dynamic is expected to continue until either global economic growth slows substantially, or additional supplies of non-conventional fuel substitutes - such as gas-to-liquids, coal-to-liquids, or biomass-to-liquids -- become available at meaningful scale. The necessary lead time on the latter option is at least 3-5 years.
"The Big Squeeze: New Fundamentals for Food and Fuel Markets", A Special Bio-era Report, June 2008, By Stephen C. Aldrich, James Newcomb, Dr. Robert Carlson