Farm Prices' Roundabout Path to Market

Midwest flooding has been driving corn and soybeans sky-high. Meat prices will follow with a vengeance. But this may take months. Here's why

After the prices of wheat and eggs soared during the past year, supermarket shoppers now find they're spending an extra quarter for each pound of pasta. Four sticks of margarine cost an extra 60¢. Even the cold glass at the frozen food section has become foreboding: Ice cream is up nearly 6%. But walk down other aisles, and the outlook doesn't seem as grim. Corn and wheat prices may have doubled in the past year, but somehow breakfast cereal prices have stayed relatively flat.

Forgive shoppers if they feel like traders climbing into the pit at the Chicago Board of Trade. As prices for commodities such as wheat, corn, and eggs have climbed, there seems to be no telling how it will trickle down to the cost of individual grocery items. Items like pasta, made with wheat and eggs, have become much more expensive, yet soda, which is often made with corn syrup, has stayed relatively level.

Adding to the confusion, flooding in the Midwest will lead to a new round of price increases in the next year, experts say, though not necessarily in the areas consumers might expect. Corn and soybean fields were flooded, and their commodity prices jumped rapidly. But foods like bacon, ribs, and chicken will probably see the most dramatic price increases.

Head-Scratching at the Grocery

Why do some items seem to skyrocket, while others—even some containing similar ingredients—barely budge? It's not just shoppers who are having trouble understanding the relationship. The experts are perplexed, too. Ephraim Leibtag, who forecasts food prices for the Agriculture Dept., expects food prices to rise 4.5% to 5.5% overall in 2008. But he acknowledges that fluctuations in the commodities markets complicate those predictions. "Predictive models are less useful in volatile situations," he said. "That's why everyone's worried, because they don't really know."

Prices can shift for all sorts of reasons, including increased demand for a product from foreign consumers, changes in government subsidies, and freakish weather that reduces supply.

In the past year or so, the amount of the price increase for various foods has depended heavily on how much processing the food requires. The more money a manufacturer spends on molding the food into bite-size pieces, putting it in a shiny box, and advertising it on TV, the more the consumer is paying for those accoutrements rather than the raw materials themselves. When commodity prices rise, heavily processed foods don't rise as quickly because the commodity is just a small part of the overall price. When corn prices triple, the cost of cornflakes doesn't triple, largely because the price of cornflakes already includes a lot of processing, packaging, and marketing costs. Raw fruits and vegetables, on the other hand, are more likely to respond quickly to changes in commodity prices.

Not surprisingly, the average American's diet has become increasingly processed, packaged, and marketed. The "farm share" of domestically produced products—the percentage of the cost of retail food products that goes to the farmer—fell from 41% in 1950 to 19% in 2006. That percentage varies depending on the product. About 5% or less of the price of cereal, granola, and corn syrup are accounted for by farm prices. The farm value of eggs, meanwhile, accounts for more like 60% of the price. So, as farmers have cut the production of eggs in the past year, making them more scarce and expensive, the price of a dozen in the supermarket has increased accordingly, by 29%.

Costs Absorbed Lower Down

Food producers, wholesalers, and retailers also generally shift their excess costs for things like energy to consumers. But consumers don't always end up paying for the full increase. "Somebody in that chain will absorb the higher costs for a while," said John Lawrence, extension livestock economist at Iowa State University.

For instance, it appears that meat producers are absorbing at least some of the increased costs of feed. Pilgrim's Pride (PPC), which processes chickens, blamed its steep second-quarter losses on the increased cost of the grain it feeds to chickens, which has outpaced increases in chicken prices at the grocery store.

Retailers also sometimes delay price increases, particularly on competitive items. "If milk goes up a dime, you don't necessarily charge an extra dime," said Dale Riley, the owner of Fresh Seasons Market in Minnetonka, Minn., which does about $11 million in annual sales. In general, however, "if we get an increase from the manufacturer, we pass that increase along."

In a difficult economy, retailers worry that if they do pass on cost increases, hard-pressed shoppers will switch to easily available substitutes or stop buying some items altogether. Sure enough, retail researcher Information Resources found that some consumers have shifted spending to private-label supermarket brands instead of more expensive brand names and stopped buying certain nonessential items as prices have gone up. Riley has seen these trends at his store, and they're eating into profits. "No one's bragging about sales in the supermarket industry this year," Riley said.

There's little sign of a letup in the coming year. Wheat prices have come down in recent months as more farmers devote land to growing it, but the flooding has drenched millions of acres of cropland in corn and soybean states such as Iowa and Illinois. That will wreck an already bad season for some farmers.

Lean Times for Livestock

In the long run, the most dramatic effect will be on that long back aisle: the meat section. That's because most Midwestern corn is used to feed animals, and as it has become scarcer, its price on the futures market has increased rapidly. Corn, which was holding steady at about $2 a bushel as recently as two years ago, has flirted with $8 since the flooding began. Farmers can lock in grain prices early in the season, but many are already paying prices that have whittled or erased their margins on each animal they sell. When that happens, farmers start taking their breeding animals to market early—known in the industry as "liquidating" their stock—in order to cut back on supply.

That has already begun in the pork industry, and it will likely accelerate, said Mildred Haley, an agricultural economist who specializes in the hog and beef markets for the Agriculture Dept. "We're going to see liquidation," Haley said. "With these corn prices, there simply is no way" they can keep feeding as many animals as they are feeding now.

Once producers start cutting back, it will take about a year for retail pork prices to rise at the supermarket, said Chris Hurt, an agricultural economist at Purdue University. Beef price increases generally take about two years to make their way to stores.

Craig Rowles, a partner in Elite Pork Partnership in Carroll, Iowa, which brings about 140,000 to 150,000 pigs to market a year, said he successfully locked in corn prices early in the season using financial instruments known as hedges. But he is still paying far more than he has in the past. He can get 75¢ per pound for his pigs, but he expects to soon pay as much as 95¢ per pound to feed them. That has compelled him to start bringing pigs to market earlier, to cut back on feeding costs. The reduced supply of pork will start pushing prices up at the grocery store during the next year, he says.

"Meat market prices eventually will have to go up to levels where we can return to profitability," he said. "Those levels will be enormously higher than what is currently out there."