Scientists from the New England Complex Systems Institute, in a paper published in September 2011, identified investor speculation and ethanol conversion as the two key causes of changes in food prices over the period 2004 to 2011. The latter linked to a gradual upward trend in prices, the former to food price spikes. Global food prices since 2007 have seen two surges whereby prices have increased by over 50% in less than a year. Authors of the paper warn that policy action to curb speculation in global food markets is urgent if we are to avoid another surge at the end of 2012. This is also important for the long-term given that the UN predicts food prices will rise by at least 40% in the next decade.
Speculation in the food market in the past has been limited to actors within the food industry itself. By setting a price, agreed between farmer and trader, prior to the harvest, risks were minimised as the farmer received a good price even in a bad year and the trader received a better than average price in good years. In general, speculation had a stabilizing effect on food prices. With the liberalisation of markets in the late 1990s, however, non-food industry actors have become involved and speculation in the food commodities market by financial institutions has grown rapidly. In 2003 the market was worth £3 billion but by 2008 its worth had risen to over £55 billion.
The involvement of the financial sector in food price speculation has come under significant criticism as contracts to buy and sell food are themselves bought and sold among traders outside of the food industry. Because of this, trading has become decoupled somewhat from what is actually happening in terms of supply and demand and the prices of foods can change very rapidly when based purely on speculative logic. Indeed increased volatility of food prices draws further interest from speculators thus driving volatility even more. A market with a large degree of speculation also introduces extra costs, pushing food prices up further. Ideally commodity markets should be 70% commercial hedgers (corporations that attempts to stabilize the price of a commodity by taking a position or stake in the commodities market) and 30% speculators, whose presence provides liquidity, but as of 2008 the ratio was thought to be more like 30:70 and at present 15:85.
The evidence backing the argument that increasing speculation has contributed to food price rises is compelling. For example, in 2011, London hedge fund Armajaro bought 240,000 tonnes of cocoa beans (representing 7% of the world’s stocks), which contributed to chocolate being its highest price in 33 years. In 2006, immediately prior to the 2007/08 food price spike, the sub-prime mortgage crisis motivated banks to move investments out of pensions and equities and into safer commodities such as food.
In Europe, new regulations have recently come into force, which mean banks must withdraw vehicles that allow investors to speculate on food prices. The motivation for this action is the surge in prices of maize and corn following drought in the US. Given the debate over whether speculation or supply and demand are behind the food price rises seen in recent years, these new rules have received criticism particularly from the financial institutions themselves. Indeed Barclays have seen revenues of as high as £340 million a year from trading food commodities. Supporters of the new regulations say the same rules should now be applied to investment vehicles on oil.