The huge, hidden upside to low oil prices

A Malawian subsistence farmer in her corn fields. Southern Africa is facing a historically bad harvest.
A Malawian subsistence farmer in her corn fields. Southern Africa is facing a historically bad harvest.
Image: Reuters Photo/Mike Hutchings
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Oil prices just keep falling and crashing into things on their way down. It seems like every day another country gets a bill for damages: Saudi ArabiaNigeriaRussia, the UK. While the global economy’s biggest players are reeling, there is a less visible group of people who stand to benefit tremendously: those without enough to eat.

The security of the world’s poor is inseparable from the price they pay for food, especially the grains that constitute most of their diet. Oil prices are a significant factor in determining the price of other commodities, including food. Tractors and other farm machinery require fuel, as does the manufacture of fertilizer. Once crops are harvested, oil prices dictate the transportation costs to get them to market, whether that’s down a highway or over an ocean.

For the last decade volatility in food prices has made food security more complex than ever. Price spikes in 2007 and 2008 led to civil unrest in many developing countries. In 2011, that volatility led Oxfam to describe the global food system as “broken.”

Global grain prices have returned to levels from before the price shocks, and some believe they are beginning to stabilize. (Futures prices are also way down.) Steve Wiggins, a research fellow at the Overseas Development Institute (ODI), says that three changes are acting to moderate prices:

  1. Demand for biofuels has plateaued. For most of the last decade, the grain market has been sapped by the growing US market for ethanol. Refineries have since hit the so-called “blending wall.” They can’t mix any more ethanol into gasoline without modifications to vehicle engines.
  2. Farmers are growing more. In response to the price shocks of the last decade, “the world’s farmers have ramped up production way ahead of the growth of population,” Wiggins said. As a result, many countries are now sitting on substantial stockpiles of grain.
  3. Oil prices have fallen. This pushes down both the costs of production as well as distribution.

The lingering question is whether those savings on agricultural commodities will translate into lower prices at local food markets. Local markets in developing countries are often insulated from global markets by significant barriers: physical distance, limited infrastructure, etc. This is somewhat less true in port cities, which have more immediate access to international markets. However, inland communities are largely out of luck when it comes to buying up cheap imports.

However, there is another avenue for the global market to influence local prices. Research by economists Brian Dillon and Christopher Barrett suggests that price savings arrive mostly through transportation costs (pdf). Barrett said in an interview, “There is surprisingly strong integration between the global market and rural markets.”

Transport is what connects them. It is expensive to ship food from farms to cities or from ports to rural markets. This is especially true in large countries with poor roads. A shift in oil prices may affect local food prices more through fuel costs than through any effect on production costs. In fact, according to Dillon and Barrett’s research, the farther a consumer is from a port, the more that transportation costs factor into their local food prices and thus the more they could save from cheap oil.

The transmission of cost savings through the supply chain is slow. International commodities traders lower their prices first. Domestic wholesalers will follow suit, but usually not until they’ve cleared out existing inventory. Local markets are the last to reduce prices. Even in the most optimistic scenario, the effects of a drop in oil prices may not reach rural consumers for months or years.

Even with perfect data, which we often don’t have, effects of oil prices on other commodities are virtually impossible to measure in real-time. Economists rely on past trends to estimate the impact of falling prices. Separate reports by the World Bank and the ODI have found that a halving of oil prices typically leads to a decline in commodity grain prices of more than 10%. The poorest people in the world spend more than half of their money on food. If they saw a 10% savings on their local food prices, it would be the equivalent of 5% growth in real income. Of course, not all of that savings is likely to carry over, but it gives some sense of the scale of the changes.

The ODI also looked at what might happen if oil prices stay low (pdf). Using a model created by the International Food Policy Research Institute, they estimated that a halving of oil prices from 2011 levels would result in a 14% decrease in the number of malnourished people in the world. Again, this scenario is for oil prices falling to half of their 2011 peak, but oil prices have actually fallen by 75%. Projections based on economic models should always be greeted with healthy skepticism, but it is another indication that the aggregate effects of falling oil prices could be substantial.

Unfortunately, food prices are also affected by everything from weather to local labor conditions. John Baffes, an economist at the World Bank, said that in food-insecure African nations, “two-thirds of the price…depends on factors that are unique to those countries.” For example, many African countries maintain monopoly control over oil imports. They may choose to deposit the savings from lower oil prices into the government treasury, rather than pass them on to consumers. Other countries have agricultural taxes or subsidies that manipulate local prices.

And then there are the low-income countries that are major exporters of oil, such as Nigeria and Angola. The decline in oil prices is a massive blow to those economies. Any drop in food prices is likely to be offset by lost oil revenues and unstable currencies.

Even in stable, oil-importing economies, low food prices may not bring uniformly positive changes. Some studies of the 2007–2008 crisis have found that higher food prices were actually better for the rural poor. According to Wiggins, this is especially likely to be true in India and the rest of Asia, where the poor are more likely to be farm laborers than subsistence farmers.

“Higher rice prices can actually net improve the lot of the farm laborer household, because even though they are paying high prices they are getting so much more work and better wage rates,” Wiggins said.

Cities, on the other hand, are much more dependent on deliveries of food, both from domestic farms and from imports. As a result, urban consumers are likely to see more consistent benefits.

If there is anywhere where the drop in prices will make an immediate difference, it’s probably in Southern Africa. There, El Niño has disrupted weather patterns and forecasters are predicting one of the worst harvests in decades. Countries such as Malawi and Zimbabwe are expected to require substantial imports of food this year. A drop in oil prices is a poor substitute for rain, but lower import prices should at least help those countries to weather the crisis.