Record high food prices globally are due to excessive speculation by large foreign institutional investors (FIIs) in commodity markets and the global integration of a previously diverse agri-food system, according to French bank Credit Agricole Group.

The bank said in a research report on soft commodities that the number of futures and options deals in agricultural commodities recorded at leading commodity markets has gone up substantially in recent years.

The report said: "In May 2008, the long position on the Chicago market alone amounted to about 25 per cent of the world's production of soybeans and corn, and eight per cent for wheat, which is very high.

The financial players who speculate on commodities hold positions much larger than commercial players, who actually need to hedge on these commodities for commercial and industrial purposes.

"Agricultural commodity prices, or at least prices of crops traded on the global market, have always been volatile, sometimes doubling in a short span. But the recent run up in prices marks a break from the previous 20 years – starting with sugar in 2006, soyabean, corn, wheat and rice." Half the long-term corn and soyabean financial positions are made of index fund related investment – more than two-thirds in the case of wheat.

"Farmers or brokers who must go short on the commodity exchange to hedge their long physical positions outweigh buyers (processors). Financial sector firms have even advertised to advise individual investors to take advantage of high food prices to get richer," the report said.

In 2006 and 2007, the number of agricultural commodity contracts (four per cent of the total contracts) increased faster than the average. Credit Agricole, present in 58 countries and major financial centres, offers crop insurance and wheat futures options through its Agriculture and Agrifood Department, and its subsidiary, Calyon.

The bank has warned that implications of large FIIs' involvement in commodity markets are far reaching.

Unlike the volatility in equity markets, which affects only financial investments, volatility in agro-commodity markets affect the whole population.

Index funds and speculators with no physical capabilities are playing an increasing role in the commodity markets and many investors look at the commodity market as an inflationary hedge.

Due to soaring food prices, India banned wheat and rice futures trading in 2007 and suspended trading in futures in soya oil and other commodities until September 2008.

According to the Credit Agricole report, the US Commodities Futures Trading Commission (USFTC) is also under pressure from US Congressional committees, which are considering legislation to control large institutional investors in commodity markets.

The crops traded on the world's commodity markets – cereals, oilseeds, sugar, coffee, cocoa and virtually all other products that provide calories – account for 400kg per capita of the world population, compared to 660 kg per capita for petroleum products.

Cereals account for the largest share – wheat and rice feed humanity.

The report said after the development of spot markets (immediate delivery of goods) and forward markets (delivery at a future date at a price set in advance), futures and options markets in soft agricultural commodities is the latest trend.

A futures contract can be settled without physical delivery of the commodity and options is a form of insurance (bought or sold) on a future price of the commodity. Futures and Options deals can be done over the counter between two players and involves considerable amounts of money.

Numerous futures markets deal in agricultural commodities and, in some cases, financial products along with energy products and precious metals.

The principal exchanges are located in the US – the Chicago Mercantile Exchange (CME) and ICE (International Commodity Exchange) – and in Europe – NYSE-Euronext – whose commodity operations are based in Europe.

There are also smaller markets, such as Kansas City and Minneapolis (USA), and large markets are developing in emerging economies – especially the Dalian Commodities Exchange in China and the BM&F (Bolsa de Mercadorias and Futuros) in Brazil. The report said some countries in the Middle East would continue to remain net importers of food products, while others will try to reduce their dependence on imported food products and maintain food sovereignty.

The integration facilitated by progress in transport and communication, trade liberalisation and the role of institutions like the World Trade Organisation, IMF, World Bank and European Commission in reducing development aid and agricultural subsidy are other reasons for the current crisis.

The report predicted that while some Middle East and Asian countries will continue to depend on imported food, other countries in the world will adopt new strategies to ensure food sovereignty.



GRAINS TO HIT DAIRY PRODUCTS

High grain prices will affect the price of meat and dairy products because grain represents 60 to 70 per cent of the cost of raising animals.

The Credit Agricole report said the surge in sugar prices was caused by the increased demand for fuel ethanol. Currently, 20 per cent of the world's sugar production is used for making ethanol.

The report added that wheat and corn harvests have lagged behind consumption every year since 2003 – except for the record production of 2004 – resulting in a sharp price increase later as stocks of the two staples fell sharply.

As corn prices went up, the total area under corn cultivation in the world increased by 6.9 per cent – 4.4 per cent alone in the US, the largest corn producer in the world. Increased acreage for corn lead to record harvests and the softening of the corn market, but the area under soybean cultivation declined, affecting the soybean inventory. Record wheat prices prompted farmers to cultivate wheat as the first crop in 2008, and, if weather conditions remain stable, a record wheat crop is expected.

The report said crop substitution is happening in the US and Europe and cultivable land removed from cultivation needs to be brought back for farming. Large areas could be farmed again in the countries that constituted the former Soviet Union, where large stretches of land formerly cultivated with secondary grains – rye, barley and oats – have been uncultivated since 1994.

The report said there was enough arable land ready for cultivation in the former Soviet Union.