The slump in oil prices continues to upend the global economy and experts believe that this is likely to last for several years. Oil prices dropped by about 50 percent from the fourth quarter of 2014 to the first month of 2015, the second largest annual decline ever where the falling oil prices have helped to push food prices down, according to data from the United Nation’s Food and Agriculture Organization (FAO).
Of the regions affected by these declining oil prices, the MENA region is affected the most. That is due to the fact that the majority of its countries depend on oil revenues for growth and because it is the most food import dependent region where food dependency ratios exceed 50 percent on average. According to the IMF, the net impact on growth for the region will probably be negative. However, there is hope that consumers in the region will see their purchasing power improving.
Why are food prices linked to oil prices?
Due to falling oil prices and record harvests, global food prices fell for almost all commodities. Throughout 2014, the FAO food index fell by 3.7 percent from 2013, with the sharpest year-on-year falls registered by cereals (12.5 percent), followed by dairy products (7.7 percent), then oils (6.2 percent) as well as sugar (3.8 percent). According to the FAO, world food prices are not expected to rise in 2015 provided; increased production, low oil prices, and reduced import demand continue.
Source: FAO and the World Bank
The strong relationship between oil and food prices may be explained by a key fact and that is, our modern global food system is highly oil-dependent. Oil is the key fuel for production and for transporting food from field to market. Fuel costs make up as much as 50 to 60 per cent of total shipping costs. In addition, energy related costs such as fertilizers, chemicals, lubricants and fuel account for close to 50 percent of the production costs for crops such as corn and wheat in some developed countries. As a result, declining oil prices will have a direct influence on production costs. Furthermore, grain prices have become increasingly linked to the movement of oil markets since more corn is being diverted to biofuel production. Generally, as demand for these alternative fuels decreases, crop prices are forced down, making food more affordable.
How can the region benefit from lower oil and food prices?
Consumers across the region will benefit because food and transportation will become cheaper. As food represents a relatively large share of the consumption baskets of poor households, decreasing prices may lead to declining poverty and inequality. However, this will largely depend on how, or whether, industries will pass the energy savings on to their consumers.
Governments across the MENA region could also benefit from oil and food price reductions as they can take advantage of the lower oil prices to increase their revenue. They can raise taxes on oil products as a way to benefit from the lower prices. More importantly, governments can take advantage of these price reductions to reduce subsidies on fuel and food thereby greatly reducing their fiscal spending.
The lower oil prices are expected to influence domestic prices by lowering firms’ costs of production. As production costs go down, firms can lower the prices they charge for their produced goods. This may eventually lead to lower consumer food prices where, depending on their price elasticity of food products, some countries may benefit more from these lower costs than others. Using monthly data from FAO we find first, that consumer prices in MENA countries are significantly and strongly correlated with global food prices. Second, reductions in global food prices, following an oil price decrease, will result in a drop in consumer prices in the MENA region, with an elasticity of 0.6. That strong correlation between the global food prices and the domestic food prices can be explained by the fact that the majority of countries in MENA region are net food importers.
Source: Author’s Calculation
Therefore, in addition to their impact on growth, oil price reductions are expected to bring some relief to consumers and governments in MENA region, however, not as quickly as we might like. Many experts confirm that food prices will take anywhere from 3 to 6 months to adjust to oil price reductions. An important question may be, how can governments in the region benefit from the expected reductions in food prices and how can they guarantee the fair distribution of these gains?
