Why the FAO food index is also an oil gauge

The revealing relationship between the FAO cereals price sub-index, the OPEC Reference Basket price of a barrel of crude oil, and the Baltic Dry Index (right scale).

The Food and Agriculture Organisation (FAO) of the UN has released its food price index data and commentary for 2014 October. This would be of considerable interest if only the index described the tendencies of food prices as experienced by consumers. Alas FAO’s food price index, as we have remarked upon several times in the past, pays no attention to the true cost of food staples.

Of what use is the FAO index, which is used as a reference by any government (and UN member state) to judge the value of its food exports (or to judge whether when importing grain it is paying what seems to be a fair price)? In the first place, the index (which itself is composed of separately calculated cereal, vegetable oil, dairy, meat and sugar indices) is not a consumer food price index.

The FAO food price index and its component sub-indices for the period 2012 January to 2014 October. A general downward trend, says the FAO, but this is the picture for international food trade and not consumer food retail price.

The FAO has not claimed it is, but neither has the agency clearly and plainly said it is not. It should, because financial and general interest media all over the world report the ups and downs of this index as if it portrays how local food prices move, and of course it does not.

The FAO index is used by international traders whose business it is to buy and sell food staples (including cereal, vegetable oil, pulses, dairy, meat and sugar). Perhaps some of them use it as a benchmark while others forecast trends from its sub-indices. It may be used to validate the accuracy of a particular kind of agricultural commodity futures index, and help judge whether an investment in the production of food, its movement, its stocking or its trade is going to be a good investment or not. As you can gather, it is not an index that consumers can use, because consumers are local and this is assuredly not.

What pulls the FAO food price index up, down or sideways? There are two important factors at work on the main index. One is the price of petroleum products, the other is the cost of moving grain (or any other food staple). You may assess the short or long-term trend of the food index against the current or projected price of Brent crude (preferred in Europe), West Texas Intermediate (preferred in the USA) or the OPEC reference price (preferred almost everywhere else).

The FAO food price index and its component sub-indices for 2014 till October. The downward trend of the last six months, which the FAO commentary is faintly praising, mirrors the trend of crude oil prices over the same period.

And then you will assess what the food price index describes against the cost of moving a large quantity of the agricultural commodity to be traded across an ocean, for which the Baltic Dry Index will be consulted.

[If you are a trader and want the FAO food price data and movements, go here. The usual commentary can be found: “The FAO Food Price Index averaged 192.3 points in October 2014, marginally (0.2 percent) below the revised September figure but 14.3 points (6.9 percent) short of its corresponding level one year ago” and so on.]

To help determine what the FAO food price index is depicting, I have made charts for the index (and sub-indices) for the period 2012 January to 2014 October; for the index (and sub-indices) for 2014 till October; a chart that shows the FAO cereals sub-index together with the OPEC Reference Basket Price for a barrel of crude oil and the Baltic Dry Index (this is the shipping index most commonly referred to for the movement of dry goods by sea) for the period 2012 January to 2014 October; and a chart that plots the changes (from month to month) in the three indexes taken together (FAO Cereals, OPEC Reference and Baltic Dry).

The FAO food price index and the OPEC Reference Basket price of oil have much more in common than the Baltic Dry Index, which has swung with volatility since 2012 January.

What they describe can be found in the captions, but it becomes clear from a glance at the FAO-OPEC-Baltic charts that the food price as calculated by FAO has very much more to do with how energy is used to produce food staples (that is, the use of petroleum products directly, and the use of fossil fuels-derived energy) and how energy is used to transport, store, process, transport it again and retail it.

I see it as an index that describes the energy quotient of industrially produced food staples, and so it has little if anything to do with any other form of agriculture, in particular the smallholder, family-oriented and organic agriculture that the FAO advertises its concern about.