Why are corn and oil prices rising in tandem?

I've become a bit obsessive about oil prices -- I check them online several times each day, just out of habit.

But most other commodities remain something of a mystery to me.  I keep hearing, for example, about the tremendous increase in corn and soybean prices, along with other grains and oil seeds.  Still, until last night, I'd never taken the time to find out just how steep that increase has been.

So to satisfy my curiosity, I put together the following chart, using figures from the phenomenally helpful futuresource.com, comparing the rise in recent futures contracts for corn and crude oil.  Behold:

Remarkably similar, no?  Obviously, price trends in corn and oil aren't completely identical.  But starting last September or so, they start moving up more or less in tandem, with roughly the same percentage increase since then.

What's going on here?

Well, for one thing, high energy prices have increased the cost of tractor fuel, fertilizer, and other petrochemical inputs, which makes it more expensive to grow corn -- which, in turn, raises the amount of money that farmers demand for their crops. 

But that's at most a partial explanation.  Even at last year's relatively high fuel prices, energy intensive farm inputs -- such as tractor fuel, fertilizers, and pesticides --  represented less than a quarter of the costs of corn production in the corn belt.  Rent, taxes, interest, labor, machinery, seed, and other factors were cumulatively far more costly.  So a doubling of fuel costs simply doesn't double production costs -- and yet, oil and corn prices both doubled. 

To me, that suggests that some additional factors besides higher input costs must be influencing corn price trends. Other forces that are often cited for the rising price of corn include:

• The fall of the dollar on international currency markets, which raises the buying power of foreign purchasers -- though again, that's only part of the story, since the corn and oil have risen faster than the dollar has fallen.
• Drought in many grain-producing parts of the world.
  
• Rising demand from rapidly industrializing nations such as China.
  

There's good evidence for all of those factors, I'm sure.  But given how closely the past year's corn and oil trends match up, I can't help but think that higher oil costs may be affecting corn prices more directly, through the ethanol market.  

At this point, the growth of the ethanol industry has turned corn into a substitute for crude:  when oil prices go up, ethanol (a gasoline substitute) is automatically worth more on the market.  And that means that when oil prices rise, ethanol distillers are willing to pay more for their feedstock. Rising oil prices thereby give distillers a natural incentive to bid up the price of corn -- a trend that's great for farmers, but certainly puts a financial squeeze on distillers' profit margins.

I think that most analysts now agree that the demand for biofuels feedstocks is having some sort of effect on commodity markets.  But there's a huge debate over just how strong this effect is.

• The USDA, for example, has cited estimates from the President's Council of Economic Advisors that "only 3 percent of the...increase we have seen in world food prices this year is due to the increased demand on corn for ethanol."  That figure's gotten a lot of play in the press; but...well, let's just say, use it at your own risk.
  

• The international Food Policy Research Institute -- a reputable bunch, in my opinion -- says that biofuels account for roughly 30 percent of recent food price increases. 
  

• And a article in the UK newspaper The Guardian discusses a "secret" World Bank report that found that three-quarters of the global increase in food prices could be attributed to biofuels. (That's another figure that, given the "secret" sourcing, I'd view with some skepticism.)
  

So there you have it -- biofuels are either responsible for 3 percent, 30 percent or 75 percent of the increase in global food prices!! Good luck figuring that one out. 

At the moment, I don't really have an opinion right now on which estimate is right.  But eventually the markets will tell us:  if corn continues to move in tandem with oil -- at least in broad terms -- that'll strengthen the hand of those who argue that biofuels are having a major effect on food prices.  If corn and oil prices start to decouple, then perhaps biofuels aren't such a big deal for food costs. 

As for me, I just keep looking at the graph above, considering the similarities the trajectory of food and fuel -- and pondering the implications.