lead oil analysis

Deflation was one of the watchwords for UK grocery in 2015. Driven by intense competition between retailers and underpinned by strong harvests and rock-bottom crude prices, food prices tumbled.

Retail prices were nearly 2% cheaper in December than a year earlier [Grocer Price Index], while the FAO’s Food Price Index, which tracks global food prices, was down almost 20% on 2014 levels.

With crude dipping below the $30-a-barrel mark this week and Asda announcing a further £500m to be invested in the price war, 2016 is already promsing more of the same.

So are we in for another year of food price deflation?

Supply and demand fundamentals for most agricultural commodities suggest deflation is indeed here to stay, at least well into the second half of 2016. “A number of key commodities in the retail supply chain, in particular oil, have fallen dramatically recently and the impact of these falls will continue to make its way through to shop prices for some time to come,” says Helen Dickinson, CEO of the British Retail Consortium.

After several strong harvests, global inventories for key crops are looking healthy. “That’s going to lead to low prices for most commodities, such as grain, maize and soybeans,” says Allan Wilkinson, HSBC head of food and agriculture.

Brazil in particular has been “ramping up production to new record highs” for crops such as soybeans and corn at a time when stocks are already “massive”, paving the way for low prices in 2016, adds Rabobank senior analyst Tracey Allen.

As for the UK, and the important British wheat crop, the outlook is also positive. High global stock levels are keeping prices low, while UK crop quality has improved on the back of new varieties for growers that are “yielding at higher levels and incentivising more planting”, says AHDB analyst Arthur Marshall.

Weather and politics

Of course, there’s more to commodities than supply and demand. The biggest risk factors for agricultural markets are always weather and politics - and 2016 promises plenty of volatility on both counts.

The unusually warm and wet weather in the UK this winter is already threatening to disrupt fresh produce supply (see p44), while a particularly strong El Niño has hit palm oil and sugar production and could cause further havoc to crops such as robusta coffee in Asia.

On the political side, meanwhile, instability in the Middle East looms large and could have far-ranging implications for food. In November, for example, wheat trade between Russia and Turkey was halted after the Turks shot down a Russian bomber near the Syrian border.

The potential impact of such geopolitical events must not be underestimated, experts warn. While crude remains very cheap, and is expected to stay cheap, it typically has less direct influence on food prices than big weather or political events. Low fuel prices help alleviate the pressure on farm inputs and keep general business costs low, says Allen at Rabobank, but the Russian embargo on Western foods - imposed in 2014 and still in place today - had a bigger effect on food prices than crude.

Meat, poultry & dairy

Sectors such as meat and dairy could also see price rises despite the overall deflationary environment. Increased global demand for milk and meat coupled with recent trade deals between China, Australia and New Zealand could have a significant impact this year, says Wilkinson at HSBC. “We’ve not really seen that play out yet, and it will divert a huge amount of those countries’ milk, beef and sheepmeat to China.”

From a UK perspective, beef prices are nevertheless likely to remain low. AHDB Beef & Lamb senior analyst Debbie Butcher predicts more beef on the market, particularly from Ireland, while consumption will remain sluggish, with the strength of the pound against the euro favouring the Irish on exports into the UK and to the EU while retail sales look set to remain heavily promoted. “2016 is not going to be a year in which we see prices increase,” she says.

In dairy, reduced milk production across the southern hemisphere and the US, coupled with signs of recovery in demand from China, could point to a global recovery for the dairy market, says Arla’s head of milk and member services, Ash Amirahmadi. “However, there are many variables to contend with,” he warns, with milk production continuing to grow in Europe. Because of this “we have to put extra efforts into moving out of ingredients and into developing more branded products” he says. He adds this could lead to dairy commodity prices finally picking up in the second half of 2016, which could result in UK farmgate prices moving up again.

National living wage

The introduction of the new national living wage in April could also contribute to higher prices in some sectors. For poultry, for example, low fuel, utilities and feed costs should keep a lid on prices to an extent, but Faccenda Foods MD Andy Dawkins warns the sector is facing inflationary costs in processing by-product and in the form of higher staff and automation costs. “As an industry we are having to face higher costs associated with complying with the national living wage.”

In seafood, a boost to haddock quotas and positive developments around North Sea cod stocks are set to increase supplies and could therefore lead to lower prices. However, demand for the big five species of cod, haddock, salmon, tuna and prawns is expected to continue to soar at the same time, says Young’s Seafood CEO Pete Ward, meaning any positive impact on prices from quota increases could be offset.

It’s a highly varied picture, and the message for the grocery sector from many experts is therefore this: expect low commodity prices to continue for a bit, but don’t be surprised if they don’t last. With prices at their lowest “since the raw materials crash of 2009”, the sector should “maximise the available opportunities” now, adds Mintec director Nick Pelsa, as they are “probably on the up from here on in”.