Who Pays for Higher Commodity Prices?

05/06/2008 12:00 am EST

Focus: MARKETS

David Wyss

Adjunct Professor, Brown University

David Wyss, chief economist for Standard & Poor’s, says the winners and losers from higher commodity prices will be determined by whether you’re a buyer or seller.

In the world of higher commodity prices, corporate winners and losers fall into two distinct camps.

Commodity producers are big beneficiaries. Their business outlooks appear generally strong and their ratings stable, in our view, as scarcity and worldwide demand affect everything from corn to copper. But companies that rely heavily on grains, oil, or other commodities to make finished goods face increasing costs, and thus weaker profits, if the slowing US economy makes raising prices more difficult.

With oil well above $100 per barrel, we expect gasoline prices to soar; we believe $4.00 for a gallon of gas is not out of the question in many areas as the summer driving season approaches. In March, gas prices were already 26% higher than they were a year earlier, while home heating oil was 40% more costly.

Overall food costs climbed 4.5% during the past year, but several specific foods outpaced that gain: meat, poultry, eggs, and fish climbed 3.8%; cereals and grain products were 8.1% more expensive; fats and oil were up 7.7%, and dairy products rose 11%.

The fallout from high commodity prices will be unequally distributed and determined by whether one is a buyer or seller of commodities. The level of commodity input into finished goods and the ability to raise prices will determine how serious the impact will be for commodity users.

Low steel costs, for instance, are certainly better than higher costs for automakers. But steel is a relatively small part of a car's cost, and the woes of Detroit's Big Three (oil prices and labor costs, for example) go far beyond steel prices. Baked goods, cereals, meat, poultry, eggs, and dairy products all contain, directly or indirectly, large amounts of corn or wheat, so the impact of higher prices for those grains is widely felt among food processors.

And the high price of oil will clearly be deleterious for industries like refiners or airlines, where oil is a major input. Meanwhile, the impact of rising commodity prices on US consumers has been more straightforward. Prices for gas, home heating oil, and food have skyrocketed in the past year, boosting inflationary fears and crimping discretionary spending.

Many commodity prices have risen for reasons clearly evident: rising demand from India and China, for instance. But the volatility of commodity prices has some suspicious that the market is being manipulated. Trading volumes have increased greatly. The Futures Industry Association reports that 15.2 billion contracts were written in 2007, a 28% increase from the year before.

We expect the US economy to grow only 1.2% this year, but as higher commodity prices ripple through the economy, we could see the unholy alliance of low growth and higher inflation. That is not good either for commodity-dependent producers or for consumers, who, if they stop spending, will further depress the economy.

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