The Heat Is Online

Fast Food Giants See Crop Threat in Climate Change

Climate: The food chain's weakest link

 

McDonald's admits it needs to be aware of 'all this emerging science'

 

MarketWatch, Carolyn Pritchard,  May 17, 2007


SAN FRANCISCO (MarketWatch) -- Tens of thousands of Mexicans took to the streets in January to protest tortilla prices as they soared to their highest levels in a decade as demand for corn -- a key ingredient not only of tortillas but ethanol -- surged. Such fervor is unlikely to sweep the streets of American cities any time soon, even if the domestic food supply is already beginning to be affected by climate change.

 

The unrest in Mexico highlighted the crucial role corn plays in the modern food-supply chain. It can be found in candy, soda, prepared food, a McDonald's burger and a host of other common comestibles.

 

That single grain's central role in our diet suggests that Earth's temperature fluctuations, and concerns over emissions that are believed to affect the climate, will become a more intensive focus for the companies that put food in our mouths, as they seek to meet demand with steady supplies and at prices that preserve, or even improve, profit.

 

"Medium- to long-term, it's clear that climate change presents a challenge to the profitability of any company in the sector," said Aron Cramer, president and chief executive of Business for Social Responsibility, a nonprofit entity that works with companies to implement socially responsible practices.

 

Corn-based ethanol has been touted as an answer to an overreliance on greenhouse-gas-producing fossil fuels for energy, but the frenzy to produce it has shown how a dramatic change in demand for one essential commodity can disrupt food supplies. And the interconnected nature of the food-supply chain means that a shift in any one factor affecting it, such as regional weather patterns in the long term, or, as demonstrated by spiking in corn prices, short-term demand, can have a far-reaching and tumultuous effect.

 

"We've been living in a world where, for the last 40 years, there was too much food," said Ken Cassman, a professor of agronomy and horticulture at the University of Nebraska. "We're probably going to be abruptly going into a period where supply is much more balanced with demand so that small perturbations can cause a significant impact on food supply."

 

That impact will be felt first and foremost by food companies, said Todd Mann, senior vice president of business development at the National Restaurant Association. "Every company -- no matter where you are on the supply chain, at the start or at the retail side -- you have to be looking at sources of supply and the effect on pricing."

 

Immediate impact

 

Directly and indirectly, climate change is already making what we eat more expensive. Severe weather has been having a marked effect in recent months, and, combined with the diversion of corn-crop production away from food for people and livestock and toward ethanol, it's led to food prices that as of April were up 3.7% -- their fastest acceleration in three years.

 

The push to wean the United States off oil and reduce its contribution to climate change has sent the price of corn to record highs in recent months, with corn futures topping $4.49 a bushel in March, up 66% from early September.

 

In 2006, an estimated 5 billion gallons of ethanol were produced, utilizing about 20% of the corn harvest, according to the USDA. By 2010, 30% of U.S. corn production could be used for ethanol, producing 11.5 billion gallons.

 

The result, in all its intricacy: Fewer cattle and chickens are being raised because it costs so much more to feed them, pushing up their prices, as well as the price of dairy products. Farmers are diverting more of their acreage to the planting of corn, reducing space previously devoted to the growing of other foodstuffs such as soybeans, making them, too, more expensive. And more water is needed to run the ethanol plants -- another upward cost pressure.

 

Never mind that corn-based ethanol uses up roughly as much energy as it produces. In the meantime, the net result is food-price inflation.

 

"Almost all of the food companies expect that costs will be a big challenge" throughout the year, said Argus Research analyst Erin Smith. Across the board, beverage and food companies are raising prices. "Even so," she said, "the increases aren't enough to offset the rise in [commodity] prices."

Cost spikes are starting to show up in the income statements of many companies.

 

Meat producer and packager Smithfield Foods Inc. recently reported a lower third-fiscal-quarter profit because of higher costs and warned that expenses, particularly for corn, are likely to weigh on its bottom line for the foreseeable future. Tyson Foods Inc.'s  grain-price hedging, meanwhile, wasn't enough to offset a leap in chicken-feed prices in the latest quarter. Nestle SA  warned of higher input costs as well, pointing to a double-digit percentage rise in milk prices.

 

And the costs are being passed on to consumers, Prudential Securities' Howard Penney said. "People are paying more for food; they are going to pay more for food, period."

 

A grocer is almost required to pass higher food costs on to consumers, said Harry Balzer, who collects data on the food-consumption patterns of Americans for consumer market research company NPD Group. "Of the $1 spent at a grocer, 80 cents to 85 cents is for the food itself, while at a restaurant 30 cents is for food, 30 cents is for preparation, 10 cents is for the energy, 10 cents is for the building, etc."

 

Restaurants, however, are far from immune to the sting of higher costs. In fact, analysts who watch the sector agree that costs are likely to be the single biggest factor affecting restaurants next year. A higher minimum wage, meanwhile, will only add to the profit pressure. "It's going to be bad times for the restaurants coming up," said A.G. Edwards analyst Steve West.

 

Many consumers, industry watchers point out, are choosing to forgo a meal at a casual-dining establishment to get essentially the same one at a fast-food restaurant at a significantly lower price -- and without requiring a tip. "The quality isn't that much different," West said. Rather than a table-service restaurant, "you can go to Burger King or Hardee's and get a nice, Angus premium burger."

 

On the horizon

 

Climate change has been affecting food supply in other, subtler ways, as one recent study illustrates, and the effects provide a better glimpse into the long-term trend.

 

According to U.S. government scientists, rising temperatures reduced the annual yields of the world's major cereal crops -- wheat, corn and barley -- by a combined million 40 million metric tons, or $5 billion, between 1981 and 2002. Annual global temperatures rose by roughly 0.7 degrees Fahrenheit between 1980 and 2002, with larger variations observed in several regions.

 

"The effects are not something to anticipate, but are already being seen," said David Lobell of the energy-and-environment division at Lawrence Livermore National Laboratory, a co-author of the study. And the economic impact, he added, is not trivial.

 

Steps that can be taken to offset this change, such as growing new crops that are better suited to a particular, if changed, climate; shifting planting dates earlier or later in the year to minimize the heat stress that a crop faces; and revising the mix of artificially irrigated and rainwater-fed crops.

 

But, technically, such measures can only be taken by the growers themselves. What about their purchasers, whether grocers or restaurants?

 

"I think companies are beginning to worry about variability," in the form of year-over-year weather shifts, including increasing incidents of extreme events, said Walter Falcon, director for environmental science and policy at Stanford University. "But I'm not totally sure how many of them have grappled much yet with longer-term changes."

 

Gary Karp, executive vice president of the food-industry consulting and research firm Technomic, said climate change has been so gradual that it's not reached the radar screens of companies that are currently responding only to daily needs. "The real opportunity is to get out ahead of this and take whatever steps we can to ... do things in the here and now that will impact the longer term, as opposed to letting the long term evolve over such an extended number of years."

 

McDonald's Corp., which has shown itself to be among the more willing to change practices to reduce its global footprint, is today seeing trends that suggest a more secure supply chain is needed for future survival, according to Bob Langert, the fast-food pioneer's vice president for social responsibility.

"It's being talked about, that the food, agricultural system, with the temperature changes that are predicted, could be impacted in the future. We haven't seen that effect yet," Langert said. "But we need to be aware of all this emerging science and be ahead of the curve."

 

Despite the leverage that a food company such as McDonald's might be expected to enjoy, "their supply chain may be too long for them to have any direct influence," said John Buchanan, senior director of business practices at Conservation International, a nonprofit focused on biodiversity conservation.

 

In the meantime ...

 

U.S. companies, or U.S. divisions of overseas companies, experts agree, have been slower to address climate change than their European counterparts have been -- and oftentimes the stateside operators have only done so as a result of activist pressure.

 

"In the U.S., there's this feeling that we're so smart and we're so well-resourced that we can catch up," said Kellie McElhaney, executive director and adjunct professor at the Center for Responsible Business at University of California in Berkeley.

 

"I do think they recognize the challenge of food supply with climate change -- they're not blind to it -- and they're scrambling to play catch-up," she said.

 

And although food companies are increasingly attentive to the environment, their primary overarching focus, industry insiders and watchers agreed, remains trained on health and wellness -- or, rather, obesity.

 

Companies have yet to approach Conservation International to specifically discuss the impact of climate change on food-growing regions, Buchanan said. "They've either got it figured out already or they're not asking the right questions yet," he said. But, he added, it doesn't take a lot to disrupt a food crop.

 

"If you're trying to plan out and manage long-term, stable, food supplies, you'd want to know where it's going to come from and where the rain's going to fall," he said.

 

McDonald's is certainly not alone in putting forth a concerted effort to minimize its environmental footprint, via a reduction of carbon emissions, reduced packaging, scaled-back water usage and multiple initiatives. But securing the future food supply will take another level of planning altogether.

"It will take concerted effort to ensure that, even with the prospect of climate change, a stable, sustainable, affordable supply of food will be available," said Business for Social Responsibility's Cramer.

 

"No investor in the food industry," he said, "can be certain that the economics of the industry in an era of substantial climate change will be the same as they are now, and that ought to worry investors."

 

Carolyn Pritchard is a reporter for MarketWatch in San Francisco.