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Why food prices don't drop when gasoline prices decline

Darin Newsom analyzes the agriculture industry for a living. There is little about it that is lost on him.

But with gasoline prices down substantially for well over a year and currently hovering at multi-year lows, he is at a loss to explain why food prices for consumers have not at least leveled off in response. And he wonders why they are now expected to climb again in the year ahead.

The cost to transport food from farms to production facilities to grocery stores — heavily influenced by fuel prices — has certainly declined over the past year, he said, but savings appear not to have been passed on to consumers.

"In the past, when food prices are rising, one excuse has always been that it costs so much to transport food, but they don't have that excuse anymore," Newsom, a senior analyst for Omaha, Nebraska-based DTN, said in an interview.

"There are a lot of processes that commodities go through before they get to the grocery store, so there's not a simple, one-step connection," Newsom added.

Transportation is indeed only one piece of the farm-to-table process, so consumers should not expect food costs to tumble alongside prices at the pump, he added. As gas prices fall, costs tied to other components of the process may rise.

"But overall, with gas prices so low for so long, you would have thought there would be some significant correlation to food prices by now," Newsom said. "It would stand to reason that prices could come down for a time."

Ultimately, however, food price appreciation is driven less by economic forces and more by producer and consumer behaviors, at least in the short term, analysts said.

The disconnect

Amid an abundance of global supply, oil prices started to fall in the second half of 2014, and they continued to drop last year. Prices this month have hovered around $30 per barrel, a 13-year low, according to an analysis by data portal IndexMundi. Prices now are far below the more than $100 per barrel fetched prior to the oil downturn.

Prices of gasoline, which is refined from oil, followed suit. The national average cost for a gallon of gasoline hung just below $2 in January, according to AAA. The average price at the pump topped $3.50 in mid-2014.

Food prices, however, climbed 1.9 percent in 2015, following a 2.4 percent increase the year before, according to the U.S. Department of Agriculture's Economic Research Service. Food-at-home costs — grocery store prices, as opposed to restaurant prices — can be volatile and dipped during a couple months last year, but rose 1.2 percent over the course of 2015 and 2.4 percent in 2014.

To be sure, the pace of annual food-price increase declined, but Newsom and others attribute that in large part to falling prices for corn and other crops that serve as chief ingredients in a range of food products. Corn prices were down throughout 2015 and remain well below decade highs amid strong supply and weakened demand from developing countries such as India.

Now that those savings have been baked in, the USDA forecasts that food-at-home prices will climb this year at a 2 percent to 3 percent pace. At the midpoint of that outlook, prices would be above the 2014 increase and on par with the 20-year average, despite the historically low oil and gasoline costs.

The Federal Reserve has projected that core inflation, which excludes food and energy prices, will rise to only about 1.6 percent in 2016.

What gives?

USDA economist David Levin, who analyzes the government's food price data, said in an interview that a chief explanation for the rising food price forecast — despite the low fuel costs — is that producers and processors are loathe to lower prices only to have to turn around and raise them again.

He said that nobody has a firm handle on when oil prices — and by extension prices at the pump —will rise anew. As such, food companies would rather weather complaints now about high prices, he said, than lower prices and suffer a more hostile backlash when they have to hike prices to account for climbing gasoline prices later.

"They want to make sure it is more than temporary," Levin said of low transportation costs.

Levin has not found a reliable assessment of how much transportation costs typically influence food prices because that piece of the food-sales pie varies widely based on the type of food and where it is ultimately sold. The cost to transport seafood, for instance, to an oceanside community may be cheap; in contrast, it would prove relatively expensive to get the same food to the Upper Midwest. But he said transportation is a vital component in the food-to-table process and therefore has a large influence on overall costs.

That said, if gasoline prices stay low through all of 2016, food companies would be more likely to bring down costs, he said, and that could affect future USDA forecasts. Processors and possibly grocery chains could see an opportunity to win business from competitors via lower prices, especially if they feel confident that fuel prices have settled at low levels.

Short of competitive pressures, however, Levin said food prices are not likely to fall soon. Processors and grocers know that food holds a special place in most household budgets: The need to eat makes food among the last items on which Americans cut back. That means demand is steady and that, absent new competitive forces, downward price pressure on food companies is rare, he said.

"You'd have a business that would essentially be giving up profit," Levin said. "You won't see that."

Newsom added that Mother Nature often plays a role in pushing up prices, too. A prolonged drought in California, the nation's largest agriculture state, has increased the cost for farmers to grow certain crops there, and isolated developments can also influence the price of certain foods. Avian influenza killed millions of birds last year, for example, driving double-digit increases in egg prices.

'Sugars and sweets'

Creighton University economist Ernest Goss said in an interview that many consumers also have more money in their pockets because of savings at the pump. He said least some are spending that extra money on foods they want — including expensive items—as opposed to only what they need, and that drives up demand and puts upward pressure on prices.

The USDA data, for example, show that food-at-home prices for "sugars and sweets" was actually down slightly in 2014 but rebounded in 2015, rising 3.2 percent after consumers grew accustomed to lower fuel prices. That was above the 2.3 percent 20-year historical average gain for that category.

And while wages have stagnated in recent years, he said the U.S. job market was strong in 2015, and if it remains so this year, there is bound to be upward pressure on wages. That gives food companies another reason to pad their incomes now and create reserves they can use to pay higher wages if they need to in coming years, Goss said.

"The bottom line is that while it would seem to make sense for food prices to come down with the transportation costs, it would probably take quite a long, long stretch with low gas prices for that to happen," Goss said. "Prices will go down in certain categories or in a certain month, but because there are so many variables that go into food prices, you don't see overall prices come down very often."

Kevin Dobbs is a senior reporter for S&P Capital IQ and SNL Financial. He covers the banking system and financial markets. He can be reached at kdkdobbs@hotmail.com and is on Twitter: @Kevin1Dobbs.