Tuesday, February 5, 2013

Case Study in Supply and Demand: Why Olive Oil, Good for the Body, is Becoming Hard on the Pocket Book

This case study is also available in sideshow format. You can paste it into your lectures, use it as an in-class quiz, or assign it to your students as an on-line exercise.

It seems there almost nothing bad about olive oil. It is delicious, of course, and if you are a connoisseur, you can get as much pleasure from a fine bottle of olive oil as from a premium Brunello di Montalcino. A  high content of monosaturated fats makes olive oil among the most heart-healthy of all cooking oils. It’s great for your skin, too. Wrangler has introduced a line of olive-oil infused jeans designed to moisturize the wearer’s legs. While researching this post, I learned that you can even shave with olive oil. No kidding.

In fact, the only bad thing about olive oil is that the price is going up, and fast. As the following chart shows, futures prices have risen 75 percent since mid-2012. Observers expect the increase to show up in retail prices soon. So what’s behind the spike in olive oil prices?


Supply

There is little doubt about what is happening on the supply side of the market: The weather in Spain, the world’s largest producer, was unusually bad last year. In the spring, an unexpected frost damaged the trees just as they were blossoming. Summer brought a prolonged drought. By December, which should be the height of the 2012/13 harvest, the Spanish crop was coming in at just 44 percent of the year before.

The harvest has been better elsewhere, but as the next chart shows, Spain so dominates the world market that no one else can really make up the loss. Tunisia is trying. The fifth largest producer and fourth largest exporter, its production is expected to rise by 27 percent in the 2012-13 season. California will also have a good year. Growers there hope to reach 3 percent of world output this year, up from the 1 percent or less reported by the FAO for 2011. But none of that is going to go far in replacing the hundreds of thousands of tons of lost Spanish production.



Demand

Homer called it “liquid gold.” Greeks are still the largest per-capita consumers, going through an astonishing two liters a month for every man, woman, and child. Italian and Spanish consumers each lap up about half of that. Lately, though, Southern Europeans are tightening their belts, and even staples like olive oil are taking a hit. Over all, European consumption is down.

Meanwhile, health consciousness and the growing popularity of European foods are boosting consumption elsewhere.  U.S. consumers are set to increase their olive oil purchases by 9 percent this year. Despite the best efforts of California producers to supply the domestic market, that will mean a big increase in imports.

China is becoming a factor in the market, too. Starting from a base of almost nothing, Chinese olive oil imports have been rising at a furious pace. They increased by 38 percent last year alone. One report out of China boldly predicts that country will soon become the world’s biggest consumer. The popularity of olive oil is on the rise in Brazil and Russia, too.
On balance, growth of new markets is expected at least to balance out depressed European demand. That means there will be no relief in sight from the demand side of the market.

The Bottom Line

If you’re an olive-oil lover, you’ll just have to dip into your savings this year if you want to keep dipping your focaccia in the good stuff. After that, the market may return to normal. If you look ever so closely at the first chart in this post, you can see that futures prices for March 2014 maturities are well below those for March of 2013. Also, the preceding 2011/12 harvest was very abundant, so the current spike in prices starts from an unusually low base. If this year’s Spanish frost and drought are aberrations, and not signs of some longer climate trend, output should bounce back for the world’s largest producer. Meanwhile, even one year of high prices will give a boost to hopeful growers in Tunisia, California, and other countries where production has not yet reached its potential. Consumers can hope that for oilive oil, as for most everything else, what goes up must come down.

Thanks to Sarunas Merkliopas, who served as research associate for this post. This analysis, without the sideshow, was originally posted to Ed Dolan's Econ Blog at Economonitor

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