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Washout
Flooding in the Midwest will have a lasting effect on food prices.
Flooded corn fields are leading to sustained higher food costs for restaurants.

Though high waters are starting to recede, the effects of recent flooding in the Midwest are likely to persist in the form of higher food prices, experts say.

Across the Corn Belt, heavy rains in previous weeks have damaged and in some cases destroyed corn and soybean crops. In Iowa, the nation's top corn-producing state, 8 percent of corn acreage and 7 percent of soybean acreage were reported to be under water, according to a June 24 Weekly Weather and Crop Bulletin from the United States Department of Agriculture (USDA). Flooding also damaged crops in parts of Nebraska, Missouri, Wisconsin, Illinois, and Indiana. In all, the USDA estimates that corn and soybean crops will be reduced by about 2 percent because of the flooding.

"There are anywhere from 3 [million] to 4 million acres [of corn] in Iowa alone that are not salvageable or have taken on substantial damage" says James Bower, president of Bower Trading, a Lafayette, Indiana-based commodities brokerage. "The stocks were tight before the season started, and the situation has gotten much worse."

Two weeks ago, futures prices for corn approached $8 a bushel—almost double the price from a year ago—and soybeans neared a record high of almost $16 a bushel. Prices have eased somewhat as weather has improved in the flood-affected regions, but analysts predict prices could climb even higher in the coming months.

"I would say if we hit hot, dry conditions in the critical months of July and August, corn could hit $10 [a bushel] and beans could go to $20 [a bushel], unless there is some governmental policy change," Bower says.

Both corn and soybeans are used in animal feed and countless processed foods—corn as the sweetener high-fructose corn syrup and soybeans as oil. As a result, price increases for those commodities will have wide-reaching effects on many other foods. Hardest hit, says Don Roose, an analyst with West Des Moines, Iowa-based risk management firm U.S. Commodities, will be products such as milk, beef, pork, and poultry.

Corn prices in the U.S. have been on the rise over the past year as more of the crop has been diverted from foodstuffs to be used in ethanol production. Last year, 20 percent of the corn grown domestically was used to make ethanol. This year, that number is expected to be even higher, even though farmers planted around 8 percent fewer acres of corn. That, experts say, means spikes in the price of the crop will likely lead to higher fuel prices as well.

"By the end of the year, it's estimated that roughly 7 percent of the gas [in the U.S.] will be ethanol," Roose says. "The problem is that if we cut back on ethanol production, then your gas prices are inversely related. If you cut back on the production, you increase the cost of ethanol and, therefore, gas."

This comes in the face of already soaring food inflation, due in part to record-high fuel prices. Costs for finished consumer foods have increased 6.5 percent from May 2007 to May 2008, according to the Producer Price Index, the government's measure of selling prices received by domestic producers for their output.

The very large chains have a lot of hedging strategies in place. They're pretty protected through the end of their contracts."

A federal minimum wage hike is also set to take effect in June, further complicating the picture for restaurants.

Malcolm Knapp, a New York-based marketing research consultant, says food cost spikes caused by the flooding will affect different restaurants in different ways.

"The very large chains have a lot of hedging strategies in place," he says. "They're pretty protected through the end of their contracts."

Those restaurants, he says, are not likely to feel the full effect of the price increases until contracting talks begin for 2009. In the short-term, it will be the independent restaurant concepts that suffer the most.

"Independent operators really have a serious problem," Knapp says. "There will be shakeouts."

But, he says, it's also important to remember that spikes in food inflation are not unprecedented, citing the period from 1971 to 1981. The industry was able to weather high inflation in that time.

"Somehow, we survived," Knapp says.

Jamie Hartford is a frequent contributor to QSR.