How does price formation for organic wheat function?

How does the price-formation for organic products function? Is the market for organic products still a small and autonomous market without any links to the “big” conventional market? This hypothesis was in the past often assumed to be true. In such an environment, the market actors would know just the harvested quantity of organic products and the past price for the product and could then get and easy estimate for the actual price of any organic product. So far so easy.

But can we still assume a “small market” in a situation, where importers bring organic products to Germany at least from all over Europe and even from overseas. Additionally, we had the food-crisis of 2006/07 with a huge price-turbulences, we had extremely low prices in 2009 with a comeback of the EU-grain intervention again. And in 2010, grain prices increased again and remained high until mid 2014. Therefore, can we still explain the price development for organic products by excluding all those market dynamics on the world-markets, more sharply can we simply ignore these price-development including the food-crisis?

Organic grain production in East Germany (Photo Sebastian Lakner, 2011)

Organic grain production in East Germany (Photo Sebastian Lakner, 2011)

Organic farming is also subject of policy-interventions: Organic farming is more or less supported by the EU, the German federal states and the federal government, depending also a bit on the color of the actual government. But does this support affect prices? What role plays the so called 2001-Agrarwende – a complete policy shift by Renate Künast (Green Party) in favor of the organic market – for the price-development on the organic market? If we support the organic sector by strong policy measures without any adjustment for the demand on the market, prices might sharply decrease and the production might . Did the reforms of the EU’s Common Agricultural Policy (CAP) matter for the development of the organic market?

The German market for organic products went through very dynamic phases of growth since 2002: According ZMP and AMI the sales of organic products almost doubled from 3.7 Bn. In 2002 to 7 bn. Euro in 2012. During that period, the supermarkets took a huge share of the markets and make about 50% of the sales, the organic food-stores are rather constant and still make 30% oft he German market. Did this influence the organic price-formation and what were the consequence of this integration of organic products into the „big sales channels” of ALDI, LIDL, REWE, EDEKA and tegut? Is the hypothesis of a small and autonomous market with a strong own-dynamics still true?

To investigate this interesting and relevant question, we took one of the main agricultural staple commodity: the price-formation of organic wheat from 1997 to 2012. We intensively studied the market reports from 1997 to 2013, and we tried find a price-transmission model which helped us to identify the price-relation between organic and conventional wheat in different phases the market. We used a so called “Markov-switching vector-error correction model”, which has the big advantage to be very flexible. Another feature of the model is, that the model is suggesting so called regimes, in which the price-relation on the market is fix. Some of our main findings are:

  1. We were able to find pronounced market phases, in which the price-relations were completely different. One phase can be characterized by a stable price-formation and there are rather small interlinkages between the conventional market. Those phases were mainly during times, where the EU-intervention was in force, so mainly until 2005. The other two phases are characterized by strong changes: During times of strongly increasing or decreasing world market prices, we could find strong interlinkages between the conventional and the organic grain prices.
  2. Our main conclusion is that the organic wheat prices tend to be increasingly connected to prices of conventional wheat. This can be easily explained by liberalized European markets for organic products. The imports of organic products to Germany are increasing during the last year, even if this development is sometimes exaggerated. The strong market integration of organic products and the rather close links between organic and conventional prices can also be explained by the increased engagement of supermarkets and the German discounter LIDL and ALDI on the organic market after 2002.
  3. In contrast, we could not find any evidence for political influence on the price-formation. Organic farms are dependent from policy support, however, we could not find any evidence for distorted prices through policy intervention. The only, and rather indirect policy effect might be the EU East-enlargement of 2004 and 2007, however, other development are of more importance.

Overall, the market for organic grain is integrated into the international markets for grain and price-formation of organic grain is also relying on the price-formation for conventional grain. And we can also show, that this coincidence is not by the same natural conditions, since harvest-quantities are not the same on both the organic and the conventional market. To be honest, our story and modeling is a bit more complex and detailed. We also argue, why both markets are not as separate as one might think. Overall, we hope, that we brought in some new and hopefully interesting arguments and insights.

Therefore, for more details, have a look in our article in Agricultural Economics: Würriehausen, N., R. Ihle and S. Lakner (2014): Price relationships between qualitatively differentiated agricultural products: organic and conventional wheat in Germany, Agricultural Economics, 22.Okt. 2014, early view.

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