A serious oversupply of many food commodities in 2016 has shaken up the stock market and led to financial bailouts for farmers who have seen their earnings drop.

While fluctuations in commodities is normal, when prices continue to either increase or decrease for a while, it could have a profound affect on the food industry — impacting food service, grocery costs and manufacturers providing the food.

Dave Donnan, a partner at global strategy and management consulting firm A.T. Kearney, and global leader of its food and beverage practice, said 2016 is the third year of a bear market for agricultural commodities, meaning prices are falling, encouraging selling. He thinks this has had an impact on prices.

“There’s severe earnings pressure on all parts of the agriculture supply market, as farmers try to cut input costs to compensate for low commodity prices,” he told Food Dive. “Consumers are also reducing their acceptance of many crop nutrition and protection chemicals. Food producers and retailers are responding to society’s concerns about agrochemicals in foods by setting pesticide residue thresholds 20 to 50% below legal requirements. That’s just the beginning.”

Jodie Gunzberg, global head of commodities and real assets for the S&P Dow Jones Indices says this is generally bad for farmers — the producers — and potentially positive for food processors — the commercial consumers.

“For processors who have hedged with swaps or futures contracts, the benefit is diminished from the loss on the contracts, but for producers who hedged, their downside was limited,” she told Food Dive in an email. “Many processors lock in their prices far in advance so volatility in the commodities markets doesn’t heavily impact their costs and retail pricing. It is possible if the abundance is persistent for long periods of time that consumers will see food prices fall, but only after processors might keep some of the difference as profit.”

Matt Beeson, founder and commodity consultant for Beeson & Associates noted lower prices of basic agricultural commodities is good news for food manufacturers.

“Producers take the financial losses and manufacturers usually enjoy better margins,” he told Food Dive in an email. “It should be noted that this sometimes is co-mingled when the producer is also the seller to the retail or food service outlet (Tyson meats for example).”

The impact on consumers

Lower commodity prices can influence what consumers pay at the store, but how much those prices change depends on the product.

“Heavy processed foods, such as cereal, show little price change while more basic items, like ground beef, can change quickly at retail,” Beeson said. “Livestock products are examples of products where the seller is also usually the producer, therefore, low prices negatively impact their margins. There is always a desire to make further processed items to achieve greater margins regardless of the market prices. Think yogurt versus a gallon of milk. Yogurt has much higher margins.”

Pablo Sherwell, Rabobank’s head of food and agribusiness research and advisory - North America, said that oversupply is a positive for consumers because prices remain relatively low.

“The food industry has a lower cost on the food production side,” he told Food Dive. “If you are looking at processed foods such as meat, the animal protein sector has expanded responding to relatively lower feed prices, so there was an increase in production in 2016 — the same thing for pork and chicken — and because prices have remained low, prices for consumers do decrease, which is a plus for consumers.”

But grocery margins are as razor thin as they always have been.

“Food prices are under deflationary pressure, and the major grocery store chains are struggling,” Donnan said. “In an operating environment like this, it’s crucial for grocery retailers to build capabilities close to the source of supply. This is difficult in an environment of negative consumer sentiment toward heretofore acceptable methods of raising these commodity crops.”

For some time now, produce has been the star of the show at grocery retailers in North America and Western Europe, Donnan said. New consumer sentiment and appetite has changed the way people shop, affecting desire for certain commodities.

“Consumers drive demand for produce, obviously, and food shopping has evolved into an experience. Consumers want produce with a clean farm-to-table pedigree,” he said. “They want transparency. Not just evidence that a product meets food safety requirements, but traceability from end to end on the supply chain, from the grower to store aisles.”

Thinking ahead

Some may think food companies stockpile some of the basic ingredients needed for their products when prices are low, but analysts say it doesn’t happen that way.

“Manufacturers do not hold large, physical stockpiles,” Beeson said. “However, they can contract for supply into the future if/when they think the price is low enough. Those contracts can extend as far as a year or more into the future.”

Depending on their flexibility, Gunzberg noted that some manufacturers may freeze or substitute ingredients at cheap prices to manage costs. Lower commodity costs don’t necessarily flow through to the retail consumer at the grocery store though, due to things like profit management and other costs like packaging and transportation.

Beeson added that product development pipelines are usually multi-year, so less frequent commodity price changes have little impact on new products coming to market.

Over the past few years the agricultural landscape has undergone significant consolidation. Donnan noted that from 2002 to 2012, almost a third fewer farms were needed to produce about 75% of all fruits, tree nuts and berries. There are fewer farms growing the products the U.S. needs. But the farms that are existing are getting bigger. Over the last 25 years, the size of the average U.S. farm nearly doubled from a median of 589 acres to over 1,100 acres today.

“This points to a need for change in the industry. Partnership and acquisition are examples of ways food manufacturers can reduce commercial risk,” he said. “One example of this is UK grocery retailer Morrisons, which acquired a flower grower as well as meat and seafood processing facilities. In the United States, Whole Foods partners with small growers, supporting them through low-interest loans.”

Partnership and consolidation aside, there are commodities that are difficult to hedge and stockpile. Gunzberg said that the nature of milk and cheese as investments potentially bring a higher price variability. Milk’s relatively short shelf life also adds to the price impact.

“For dairy farmers, this is an unfavorable environment, but for processors, like ice cream makers, it may be beneficial if long-term contracts at higher prices are not in place,” she said.

Sherwell said the most important thing to keep an eye on over the next year is corn yields, since more acreage that had been devoted to corn moves to more profitable soybeans. According to the U.S. Department of Agriculture, U.S. farmers are expected to plant a record 84.6 million acres of soybeans in 2017, an increase of nearly 900,000 acres. This in turn means a drop in corn acreage by 4.5 million acres, or about 5%. So products relying on corn could see higher prices because there will be less of it to go around.

Why so much change?

There are many sources of volatility in agriculture. Climate change makes weather events less predictable and more intense. The extreme drought that California has endured has reduced availability of popular produce. In 2014, California asparagus volumes were down 42%, snap beans down 18%, cucumbers down 22% and bell peppers decreased by 35%.

Beeson described the overall impact of commodity fluctuations as “a tale of three very different constituents.”

“Commodities producers are impacted immediately by lower prices and therefore experience lower revenue. For the manufacturers or restaurants that are buying the ingredients, lower costs without immediately lowering prices improves their margins,” he said. “If prices stay low long enough, competition pushes prices lower for the consumer. The consumer price adjustments can be as short as 30 days (milk or meat) or a as long as a year for highly processed and branded products (packaged cookies, cereal, frozen entree meals).”