The New Alchemy: Oil and Water Into Food

The focus has generally been on the near-term growth and inflation implications of higher commodity prices. What is in danger of getting lost is the underlying dynamic between oil, water and food that has important long-term consequences.

Water Futures

There may not be a water futures contract, but water is a precious commodity and one that is becoming scarcer. The global use of water tripled in the 1950-2000 period, and the water table is falling in countries that are home to half the world's population. Almost three-quarters of the water is used for irrigation, and during the last half century, the amount of land being irrigated also tripled.

To grow a ton of grain requires 1,000 metric tons of water (1,000 cubic meters). In comparison, it takes about 62,600 gallons of water to make a ton of steel. Already the shortage of water has begun to affect agricultural practices.

China's shortage of water is one of the factors behind the drop in grain production from the 1998 peak of 392 million tons to 358 million tons in 2005. That decline is larger than Canada's annual wheat harvest. Corn, which requires less irrigation that wheat or rice, is the only major grain for which China's output has not declined. Through its heavy demand for water, China reportedly is creating a desert the size of the state of Rhode Island every year.

Since grain is so water-intensive, importing grain is an efficient way to import water. Countries that have a water deficit are likely to import grains. Already, Algeria, Egypt, Iran and Mexico import more of their grain. The band of countries from Morocco in the west through Iran in the east, which have rapid population growth, rising affluence and water shortages, are among the fastest-growing grain import markets. Some countries, such as Israel, have now prohibited irrigation of wheat fields. Other countries, such as Saudi Arabia, have been forced by fiscal considerations to cut subsidies to farmers.

Roughly speaking, 97% of the water on earth is salt water in oceans and seas. Two-thirds of the remaining water is trapped in glaciers, permafrost and the polar icecaps. That leaves 1% of the water for everything else. Through the desalination process, salt water can be made fresh, but the process is very energy intensive. One estimate suggests, for example, that if China's water shortfall would be met fully by desalination, it would require almost a third of the world's annual oil output.

In part two of this article, which will run on Monday afternoon, Marc Chandler will look at how oil and water relate to the production of grains and meat.

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Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.