The rising world food prices seem to have forced the UK government to take a second look at its transport fuel policy which compels suppliers to provide 2.5 per cent of their sales as bio-fuel. The policy took effect last week. The proportion is to rise to five in 2010.

British Prime Minister Gordon Brown said in a statement last Tuesday, ahead of a meeting on food prices with industry leaders and development experts, that if a UK government review of the impact of biofuels now under way “shows that we need to change our approach, we will also push for change in EU biofuels targets”.

The review was launched in February and is due to deliver initial conclusions next month, with a full report by the end of June.

As food prices have risen environmental and social groups have intensified their campaigns, arguing that governments are diverting production away from food and animal feed. Until now, the government’s policy has been to support the increased use of biofuels.

Biofuels produced from crops such as corn and soya provide a small but fast-growing share of motor fuel, and had been expected to make an important contribution to meeting growing demand for fossil fuel.

Biofuels have strong political support in many countries. Angela Merkel, Germany’s chancellor, said last week: “Those rising global food prices have nothing to do [with] biofuels.”

Agriculture diplomats have expressed concern that governments are focusing on biofuels as the main reason for rising food prices. They argued that the use of agricultural land and crops for fuel is only part of a mix of problems including higher demand in Asia, climate change, declining growth in farming productivity and water scarcity.

The European Commission has been defending its 10 per cent biofuel mix target for motor fuels. Asked by reporters last Monday whether the EU was reconsidering its position on the biofuels target, a spokesman said: “The answer is very simple. No.”

Meanwhile, the world is still not very sure what is causing the international oil prices to shoot up so steeply over the last one year. The price has almost doubled in the 12 months from $60 to $120 a barrel. The producers claim that there has not been any disruption in supplies during this period. There has also been no significant increase in consumption in major consuming countries like the US, Europe, Japan and the UK.

China’s consumption is said to be rising at a breakneck rate. Chinese demand for oil is said to be accelerating ahead of the Olympics with crude oil imports up by almost a quarter to 4.07 million barrels a day in March, compared with the same month last year. For the first quarter, crude imports rose by 14 per cent compared with the same period last year. But then it has also been busy in Africa exploring new fields and developing them.

One would certainly find it hard to disagree with the argument that the declining dollar could have forced the exporters to push up the prices of their commodity to protect the purchasing parity of the currency they receive in exchange for their oil. But the increase in the price of oil is decidedly too high compared to the dollar’s decline.

So, there certainly appears to be a very generous speculative component in today’s oil prices. But who is fueling this speculation and why? Nobody has an answer.

Opec ministers have blamed rising oil prices on speculators and the weakness in the dollar at last week’s meeting of the International Energy Forum in Rome.

But in an effort to reassure the market, Opec’s secretary general highlighted the cartel’s plans to expand capacity. Right now, Opec has 120 projects worth $160 billion just to increase capacity by five million barrels a day to 2012. However, Opec is said to have no plans to meet before September, suggesting little prospect of any relief on supplies before then.

Developments in the dollar are likely to dominate oil price movements in the short-term and could even drag Brent crude as high as $125 per barrel this quarter. Nevertheless, with a recovery of the dollar and easing of oil market tightness in the pipeline, the Capital Economics (CE) a London based research firm expects prices to drop back to around $85 per barrel by the end of the year.

The three key drivers of the recent rise in oil prices (a falling dollar, tight fundamentals and speculative pressures) look set to ease and probably reverse in the second half of the year.

Another factor blamed for high oil prices is the inflow of capital from investors, partly as a hedge against general inflation. However, the argument for buying commodities to hedge against commodity-driven inflation is dangerously circular and it is only a matter of time, according to CE, before fundamental demand and supply conditions reassert themselves.

The demand for commodities such as industrial metals is expected to moderate on slower economic growth, while the supply response to high food prices has historically been quicker than in energy markets. The upshot is that as general inflationary pressures ease, speculative positions in oil should also be unwound, potentially leading to a very sharp correction.

The increases in world oil and food prices have devastated the economies of low and middle income oil importing countries. With soaring oil and food import bills and not much to export to pay for the costly oil and food, these countries are now looking at multilateral aid agencies for help. But there is said to be an upside as well to this steep increase in the world prices of these two essentials.

At $120 a barrel, oil exploration and development is said to have become not only an economically viable venture the world over but profitable as well for even those countries which are blessed with shallow fields. At these prices even the windmill driven energy and solar energy too are said to have become commercially economical for developing countries.

And those developing agricultural countries which so far had found it economically unprofitable to invest in food crops because of the heavy subsidies that the rich countries were giving to their farmers would now find it commercially viable to grow food commodities for home consumption as well as for export.