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|The confounding commodity boom|
Exame - April 2008
In the first edition of this column in January 2007, it was noted that having enjoyed a boom of about five years, commodity prices had begun to fall. Prices of oil and of most metals had peaked in the middle of 2006 and since then had fallen in price by up to 30%. The column explored the question of whether this might be a turning point, of whether oil and metals prices might continue to fall. On balance, your columnist said he was inclined towards bearishness, as supply was likely to increase and demand growth to ease.
This prediction does not, however, look terribly good right now, 15 months later. January 2007 did prove to be a turning point, but in the opposite direction. The IMF commodity price index rose by 44% between February 2007 and February 2008. The price of crude oil, which had fallen from $78 a barrel in June 2006 to a little over $50 six months later, has since more than doubled again, reaching more than $115.
Economists and other commentators tend, for understandable reasons, to focus on the issues on which they are proved right. Yet it is often more interesting and instructive to examine those cases in which you have been proved wrong. Why did commodity prices resume their boom and confound this columnist’s pessimism?
Follow the money
“Deep Throat”, the confidential source for Carl Bernstein and Bob Woodward of the Washington Post when they uncovered the Watergate scandal in the early 1970s, offered advice that is helpful now for understanding the commodity boom: “Follow the money”. To that one should add a further suggestion: “Also follow the politics”.
At first sight, an injunction to pay attention to money might be taken as implying that financial speculation has been the cause. But that would be wrong: although weak prices for equities and debt securities may have encouraged investors to devote more cash to commodities, especially at a time when declining dollar interest rates have made non-interest-bearing assets such as gold and oil look more attractive, the boom has lasted for too long to be explained in that way.
Rather, the money that matters is represented by the savings glut in the world’s emerging economies, especially
The main fuel for
According to the IMF again, since 2002 emerging economies have accounted for more than 90% of the rise in consumption of oil and of metals, and for 80% of the rise in consumption of grains. No one need look much further than that source of demand growth to comprehend the long-term boom in commodity prices. Yet the fall from mid-2007 and the subsequent resumption of the boom happened despite that long-term demand growth.
In the crucial case of oil, this is where the politics comes in. For as well as demand, we must look at supply. Worldwide demand for oil rose from 84.9 million barrels a day in 2006 to an estimated 85.8 million in 2007, a rise of 1.1%. Yet worldwide production of oil rose by only 0.2% last year. The cost of finding and developing new oilfields has been soaring, thanks to a shortage of rigs and engineers, but that is not the explanation. The reason why output rose so little is that the oil-producers’ cartel, OPEC, decided not to increase their supply but actually to reduce it, by 1%. Since OPEC accounts for more than 40% of global oil output, this mattered a great deal.
Back in early 2007, it looked as if the politics of OPEC might favour a rise in output and fall in prices, for
So what might happen now? Given the accuracy of the prediction made in January 2007, it would be unwise to be too bold. One can, however, note the following points. The first is taken from a chart in the IMF’s recent World Economic Outlook. From 2003 until 2008, the OPEC countries’ total spare production capacity, as a percentage of world demand, has been well below the 4% average of 1996-2007. It will remain below 4% during 2008. But it is expected to rise back to that level in 2009, thanks entirely to extra capacity in
The second point is an observation about economic conditions in the emerging economies that have driven the overall commodities boom. In both
In both countries, politics and economics are combining to make a crackdown on inflation look vital during the rest of this year. Inflation has also become a larger concern in Latin American countries and in many other parts of