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• A short history of the commodites price boom
• Why did oil and mineral prices rise and why did they rise by so much?
• The downturn: How much was due to the financial crisis?
• The recession: – How deep and how long?– Will things go back to « normal »?
The commodity price boom
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50001.1
997
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Price Index - All groups (current dollars terms) Food
Tropical beverages Vegetable oilseeds and oils
Agricultural Raw Materials Minerals, ores and metals
Crude petroleum*
Crude oil prices 1960 to mid-2008, US$/barrel
-
20
40
60
80
100
120
140
1Q
1960
2Q
1962
3Q
1964
4Q
1966
1Q
1969
2Q
1971
3Q
1973
4Q
1975
1Q
1978
2Q
1980
3Q
1982
4Q
1984
1Q
1987
2Q
1989
3Q
1991
4Q
1993
1Q
1996
2Q
1998
3Q
2000
4Q
2002
1Q
2005
2Q
2007
Nominal Real
Source: UNCTAD Commodity Price Bulletin
Reasons for the price increase
• Demand– Two years – 2003 and 2004 – with above trend increases– Geographical differences– Expectations
• Supply– Slow capacity expansion– Low spare capacity, concentrated in one place– Inventories
• Supply-demand imbalances and price spikes in commodity markets
• Other factors– US$ depreciation– Mismatch of refinery capacity– Speculation?
Global oil demand, change on previous year, %
Source: International Energy Agency, Oil Market Report, various issues
-2
-1
0
1
2
3
4
5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Shares of increase in global oil demand 2001-2007, %
21%
2%
19%
26%
19%
13%North America
Europe
Other Asia
China
Middle East
Others
Source: International Energy Agency, Oil Market Report
Large share for China, Middle East and Other Asia – but also for North America
Energy intensity, metric tons oil equivalent per thousand US$ in nominal and PPP 2000
exchange rates
OECD MiddleEast
Ex-USSR
China Asia Africa
US$ 2000 PPP
US$ 20000
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
1.8
2
Source: International Energy Agency
China was expected to follow “the Korean path”, but didn’t
Figure 8. Energy intensity 1965-2007, tons of oil equivalent per million $ in GDP, PPP adjusted
0.0
100.0
200.0
300.0
400.0
500.0
600.0
700.0
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
China
India
Japan
Republic of Korea
USA
Russian Federation
Reasons for price spikes in commodity markets
• Very low short term price elasticity of demand because of lack of substitutes and because use cannot be postponed
• Very low short term elasticity of supply because of fixed capacity and high capacity utilization (a logical consequence of product standardization)
• When prices are perceived to be rising, target inventory levels are raised because buyers want to avoid paying higher prices
• If there is a perceived risk of shortage, target inventory levels are raised to avoid having to default on deliveries
• Precautionary stocking is insensitive to price increases and will continue long after prices have exceeded “reasonable” levels
Supply side factors: Capacity developments
• Slow capacity increase– Low oil prices in the 1990s reduced the incentive to
add to capacity – There was no spare capacity among non-OPEC
producers
• OPEC spare capacity– In the 1990s, OPEC had cut back production– As late as 2001, OPEC spare capacity was 5.6 million
barrels/day– In June 2008, it was 1.5 million barrels/day (less than
a week’s world consumption), all in Saudi Arabia
Supply side factors: Production costs
• Production costs rose rapidly after 2000, both reducing incentives to invest and creating expectations about future price increases
• The “peak oil” theory made arguments based on rising costs of production more credible
Supply side factors: Inventories
• The history of inventory changes is ambiguous – total OECD stocks were actually higher than normal in the first half of 2007
• OECD stocks fell in early 2008, particularly in Asia, creating an imbalance
• Official stock build ups took place throughout the period of price increases and rumours of massive increases in Chinese stocks abounded
• Very little information was available about stocks in producing countries
• It is likely that a general atmosphere of uncertainty contributed to precautionary stocking behaviour
A source of uncertainty: Estimates of non-OPEC supply growth have been too
optimistic in recent years
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2003 2004 2005 2006 2007 2008
Mil
lio
n B
arre
ls P
er D
ay
?
Estimate 1 year ahead
Estimate end of current year
Sources: December editions of IEA’s Oil Market Report.
Summary of factors
0
30
60
90
120
150ja
nv
.94
jan
v.9
5
jan
v.9
6
jan
v.9
7
jan
v.9
8
jan
v.9
9
jan
v.0
0
jan
v.0
1
jan
v.0
2
jan
v.0
3
jan
v.0
4
jan
v.0
5
jan
v.0
6
jan
v.0
7
jan
v.0
8
jan
v.0
9
$200
8 D
oll
ars
Per
Bar
rel/
Day
s S
up
ply
0
2
4
6
8
10
Mil
lio
n B
arre
ls p
er D
ay
WTI Spot ($2008)
OECD Days Supply
World Excess Production Capacity (right axis)
Sources: WTI: Reuters; OECD Days Supply: International Energy Agency and U.S. Energy Information Administration estimates; World Excess Production Capacity: U.S. Energy Information Administration estimates.
Other factors
• US$ depreciation
• Demand rose particularly fast in the transportation sector
• Refineries produce products in fixed proportions, composition of crude oil is crucial
• A shortage of light crude oil may have further fuelled the price increases
Speculation?The argument
• Low returns on stocks and other assets led hedge funds and other investors to invest in commodity markets, particularly oil
• The volume of investment was very large and, it is argued, drove up prices
How do futures markets for commodities work?
• Futures markets trade contracts for future delivery of a certain quantity of a commodity
• The contracts are almost always cashed in and very seldom do buyers actually take delivery in commodities
• The attraction to investors or speculators compared to dealing in the physical commodity is (1) you avoid storage and handing costs and (2) you only have to pay a small part, usually 10 per cent, of the total price in advance; therefore the potential for profits is very large
Who invested in oil futures and what was the effect?
• Banks and others sold “commodity index funds”, that is, financial instruments that were intended to replicate the price movements of commodities
• Oil is usually a large component in the indices, since it is an important commodity in world trade
• Since the sellers of commodity indices wanted to avoid losses, they hedged by buying contracts on commodity exchanges that corresponded to the indices that they sold – thus they would be able to pay off the investors; this activity was responsible for the vast majority of futures market investment
• The sellers rolled over their hedges, that is, they sold the contracts for cash before the due date and bought new ones for more distant dates
• Accordingly, no oil ever changed hands and the price of physical oil was not affected
• The process can be compared to betting on the outcome of a tennis tournament – the bettors do not decide who wins the Wimbledon
Who invested in oil futures and what was the effect? (3)• No correlation
between the amount invested in futures contracts and the price level• Changes in positions did not precede price changes, but followed them (US Commodity Futures Trading Commission)• Backwardation is the classical indication of a physical shortage, speculators exploit physical shortages
0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 800 850 900 950
RhodiumCadmium
ManganeseCobalt
Iron oreRice
Crude petroleumTin
CopperSilverNickelLead
MaizeZinc
Aluminium
A. JUNE 2008 VS. JANUARY 2002(Percentage change)
-100 -90 -80 -70 -60 -50 -40 -30 -20 -10 0 10
Manganese
Iron ore
RiceCobalt
Cadmium
Rhodium
Silver
ZincMaize
Lead
Tin
Aluminium
NickelCopper
Crude petroleum
B. DECEMBER 2008 VS. JUNE 2008(Percentage change)
Exchange-traded commoditiesCommodities either not traded on commodity exchanges or not included in the major commodity indices
Mineral commodities
• Above trend growth in usage
• Under investment in the 1980s and 1990s because of low prices – therefore, capacity became a constraint
• Inventories were gradually depleted
• Price spikes resulted from precautionary buying – all buyers tried to ensure that they would be able to meet their needs
Average annual growth rates of usage of minerals, % per year
0123456789
Alum
inium
Copper
Iron
ore
Lead
Zinc
1996-2001
2002-2007
Surplus or deficit (-) of global production over usage for lead and zinc, 1996-2007, per
cent of production
-5
-4
-3
-2
-1
0
1
2
3
4
5
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Lead
Zinc
Average quarterly prices and end of quarter inventories (LME) of lead and zinc, % of 4th
quarter 2003 prices and end 2003 inventories
0
50
100
150
200
250
300
350
400
450
500
4Q200
3
1Q200
4
2Q200
4
3Q200
4
4Q200
4
1Q200
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2Q200
5
3Q200
5
4Q200
5
1Q200
6
2Q200
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3Q200
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4Q200
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1Q200
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2Q200
7
3Q200
7
4Q200
7
1Q200
8
2Q200
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3Q200
8
Lead stocks
Zinc stocks
Lead prices
Zinc prices
Iron ore prices, US$/ton
0
50
100
150
200
25011
.03.
2005
11.0
7.20
05
11.1
1.20
05
11.0
3.20
06
11.0
7.20
06
11.1
1.20
06
11.0
3.20
07
11.0
7.20
07
11.1
1.20
07
11.0
3.20
08
11.0
7.20
08
11.1
1.20
08
Spot price, mid-point ofrange
Hamersley fines, cfrChina
Carajas fines, cfr China
Sources: UNCTAD Iron Ore Trust Fund, TEX Report, Metal Bulletin
Freight rates reflected the overall boomExample: Iron ore freight rates, 1999-2008, US$/ton
0
20
40
60
80
100
120
janv
.99
Jul
janv
.00
Jul
janv
.01
Jul
janv
.02
Jul
janv
.03
Jul
janv
.04
Jul
janv
.05
Jul
janv
.06
Jul
janv
.07
Jul
janv
.08
Jul
Brazil-China
Australia-China
Sources: Drewry, SSY
The downturn
• Did not happen at the same time for all commodities • The recession in the US began in the 4th quarter of 2007
– well before the collapse of Lehman Brothers in September 2008
• It started as a “typical” recession brought on by a commodity price boom– High commodity prices lead to higher general inflation, deterring
investment and constraining production– Tightened monetary policies reinforce the trend, causing an end
to the boom• But it became a financial crisis: “when the tide goes out,
you can see who’s been swimming naked” (Warren Buffett)
• As a result, worst recession since the Great Depression
Characteristics of the recession for commodities
• Widespread downturn led to falls in demand• Note: Mineral commodities are used in
construction, capital equipment and durable household goods, first sectors to be hit in the crisis
• Lack of credit led to:– No trade finance – No working capital finance– No finance for investment
• As a result, world trade was strangled and commodity demand fell precipitously
Monthly world crude steel production, % change year-on-year
-30
-25
-20
-15
-10
-5
0
5
10
Febr
uary
200
8
Mar
chApr
ilM
ayJu
ne July
Augus
t
Septe
mber
Octob
er
Novem
ber
Decem
ber
Janu
ary 2
009
Implications, oil and mineral exporters
• Real exchange rate appreciation during boom
• Undiversified exports and economic structure, low productivity growth
• Subsidized fuel consumption, leading to allocation errors and inefficiencies
• Widening income differences• Eventually, slow growth• But, the scenario takes place against a
background of high incomes
Implications, oil importers
• High energy costs act as a tax on development, reducing real income
• For commodity exporters, effect is offset – at least to some extent - by high prices for export products, and prices of most commodites have fallen less than oil prices
• Exporters of manufactures experience income losses
Terms of trade, developing countries and countries in transition
Source: UNCTAD, Trade and Development Report, 2008
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
160.0
180.0
200.0
2000
2001
2002
2003
2004
2005
2006
2007
Oil exporters
Exporters of minerals andmining products
Exporters of agriculturalproducts
Exporters ofmanufactures
What happens now?
• How long and how much will commodity prices be depressed?
• Short to medium term
• Long term
Short to medium term:Prices have fallen by less than generally
thoughtAverage 2008 and December 2008 (2000=100)
0.050.0
100.0150.0200.0250.0300.0350.0400.0450.0
All
com
mo
diti
es
Wh
ea
t
Ric
e
Su
ga
r
Co
ffee
Pa
lm o
il
Co
tton
Ru
bb
er
Alu
min
ium
Co
pp
er
Cru
de
pe
tro
leu
m
Average 2008
Dec2008
Short to medium term, cont’d• Demand for food commodities has held up
relatively well – people have to eat, even in a recession
• Minerals and metals producers have cut production drastically, reducing the impact on prices
• Oil producers (OPEC) have instituted cutbacks, but quota limits are not observed
Short to medium term, cont’d
• The impact on investment has been severe, but has mainly hit projects that are in the midst of the project cycle– Projects that were almost finished are going
ahead but may not enter into production– Long term projects are continuing, but at
lower spending rates
• Prices have probably bottomed out and will start rising slowly towards the end of 2009
The long term1. The new oil economy
• The lesson learned from the oil crisis is that energy diversification is a necessity
• This is reinforced by the need to slow climate change• Accordingly, oil demand will grow more slowly than
otherwise• A “floor” to prices will be set by production costs for
alternatives – US$ 50/barrel?• A ceiling will be set by moderate demand growth – US$
80/barrel?• OPEC discipline will hold up if prices fall too far• Unknown factor: risk for new supply shortages due to
under investment in exploration and development• What is the future for oil economies?
The long term2. Minerals and metals
• Chinese transformation from export orientation to push for domestic demand – effect on minerals demand?
• In spite of this, minerals demand is likely to grow fast in emerging economies because of rising incomes and need to improve infrastructure
• Because of cuts in investment, bottlenecks may emerge quickly and prices could rise to new heights
• Reinforcement of existing pattern of production, Africa may have lost its opportunity…and Russia?