Oil and trouble
Tumbling resource prices suggest the world economy is slowing
GIVE commodity markets credit: they are anything but boring. Between 2000 and 2011 broad indices of commodity prices tripled, easily outpacing global growth and stoking Malthusian hysteria. Jeremy Grantham, a wealthy financier, noted at the time that it was not so much “peak oil” that would undo humanity but “peak everything else”. Yet since then commodity prices have slumped by about a quarter, and roughly 11% since June alone. That is not, however, an unalloyed good.
This reversal of fortunes, naturally, is much better news for net importers of resources than for net exporters. For consumers, a drop in the price of natural gas or rice is like a tax cut: it leaves households with more disposable income. Rising oil prices often tip importing countries into recession, and can put pressure on currencies as current-account deficits widen. The cheap resources of the 1990s, in contrast, helped to buoy real wages in the rich world.
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Producing countries, many of which are relatively poor, suffer when prices drop. The last great bust, which began in the late 1970s, was a drag on developing economies for two decades (while the commodity boom of the 2000s was a big contributor to fast-growing incomes in the developing world). Low prices can mean financial turmoil for governments that relied on high ones to fund generous spending. A big enough bust could rattle financial markets around the world.
Just how much trouble to expect depends on the scale of the drop. In the short term commodity prices are a function of shifts in expectations of global demand, along with passing interruptions in supply. When the financial crisis took hold in late 2008, the price of raw materials plummeted. Oil, for example, fell from a high of $144 a barrel in the summer of 2008 to $33 a barrel in December of that year. Yet by late 2010, as global growth recovered on the back of rapid expansion in emerging markets, the price was nearing $100 again.
The current, gentler slide in prices also reflects a weakening world economy. Since 2010 global GDP growth, measured on a purchasing-power-parity basis, has slipped from more than 5% a year to just over 3%. The Chinese economy expanded at a double-digit pace in 2010 but may struggle to grow by 7% this year.
Global trade is decelerating too (see chart 1). In 2010 it made up lost ground from the recession, expanding by 12.8%. It has since slowed, to 6.2% in 2011 and to 3.0% in 2013. The World Trade Organisation (WTO) had forecast growth of 4.7% this year but revised that figure down to 3.1% in September. One of the main culprits, it reckons, is weak growth in imports in commodity-exporting countries, due to their straitened circumstances.
The WTO forecasts a rebound in growth and trade next year. Yet a return to the heady growth rates of the 2000s is unlikely, and risks abound, from conflict in Ukraine to Ebola in west Africa. The rich world’s recovery is anything but assured; the euro zone, which accounts for 13% of global output, is once again teetering on the brink of recession. China, an almost insatiable consumer of raw materials in recent years, is perhaps the biggest risk. The authorities there are trying to rebalance growth away from commodity-intensive investment in housing and other infrastructure. They also want to stem credit growth. If they overshoot and undermine growth, commodity prices will fall further.
Meanwhile, the investments in new supply initiated when prices were at their peak are finally coming to fruition. America’s oil production, for instance, has grown by 4m barrels a day since 2008 thanks to the fracking revolution.
Finding new mineral deposits or new land to cultivate takes time, and once new supplies have been identified, bringing them to market can take years as mines, wells and canals are dug and infrastructure is built. As a result, prices may rise for several years before the anticipated new supply materialises. Once it does, however, markets can become saturated and prices then fall for a prolonged spell.
This pattern is commonly called the commodity-price super-cycle. A few times, notes David Jacks of Simon Fraser University, the cycles for several different commodities have become synchronised during episodes of broad global growth—such that wheat, oil and nickel, say, all seem scarce at the same time. During such booms fears inevitably proliferate that the world will run out of essential raw materials. During the last great commodity wave, in the 1960s and 1970s, Paul Ehrlich, a biologist at Stanford University, published “The Population Bomb”, which gave warning that the world could not provide for its growing number of inhabitants. In 1980 Mr Ehrlich bet an economist, Julian Simon, that a basket of metals would rise in price over the next ten years. Mr Simon won, as supplies grew while consumers became better at conservation.
Production of most commodities has risen sharply over the past decade. The world’s output of iron ore, for example, has roughly tripled since 2000. Supply growth has begun to outstrip rising consumption for some commodities (see chart 2). With the world economy growing less frenetically than in the 2000s, lower commodity prices are inevitable.
The most worrying possibility is that lower prices may feed on themselves. Emerging markets were a big driver of global GDP growth in recent years; if commodities can no longer be counted upon to provide a tailwind, growth might sputter. Slower global growth could then feed back into weaker commodity demand. The cycle might be amplified by financial havoc as firms and governments in commodity-producing countries find their budgets stretched by tumbling prices and their balance-of-payments stressed by the reversal of capital flows.
Some commodity exporters are better equipped to manage a slowdown than in the past. A few used the boom to fill sovereign-wealth funds, to build stockpiles of foreign-exchange reserves or to pursue broader economic reforms. Colombia, Indonesia and Peru, for instance, have put themselves on a sounder economic footing as commodity prices have risen. In other countries, such as Russia and Venezuela, the bust is revealing the extent of the rot. The lower prices go, the more mismanagement will be laid bare.