Low commodity prices will rebound, with impact on world economies

Sept. 1, 1999
Energy central to economic planning

Editor's note: This article is part of an unlinked series on the significant long-wave forces that affect all commodities, including oil and gas. Outlined below is an often overlooked perspective on the basic position of commodities and the direction of commodity price movement in the global economy.

The health of the oil and gas industry in general, and the offshore component in particular, is tied to the world's need for liquid fuels to power industrial manu facturing and transportation systems. The personal comfort and convenience of the con sumer is also a major component. Con sumers use petroleum either directly or indi rectly to cook food, control housing temper atures, produce goods, and fuel trans portation systems. Consumers in developing countries seek to raise their living standard to developed country standards.

Current and previous declines of the non-energy commodity price index (peak=100) are shown. Commodity prices generally have a 4-5 year cycle. The world is experiencing a significant low price index that reflects an over-supply situation.
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The world is presently enjoying a period of commodity oversupply, not just in oil, but in all major commodities: energy, fertilizers, grains, and metals. It is a great time to be a consumer, and a difficult time to be a commodity producer.

Will this be a short-term or long-term phenomenon? The answer is that it will be both. Short-term commodity prices will continue to be depressed. Long-term prices will rise as the oversupply is used and as population grows.

Long wave trends

Consumers drive oil demand, and their numbers are growing. According to the Population Reference Bureau's 1999 World Population Data Sheet, the world's total population will reach 6 billion in the second half of 1999 - as early as October.

Even more compelling is the next billion people that will quickly follow. Projections indicate that by 2014 the world's population will reach the 7 billion-person mark. All of these consumers will be seeking the best possible life for themselves and their families. Food, clothing, shelter, and more energy will be required to provide a reasonable life for them. Most of these new people will live in the developing world, where the oversupply problem has its worst effects.

Relatively low oil prices since the mid-1980s laid the groundwork for the current situation. Very high prices through the 1970s suppressed the growth of world trade and hurt developing countries.

With the crude oil price drop in the mid-1980s, these countries moved to expand rapidly, leveraging natural assets and developing as quickly as possible. They were caught by financial over-extension in 1997 and continue to restructure their industries and economies.

Low commodity prices

Low prices for all commodities are directly related to the supplies on hand. The financial collapse in Southeast Asia severely reduced demand and led to a buildup of excess supply. This has created a major problem for the developing countries that will persist for at least another year. Because much of their cash flow is dependent on commodity sales (see table), their economies will continue to recover very slowly.

The problem extends to all major commodity segments: petroleum, cash crops (cocoa, tea and coffee), edible oils, and grains (soybeans, wheat, maize, and rice). All segments are carrying significant production overhangs that must be reduced before prices will improve.

Social stability in these areas will require that people continue to work and produce, but at reduced wages, or at least in other positions that pay less. Oil industry veterans who lived through the 1970-1980 period will find this familiar.

Tracking growth

Over the longer term, a growing world population will absorb the agricultural supply excess. In fact, agricultural production has been able to keep apace with population growth such that production and consumption track each other very closely. New foodstuffs and genetically enhanced crops will likely continue to extend the current trend.

In large measure, the present situation is due to the ready availability of fertilizers. Excess fertilizer supplies are sufficient to sustain upward agricultural production to meet the needs of the growing population. Ready availability has, in part, also led to agricultural over-production. Every farmer wants to see large crop yields as validation of his efforts.

Metals

Industrial commodities are also in excess supply. Production of aluminum, copper, gold, iron and steel are all at record levels. This is a boon to the manufacturers. Their raw material costs are lowered, which allows them to earn a larger profit if they can find a market for finished goods. That is the problem, of course.

With the developing countries struggling financially, there are reduced markets for finished goods, except in the developed countries. Developed countries are absorbing their own excess capacity of finished products, as well as the output of under-developed countrires, and running deficits as a result.

There is a positive side. Ready access to inexpensive raw materials and reduced costs in developing lands also makes it easier to open new factories in those areas. We are seeing this happen as multinational corporations create joint ventures with existing firms in developing nations.

Production in these nations reduces the worldwide overhead to produce goods, adds liquidity to struggling local markets, and disperses new technologies and efficient work processes into the developing regions. The ultimate effect is to quicken the recovery and prepare them to compete better in the future.

Creative dispersion

Major technological development of human society has occurred in three major phases: hunter-gatherer, agricultural, and industrial. Each major advance led to optimization and dispersal of the former. Hunter-gatherer societies were optimized by the domestication of animals (herding). Agricultural economies were optimized after the "green revolution" of the 1960's, which spread new fertilizers, hybrid crops and farming techniques to developing countries. Industrial societies are now being optimized and dispersed worldwide, giving rise to global manufacturing systems and demand driven production.

The developed world is entering a new technological phase that revolves around high-speed communication systems and information transfer. This is driving costs down in the industrial sector and encouraging the dispersal of its systems to other parts of the world.

In the developed countries, industrial processes are being made more efficient and optimized to serve in-country markets. Ultimately, these enhancements will work themselves outward to developing nations. This will diversify developing economies, reduce sensitivity to commodity price swings, advance living standards, and increase energy use.

Oil's future - up

The basic human need for energy will continue to grow because of:

  • Increasing numbers of people
  • Increasing energy intensity per person
  • Increasing productivity (high-efficiency energy use).

One potential drag on this advancement is the future of oil supply. The industry is somewhere near the peak in world oil production according to many forecasters (a la the Hubbert Curve). The "Oil Age" will continue far into the next century and is the only economically viable source of liquid fuel to operate the world economy. It will remain so until the reserves of the Middle East are sufficiently depleted to constrain supply and open a price advantage for a new fuel source.

Growing world population, major growth in developing countries, and consumers seeking a better lifestyle will drive growing demand. This will be fueled by the advertising and film industries as the information age pushes more product choices on a wider population through expanded telecommunications and Internet connections.

The base load in the developed world will grow as well. There will be a continuing need for energy to fuel the optimized industrial economies and create new efficient industries in developing nations to meet both internal and growing global demand.

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In this expanding market for hydrocarbon-based energy, the offshore oil component will also grow. The oceans continue to hide major reserves and technology continues to expand the reach of exploration and production tools into deeper waters.

The newest drillships are designed to operate in 10,000-ft water depths and production technology is reaching deeper into new basins every year. When sights are raised above the daily turmoil, there is plenty of incentive to persevere and excel in the challenge of the world's growing future demand.

References

"Global Commodity Markets," The International Bank for Reconstruction and Development/World Bank, April 1999.

"East Asia - The Road to Recovery," The International Bank for Reconstruction and Development/World Bank, September 1998.

Source: Energy Capital & Power
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