Oil and Mineral Commodities,
and the Financial Crisis
30 March 2009
Olle Östensson
Outline
• 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
500
450
400
350
300
250
200
150
100
50
Price Index - All groups (current dollars terms)
Food
Tropical beverages
Vegetable oilseeds and oils
Agricultural Raw Materials
Minerals, ores and metals
Crude petroleum*
07.2008
01.2008
07.2007
01.2007
07.2006
01.2006
07.2005
01.2005
07.2004
01.2004
07.2003
01.2003
07.2002
01.2002
07.2001
01.2001
07.2000
01.2000
07.1999
01.1999
07.1998
01.1998
07.1997
01.1997
0
Nominal
Source: UNCTAD Commodity Price Bulletin
Real
2Q2007
1Q2005
4Q2002
3Q2000
2Q1998
1Q1996
4Q1993
3Q1991
2Q1989
1Q1987
4Q1984
3Q1982
2Q1980
1Q1978
4Q1975
3Q1973
2Q1971
1Q1969
4Q1966
3Q1964
2Q1962
1Q1960
Crude oil prices 1960 to mid-2008,
US$/barrel
140
120
100
80
60
40
20
-
Reasons for the price increase
• Demand
– Two years – 2003 and 2004 – with above trend increases
– Geographical differences
– Expectations
• Supply
– Slow capacity expansion
– Low spare capacity, concentrated in one place
– Inventories
• Supply-demand imbalances and price spikes in
commodity markets
• Other factors
– US$ depreciation
– Mismatch of refinery capacity
– Speculation?
Global oil demand, change on
previous year, %
5
4
3
2
1
0
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-1
-2
Source: International Energy Agency, Oil Market Report, various issues
Shares of increase in global oil
demand 2001-2007, %
Large share for China, Middle East and
Other Asia – but also for North America
13%
21%
North America
2%
19%
Europe
Other Asia
China
19%
Middle East
Others
26%
Source: International Energy Agency, Oil Market Report
Energy intensity, metric tons oil equivalent per
thousand US$ in nominal and PPP 2000
exchange rates
2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
US$ 2000
OECD
Middle
East
ExUSSR
US$ 2000 PPP
China
Source: International Energy Agency
Asia
Africa
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
700.0
600.0
500.0
China
India
400.0
300.0
Japan
Republic of Korea
USA
200.0
100.0
19
65
19
68
19
71
19
74
19
77
19
80
19
83
19
86
19
89
19
92
19
95
19
98
20
01
20
04
20
07
0.0
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
Production costs, conventional oil
Source: US Energy Information Administration
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 nonOPEC supply growth have been too
optimistic in recent years
2.0
Million Barrels Per Day
1.8
Estimate 1 year
ahead
1.6
Estimate end of
current year
1.4
1.2
1.0
0.8
0.6
0.4
?
0.2
0.0
2003
2004
2005
Sources: December editions of IEA’s Oil Market Report.
2006
2007
2008
Summary of factors
10
OECD Days Supply
120
8
World Excess Production Capacity (right axis)
janv.09
janv.08
janv.07
janv.06
janv.05
janv.04
janv.03
janv.02
0
janv.01
0
janv.00
2
janv.99
30
janv.98
4
janv.97
60
janv.96
6
janv.95
90
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.
Million Barrels per Day
WTI Spot ($2008)
janv.94
$2008 Dollars Per Barrel/Days
Supply
150
Other factors
• US$ 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
A. JUNE 2008 VS. JANUARY 2002
(Percentage change)
Aluminium
Zinc
Maize
Lead
Nickel
Silver
Copper
Tin
Crude petroleum
Rice
Iron ore
Cobalt
Manganese
Cadmium
Rhodium
0
50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 800 850 900 950
B. DECEMBER 2008 VS. JUNE 2008
(Percentage change)
Crude petroleum
Copper
Nickel
Aluminium
Tin
Lead
Maize
Zinc
Silver
Rhodium
Cadmium
Cobalt
Rice
Iron ore
Manganese
-100
-90
-80
-70
-60
-50
-40
-30
-20
-10
Exchange-traded commodities
Commodities either not traded on commodity exchanges or not
included in the major commodity indices
0
10
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
1996-2001
Zi
nc
Le
ad
or
e
Iro
n
op
pe
r
2002-2007
C
Al
um
in
iu
m
9
8
7
6
5
4
3
2
1
0
The main factor: China
Surplus or deficit (-) of global production
over usage for lead and zinc, 1996-2007, per
cent of production
5
4
3
2
1
Lead
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
-1
-2
-3
-4
-5
Zinc
Average quarterly prices and end of quarter
inventories (LME) of lead and zinc, % of 4th
quarter 2003 prices and end 2003 inventories
500
450
400
350
300
250
200
150
100
50
4Q
2
1Q 003
2
2Q 004
2
3Q 00
20 4
4Q 04
2
1Q 004
2
2Q 005
2
3Q 005
2
4Q 00
20 5
1Q 05
2
2Q 006
2
3Q 006
2
4Q 006
2
1Q 00
20 6
2Q 07
2
3Q 007
2
4Q 007
2
1Q 007
2
2Q 00
20 8
3Q 08
20
08
0
Lead stocks
Zinc stocks
Lead prices
Zinc prices
Iron ore prices, US$/ton
250
200
Spot price, mid-point of
range
150
Hamersley fines, cfr
China
100
Carajas fines, cfr China
50
11.11.2008
11.07.2008
11.03.2008
11.11.2007
11.07.2007
11.03.2007
11.11.2006
11.07.2006
11.03.2006
11.11.2005
11.07.2005
11.03.2005
0
Sources: UNCTAD Iron Ore Trust Fund, TEX Report, Metal Bulletin
Freight rates reflected the overall boom
Example: Iron ore freight rates, 1999-2008, US$/ton
120
100
80
Brazil-China
60
40
20
Australia-China
Sources: Drewry, SSY
Jul
janv.08
Jul
janv.07
Jul
janv.06
Jul
janv.05
Jul
janv.04
Jul
janv.03
Jul
janv.02
Jul
janv.01
Jul
janv.00
Jul
janv.99
0
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
ru
ar
-10
-15
-20
-25
-30
ly
ne
Ju
Ju
ril
ay
M
Ap
ch
08
ar
20
M
y
-5
Au
gu
Se
st
pt
em
be
r
O
ct
ob
er
N
ov
em
be
D
r
ec
em
Ja
be
nu
r
ar
y
20
09
Fe
b
Monthly world crude steel
production, % change year-on-year
10
5
0
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
200.0
180.0
160.0
140.0
120.0
100.0
Oil exporters
Exporters of minerals and
mining products
80.0
Exporters of agricultural
products
60.0
Exporters of
manufactures
40.0
20.0
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
0.0
Source: UNCTAD, Trade and Development Report, 2008
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
thought
Average 2008 and December 2008 (2000=100)
450.0
400.0
350.0
300.0
250.0
200.0
150.0
100.0
50.0
0.0
Average 2008
Crude
petroleum
Copper
Aluminium
Rubber
Cotton
Palm oil
Coffee
Sugar
Rice
Wheat
All
commodities
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 term
1. 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 term
2. 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?
Thank you!