Energy in the 21st Century - Commodity Markets

'Cheap resources underpinned economic growth for much of the 20th century. The 21st will be different'. http://www.mckinseyquarterly.com/A_new_era_for_commodities_2887?srid=520

Read the short article about the future for commodities to give you a better overview of the commodities market. You might need to register to read the full article, but if you don't want to register, I have posted up a summary below.

  · Research from McKinsey Quarterly shows that in the past eight years, prices have risen to levels not seen since the 1900s.

  · Price are very volatile – similar to that of the oil shock in the 1970s.

  · The future oil prices look set at remaining high and volatile because of two factors:

o Global supply is changing. If oil reserves begin to decline, prices will shoot up, until a factor such as new reserves being found, affects the price and they begin to drop.

o Inelastic supply. This means that OPEC for example, can charge high prices because they know that demand from Western countries particularly, will not decrease so much. To refresh your memory on elasticity, click here.

· Demand for energy, food, water and raw materials will rise exponentially as three billion new middle-class consumers will arise in the next 20 years.

o In India, calorie intake is predicted to rise by 20% within the next 20 years and per capita meat consumption is set to rise by 60%

o Demand for infrastructure will rise

  · Through the 20^th century, demand rose between 600-2000% for some commodities, however the reason prices did not rise so dramatically was due to improvements in exploration and extraction techniques enabling new reserves and sources to be found.

· Climate change and rising carbon emissions illustrates the rise in resource usage.

· For the future, outlook for supply increases in bleak because it is becoming harder to find new reserves of raw materials and freshwater in the short run.

o Supply is increasingly becoming inelastic in the future

o The marginal cost for resources is increasing as they are depleted faster and costs of extracting in unconventional methods/locations rise. For example, tar sands, the alternative to pure crude oil, requires separation from sand, using up more energy and water.

o In Uganda, water shortages have led to higher energy prices in a country already trying to develop. This has led to burning wood for energy à deforestation à soil degradation à food supplies fall.

·  A future solution includes trying to increase productivity from natural resources by, for example, improving mining recovery rates, making households more energy efficient (home insulation, solar panels…etc) and reusing wastewater.  

·  If you want to find out more, check out this live stream of the event ‘Resource Revolution: Meeting the World’s Energy, Water, Food and Material Needs’ that you catch watch on Thursday 24^th November through this link:

http://www.chathamhouse.org/livestream-mckinsey

Absolute and Comparative Advantage

Absolute Advantage

A country specialises in what it does best. It is technically and productively efficient at producing the good (after taking into account administrative and transport costs). This can be determined by natural factors such as land or climate. It is important to remember that when a country has absolute advantage, they must make sure that there is demand for the good/service they are providing, thus enabling trade to occur.

Comparative Advantage (CA)

A country has the lowest opportunity cost when producing the good. If a country wishes to increase production in one particular commodity, it must give up the least of the another commodity to have the CA. The CA is the case for free trade because it enables countries to trade.

A country that has an absolute advantage may not necessarily have the competitive advantage.

If countries specialise in activities which they possess a comparative advantage, they can trade their surpluses and the result will be gains in output and welfare.

Assumptions upon which the CA relies upon (and therefore assumptions which the case for free trade relies upon)

·     The country’s factors of production are fixed and factors can only be switched between industries (which means the country can change what they specialise in).

·     Finished goods are mobile between countries.

·     There are constant returns to scale. If this assumption were to be dropped, the country can experience decreasing returns to scale whereby increasing the scale of the factors of production leads to a less proportionate rise in output. This causes inefficiencies therefore the country cannot have the CA. If there are increasing returns to scale, the country is allocating more scarce resources to produce more output which compromises the production of other goods, leading to a greater opportunity cost. Also, in the long run, production can become unsustainable, for example, producing one single agricultural product (monoculture), can lead to soil erosion, vulnerability to pests and falling yields.

·     There are stable demand and cost conditions. If demand conditions were unstable or new technologies caused costs to change, the country would loose its comparative advantage because, again, inefficiencies will result.

Open Economy/Closed Economy

The table below shows the cases for an open economy.



Case Study: Iceland

·     Deregulation of the financial system in 2000 led to a large growth in Iceland’s banks.

·     Iceland’s economy is small and so the banks expanded overseas and began to export financial services which enabled them to accumulate a lot of wealth (assets).

·     Because of this, Iceland began to import many luxury goods to maintain high standards of living for the rich population (Iceland’s HDI was the highest in the world in 2008).

·     In the economic crisis, Iceland’s banks also owned toxic assets thus the country’s financial system crashed and the economy shrunk.

·     The exchange rate fell.

·     Unemployment rose.

·     This case study is an argument against free trade and therefore for import controls because deregulation led to overexposure to free trade and capital. It argues the case against an open economy.



Word of the Day

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Word of the Day: Competitive Advantage

Similar to absolute advantage, except you must remember not to confuse them! Competitive advantage is where a country/firm produces the good at lower costs, better prices and higher quality than it's rivals. A viruous circle is created:

See notes on absolute and comparative advantage for more details.