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

The Economic Cycle

The Economic Cycle

Also known as the business cycle, it shows how the economy fluctuates above and below its trend rate of growth.

When the economy is performing above its trend rate of growth, there is a positive output gap. During a positive output gap, the economy is in a boom whereby growth is high and unemployment is low.

When the economy is producing below its trend rate of growth, there is a negative output gap. The economy is said to be in a recession where growth is very low or even negative, along with high unemployment.

Reasons for these fluctuations

There are many theories devised to help explain fluctuations in the economic cycle. In the exam, it is important to prioritise your arguments, thus I have ordered the following according to my opinion, of course you may think otherwise:

1. Outside shocks

Outside shocks can be classified by demand shocks and supply shocks. Demand shocks affect AD in the economy, and can lead to a recession or downturn. For example, e-coli in German cucumbers supposedly sourcing from Spain led to AD for Spanish (and other European grown) vegetables, see article, to fall (from Russia in particular). 

A supply side shock affects AS within the economy. Examples include conflict in the Middle East affecting oil supplies and the Japanese earthquake affecting supply chains of manufactured goods, see article. Other evidence for this is, if you take a look at this website, you will see that Japan is currently experiencing negative growth, due to the earthquake.

2. Speculative bubbles

Rapid growth of asset prices (gold, property, shares…) leads to a bubble because people will speculate that the price will continue to rise and buy the asset. When the price is above the real value of the asset, people will start to sell and the bubble bursts. Speculation can destroy business and consumer confidence. People will stop spending, leading to a recession. This contributed to the UK recession (2008) when house prices plummeted, see article.

3. Changes in technology on the supply side of the economy

Technical progress can increase the rate of growth of total factor productivity (TFP). A change in TFP measures the change in total output when all the factors of production are changed in the economic long run. Technical progress measures how much more productive the factors of production have become over a period of time. Technology has inevitably increased the rate of economic growth in some developing countries where it is much needed, e.g. mobile phones in Uganda, and it has also led to the growth of developed countries thus creating the world’s most powerful economies, e.g. Japan.

4. Changes in inventory

Firms invest in stocks of raw materials and finished goods to smooth production and cope with changes to demand. However sometimes firms can over-anticipate demand leading to unsold stock, which can lead to a cut in current production and a slow down in the economy. Recessions in the UK and USA are made worse due to changes in inventory.

5. Political business cycle theory

Governments tend to cut taxes or implement new policies to give people more money before elections as a way a ‘buy votes’. People have more money, thus increasing spending leading to a boom period. After the election, governments deflate aggregate demand to prevent the economy from over-heating.

6. The multiplier and the accelerator

An increase in investment increases AD and leads to an increase in national income. This is known as the multiplier. Higher income leads to more investment (increasing AS), known as the accelerator. The extent to which the multiplier increases AD is down to:

a)     The marginal tax rate

b)    Marginal propensity to import

c)     Savings

Therefore this isn’t top in my list because, for the UK, the multiplier is not large since all of the above are reasonably large (the multiplier is calculated by 1 divided by the above). If the values for all of the above are high, there will be lower investment.

7. Climatic factors

El Nino/La Nina and sun spots (or lack of) can create extreme conditions resulting in   changes to harvest, affecting the agriculture market. The price of the grain and the quality of food can be damaged, leading to a fall in output in the producer country. This can lead to a fall in business confidence and thus a recession. El Nino Southern Oscillation is an event that occurs every 2 to 7 years and last 1 to 2 years. Cold water is suppressed in the Pacific Ocean, causing warm, dry weather over Southern Asia (India, Philippines…) and Oceania (Australia, New Zealand…) and increased rainfall over the America’s. El Nino can also affect the fishing industry. Sun spots can increase surface temperatures, causing warmer and drier weather.