The economic consequences of rising commodity prices

20th July 2012

Sometimes we see that the latest economic data collides with what has happened since it was collected and this week and indeed today have been examples of this. We saw earlier this week the annual rate of official consumer inflation (CPI) in the UK fall back to 2.4% and today we have seen German producer price inflation fall by 0.4% in June compared to May reducing the annual rate to 1.6%. Unfortunately just as the official data looks better the outlook has taken a turn for the worse in the lead time that collection, collation and publication of the data takes.

The price of oil is back on an upwards march

The price of a barrel of Brent Crude Oil had declined substantially since its peak in the mid US $120s of March 2012. Indeed the fall had been rapid as the price declined by 15% in May alone and on the 21st of June we saw the price dip below US $90. This provoked hopes of an economic stimulus to the world economy based on lower inflation and that the oil importing nations would have more money to spend. In essence this drop has been captured by the inflation numbers that I highlighted above. There have been others too if we recall the drop in Chinese consumer inflation and the fact that she has disinflation in her producer prices as they fell outright in June.

However this more hopeful trend came to an end in late June and we have seen the oil price rise to just over US $107 per barrel. The price has so far risen by 10% in July alone. So many of the hoped for gains from a lower oil price have now been lost. We are not yet at red alert like we were in March but are now on a possible amber alert. As we review economic difficulties around the world over slowdowns in the US and China as well as outright contractions in parts of Europe we see that it has come at a bad time.

As to what has caused the rise I think we can be fairly sure that it was not rising demand! There is a certain irony in the rise happening just as the Harvard energy study informed us that we would have plenty of oil in 2020 and that the United States could be self-sufficient in 2030. You kind of get the idea from the title I think:

"THE UNPRECEDENTED UPSURGE OF OIL PRODUCTION CAPACITY AND WHAT IT MEANS FOR THE WORLD"

So keen was the author to get the message over that he used capitals too! And if we take a deeper look here is the core message:

"Contrary to what most people believe, oil supply capacity is growing worldwide at such an unprecedented level that it might outpace consumption. This could lead to a glut of overproduction and a steep dip in oil prices.

the net additional production capacity by 2020 could be 17.6 mbd, yielding a world oil production capacity of 110.6 mbd by that date – as shown in Figure 1. This would represent the most significant increase in any decade since the 1980s. (mbd is million barrels per day)"

As you can imagine this had the effect on the peak oil believers of pushing a stick into a nest of ants! They believe that we are in danger of exactly the reverse scenario as major oilfields such as in Saudi Arabia continue what they believe has and will be a steady decline.

There was also a welcome message for the home town readership:

"The most surprising factor of the global picture, however, is the explosion of the U.S. oil output.

Thanks to the technological revolution brought about by the combined use of horizontal drilling and hydraulic fracturing, the U.S. is now exploiting its huge and virtually untouched shale and tight oil fields."

It only missed out Mom and apple pie didn't it? Anyway the markets have not been convinced as the oil price has risen as I pointed out above. Actually there is more than just irony in that as I have long believed it is something in the human psyche in the timing of such events. Still the author shouldn't be too nervous as by (wisely) choosing a date in the distance it will likely be long forgotten if he is proven to be wrong.

Food prices are rising too

This is an event which causes concern beyond economics as rising food prices contributed to the Arab Spring of last year. The driving event here has been the weather and in particular that in the corn belt of the United States where according to the USDA this is happening:

"The U.S. Drought Monitor currently reports that 61 percent of the continental United States is in a moderate to exceptional drought"

And this has been the effect:

"Increasingly hot and dry conditions from California to Delaware have damaged or slowed the maturation of crops such as corn and soybeans, as well as pasture- and range-land"

Unfortunately for the US declaring a drought has not had the same effect that it had in the UK where we were soon left wondering where Noah's Ark was and if it was available for Olympic events.

Continue reading…

 

More on Mindful Money:

Rare earths – the elements of a new investor danger

America's Holy Grail: Achieving energy self-sufficiency

Gold – The Next LIBOR Scandal?

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