Shifting Commodity Markets in a Globalized World

Rabah Arezki, and Akito Matsumoto

• Publisher: INTERNATIONAL MONETARY FUND
• Year: 2017
• eBook ISBN: 9781484310328

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Chapter 1. Introduction

The chapters in this book were prepared by the Commodities Unit of the Research Department of the IMF between 2014 and 2017, a period of great upheaval for global commodity markets. Individual chapters track developments and prospects for energy, metals, and food markets since the early 2000s, the start of what is termed a “commodities supercycle”—the rise of commodity prices over a decade or more as a result of a rapid urbanization and an expansion of infrastructure. The recent commodities supercycle coincides with the growth of large emerging market economies, specifically China and India. This book examines the complex and intertwined set of forces that affect various commodity markets and the complex interplay between these market forces and the broader global economy. Instead of focusing on short-term developments and their immediate causes, this analysis takes a longer view. It examines the relative importance of technology, geography, demography, and policy in each of these commodity markets and how their interplay sends price signals to producers and consumers, who in turn adjust their behavior.

Technology

Macroeconomists often assume that technological innovation is exogenous (driven largely by external factors or forces), but this volume documents how innovation in energy markets is directly affected by prices. When oil, natural gas, or fossil fuels become scarce, prices increase. This stimulates innovation and the adoption of new technologies and techniques for recovery and use of these resources. Conversely, when these commodities are abundant, prices fall, slowing the pace of innovation and the adoption of new techniques. Deepwater extraction and high-efficiency vehicles are innovations developed during periods of high oil prices, as outlined in Chapter 2. Chapter 3 describes how the development of hydraulic fracturing for the recovery of natural gas from shale rock formations led to significant declines in the natural gas prices and a corresponding increase in the use of natural gas in manufacturing and power generation. Chapter 4 describes how a decline in fossil fuel prices led to an increase in the number of coal-fired power plants in Europe and increased the sale of gas-guzzling vehicles.

Geography

At the heart of international trade in commodities are cross-country differences in resource endowments. Natural resources are materials or substances that occur in nature and can be used for economic gain, and so these include not only reserves of hydrocarbons, minerals, fisheries, and forests, but also temperate weather, fertile land, and access to water, which are important to agriculture.

A given country’s geology and natural resources are largely predetermined, but its ability to exploit its endowments depends on institutional factors. The discovery of major mineral deposits in Latin America and sub-Saharan Africa in recent decades occurred following the liberalization of these economies.

This volume documents that the geography of trade in commodities has evolved as a result of shifts in both supply and demand. On the supply side, Chapter 5 documents how the supply of metals has shifted in recent years from the northern hemisphere (primarily advanced economies) to the southern hemisphere (largely emerging markets) with the depletion of longstanding reserves and the opening of potential new resources for exploration. On the demand side, the rise of large emerging markets has contributed to a rapid increase in global consumption that helped set off the recent commodities supercycle and shift demand for commodities from the western hemisphere and Europe to Asia.

Demography

The size and demographic structure of a country’s population are closely linked to its pace of economic development. And economic development, in turn, affects the size and structure of the population—in general to reduce family size and increase the share of older people in the total population. This demographic transition also translates into changes in the geographic distribution of a country’s population, with people migrating from rural to urban areas. These demographic and economic transitions obviously have important implications for the structure of agriculture and the demand for food products, but they also influence demand for metals and energy because of changes in the demand for housing and transportation services. Chapter 6 explores the implications of demography and urbanization for global food markets and food security.

Policy

Policies and regulations, including those designed to address environmental concerns and achieve food or energy security, may either counteract or exacerbate market forces, and they play a key role in commodity markets. One example from the energy market is the explosion of shale oil production in the United States, which was the result of a regulatory shock in the United States. Specifically, the Energy Policy Act of 2005 exempted the chemicals used in hydraulic fracturing from safe drinking water standards. This coincided with a period of high oil prices, driven by the rapid increase in demand from large emerging market economies, which helped spur innovation in hydraulic fracturing techniques as described in Chapter 3.

Trade policy instruments such as export and import tariffs, subsidies, and quotas have significant effects on global food markets and serious distributional consequences for consumers. Food has been a longstanding sticking point in trade negotiations, despite the fact that food represents a relatively small share of global trade. Tariff and nontariff barriers to trade in agricultural commodities are often motivated by concerns over food sovereignty (that is, preserving domestic production capabilities for key foodstuffs) and protecting the well-being of domestic farmers. All countries continue to have a strong anti-trade bias in the structure of assistance to their agricultural sector, and there are multifaceted distortions to global food markets as described in Chapter 6.

Part I: Energy Markets

Chapter 2. Technology and Unconventional Sources in the Global Oil Market

Technological factors played an important role in the collapse of oil prices that started in June 2014. Macroeconomists often assume that technological innovation results from independent, external forces (is exogenous), but in oil markets innovation is driven by prices. Indeed, high oil prices prompted breakthroughs in technology in extractive industries and led to the emergence of new sources known as “unconventional oil.” Shale oil in particular has important consequences for the oil market outlook in that it not only significantly increases supply but also contributes to more limited and shorter production and price cycles.

Technology has transformed the oil market in powerful ways. Technological innovation and the subsequent adoption of new recovery techniques—including for drilling and processing—have given rise to new sources known as “unconventional oil.” One recent example is shale oil (also known as tight oil), which has become a major contributor to global oil supply. Provided they are effective and widely adopted, improvements in recovery techniques mechanically increase the size of technically recoverable oil reserves. This increase, in turn, changes the outlook for oil supply—with potentially large and immediate implications for oil prices—by changing expectations about the future path of oil production. Increased supply lowers oil prices, but even if this has the effect of reducing investment and hence production, the industry is nonetheless forced to become more efficient, unleashing automatic stabilization forces.

Innovation in recovery techniques typically follows periods of prolonged high prices or changes in regulations that render new techniques more economical. New oil sources often come onstream in times of need—because of, say, the depletion of existing conventional sources—and in places that have economic and institutional systems more favorable to both innovation and the adoption of new recovery techniques. Innovation has led to significant improvements in drilling techniques in particular. The advent of hydraulic fracturing and directional (non-vertical) drilling gave rise to the production of shale oil in the 2000s by allowing for the capture of oil trapped within layers of rock. In the wake of the two oil crises of the 1970s, which dramatically increased oil prices, successive improvements in techniques for deepwater drilling spurred production in the North Sea and the Gulf of Mexico. In both these examples innovation opened new oil sources from relatively high-cost producers and gave rise to tensions with the lower-cost producers from the Organization of Petroleum Exporting Countries (OPEC), who in the 1980s and again more recently responded by strategically moderating their production levels.

This chapter addresses four questions about the role of technology and unconventional oil sources in the global oil market:¹

• What constitute unconventional oil sources?
• Where are the production and reserve centers?
• How have investment and production evolved?
• What lies ahead?

What Constitute Unconventional Oil Sources?

Today’s unconventional oil sources are extra-heavy oil extracted from oil sands, shale (or tight) oil, and ultra-deepwater oil.² Unconventional oil is typically more difficult and more expensive to extract and process than conventional oil. The categorization is, of course, time specific because the sources of oil evolve along with improvements in recovery techniques. “Conventional oil” used to refer only to light crude that was easily captured by tapping into a reservoir. But the term now often applies also to heavy oil and deepwater oil, which were once considered unconventional. To give a historical perspective on how “new” oil sources have contributed to the evolution and transformation of the oil market, this chapter adopts a broad, all-encompassing definition of unconventional sources, including those no longer considered unconventional (such as heavy and deepwater oil).

• Oil sands are either loose sands or partially consolidated sandstone containing a naturally occurring mixture of sand, clay, and water saturated with a dense and extremely viscous form of petroleum referred to technically as bitumen and colloquially as tar because of its superficially similar appearance. Heavy and extra-heavy oil are characterized by high viscosity, high density, and high concentrations of nitrogen, oxygen, sulfur, and heavy metals. These characteristics raise the costs of extraction, transportation, and refining. Despite the cost and technical difficulties, major oil corporations regard these resources as providing reliable long-term flows of liquid hydrocarbons with substantial payoffs for any incremental improvements in recovery. However, there are environmental concerns about potential damage from extracting and refining these new oil sources, which have often been met with specific safety regulations and standards meant to help limit the risks.
• Shale oil (a...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Preface
• 1 | Introduction
• Part 1. Energy Markets
• Part 2. Metal and Food Markets
• Bibliography
• Index
• Footnotes