August 4, 2013
Commodity Price Fluctuations
Commodity Price Fluctuations—Posner
Becker's discussion of natural resource price fluctuations presents a compelling picture of the role of demand and technology in the price of oil and natural gas. Similar fluctuations, with varied causes (though reducible generally to demand and supply changes), affect other natural resources as well. The fluctuations in the natural resources that Becker describes are relatively benign, and though often steep, are kept within tolerable levels by the competing effects of increased demand, which pushes prices up, and technological advances, which pushes them down by increasing the practical availability of the resources.
The fluctuations can however be socially or politically destabilizing, sometimes in unusual ways. A striking example is the rapid rise in gasoline prices (gasoline being itself a manufactured good, but the major component of its cost is of course oil) in the summer of 2008, peaking at $4.11 a gallon. The rise helped to blind the Federal Reserve to the impending financial crisis. Minutes of the Board's open market committee that summer reveal a preoccupation with the threat of inflation, of which the gasoline price rise was thought symptomatic, when in fact the danger to the economy was a nascent financial crisis having nothing to do with commodity prices.
But to understand the real danger to economic and political stability (and the economy and politics are closely entwined of course) that fluctuations in commodity prices can cause, we need to turn from natural resource commodities such as oil to agricultural commodities such as wheat. For the current instability in the Arab world, which has engulfed Tunisia, Egypt, Jordan, Lebanon, and Syria, appears to be traceable mainly to increases in the price of wheat and corn, though it is possible that those increases were triggers, affecting the timing of the political instability of those countries, rather than basic causes.
The Middle Eastern countries are large importers of wheat and corn, and to a lesser extent other grains. The prices of those commodities fluctuate a great deal. Between 2006 and 2008, the prices of these two grains rose by 136 percent and 125 percent respectively; the price of rice rose by more than 200 percent and the price of soybeans by more than 100 percent. The prices dipped in 2009 and 2010, as a result of the global depression touched off by the financial collapse of September 2008, but they spiked again in 2010; and the "Arab Spring" (an odd term for what seems unmitigated region-wide political disaster) ensued.
The cause of the price spikes that began in 2006 appears to have been a confluence of increased world population, increased per capita incomes in consuming nations, diversion of corn to the manufacture of ethanol, increased oil prices, and droughts. The effect on the Middle Eastern countries, where bread (made of course from grains) is the basic foodstuff, was dramatic. The governments of these countries subsidize bread, and had to increase the subsidies as the price of grains rose. But the governments have limited resources, so could not prevent the price to the consumer from rising, or shortgages if imports were reduced to save money.
The price increase was the last straw for the citizens of these countries. They had much to complain of anyway. But the idea that the protests that led to riots and the overthrow of governments and the civil war in Syria resulted from a yearning for democracy or from religious antipathies appears to be incorrect; or in any event the spark that triggered the conflagration was not political or religious discord but economic desperation. (There is by the way considerable grounds for doubting that these countries are ready for democracy.)
The irony is that agriculture is generally regarded as the poster child for the market allocation of goods, since agricultural commodities tend to be homogeneous and to be produced by very numerous independent producers, so that cartelization is infeasible and deception or confusion of consumers unlikely. Of course governments will not let well enough alone, so there is a great deal of regulation of agriculture; nevertheless the international market in agricultural commodities is highly competitive. But there does not seem to be any mechanism for smoothing price changes at the international level. In principle futures and forward contracts should enable prices of agricultural commodities to be smoothed over time, but these, though common in economically advanced countries, seem not to be employed by the nations that are most susceptible to political challenge—even to political disaster—as a result of fluctuations in the prices of agricultural commodities.
Technological Change and Natural Resource Prices-Becker
Natural resource prices increased rapidly during the first decade of this century, mainly propelled by rapid increases in world GDP, especially of the US, China, Brazil, and other fast developing countries. These prices then stabilized and many declined due to the world recession brought on by the financial crisis in 2008.
Some examples illustrate the magnitude of the price movements. Nominal copper prices quadrupled from 2001, despite a sharp fall in 2008, peaked around 2010, and declined by about 25% since that peak. Oil prices increased from $20 a barrel in 2002 to more than $140 a barrel in 2008, and have been in the range $100-$120 since then. Natural gas prices in most of the world increased several fold since 2000, and have been flat for the past couple of years. At the same time, natural gas prices in the US have fallen by more than 2/3 since their peak a few years ago.
These higher prices encouraged companies and consumers to economize on resource use. In the short run, however, both the demand and supply of oil and many other natural resources are only mildly responsive to higher or lower prices.
The long run picture is very different, for then opportunities to substitute away from the resources rising most in price are much greater because users have more time to adjust. For example, more permanent higher prices of gasoline induce consumers eventually to shift toward smaller more fuel-efficient cars, and drive less with the cars they have. They carpool more, make greater use of public transportation, or even take jobs nearer their homes. Cars are smaller and more efficient in Europe and Japan than in the US in good part because gasoline prices have been much lower in US.
Longer run adjustments on the supply side are also much larger, and some of them are game-changers. Although the world stocks of natural resources in the ground cannot be augmented since they were created by millions of years of evolution on the earth, the cost of getting these stocks out of the ground vary enormously: from the cheap and easily accessible oil just below the surface in Saudi Arabia to the difficult to access resources very far below ocean surfaces. Higher prices of a natural resource encourage extraction of more costly deposits, which increases the supply of that resource.
High prices also encourage investments in technologies to lower the costs of accessing various deposits that make them worthwhile to develop commercially. The most important example in recent years is the improvement in fracking methods used to extract oil and natural gas hidden in shale rocks. Wildcatters in the United States, like the recently deceased George Mitchell, spent years and much money, sometimes assisted by government support, in developing fracking to the point where it became commercially viable at the oil and gas prices prevailing during recent decades.
The success of fracking has resulted in a huge increase in American oil and especially natural gas production that greatly increased the American supply of these fossil fuels to produce gasoline, substitute for coal in electric power plants, and for many other purposes. Due to this revolutionary technology, American oil imports are at their lowest level in more than a decade, and natural gas prices in the US are now a fraction of what they are in Europe, Japan, and other gas importing countries.
The price of oil in the US remains close to the world price since oil continues to be imported. American oil commands the world price because it competes against imported oil at that price. Natural gas prices differ greatly among regions of the world because these prices depend on whether pipelines and liquefied gas facilities allow gas to be imported or exported. As I mentioned earlier, the widespread use of fracking techniques in the US has produced a huge fall in the domestic price of gas in this country.
Of course, companies that extract natural gas from shale would like to export some of their production to other countries to take advantage of higher prices there. Since such exports would raise gas prices in the US and lower them in the recipient countries, domestic users of cheap natural gas have organized to oppose its export elsewhere. Restrictions on gas exports would be unwise because the value received from the higher prices in other countries would exceed the value created by the artificially induced increase in American industrial output. It is poor policy to encourage domestic American industry through costly and inefficient methods like export restrictions.