The consequences of living better and eating better

The big grab for resources is underway - and prices are skyrocketing

Urbanization and consumerism are increasing demand for… well, everything

Let’s take a moment to say goodbye to the world of cheap energy and cheap raw materials that we have known and loved over the past couple of generations.  Although there will be the usual ups and downs along the way, the overall trend line over the next 11 years will be one of steadily rising commodity and energy prices.

In the good old days, commodity prices were mainly determined by supply issues and constraints.  What affected prices were such things as harvests and hurricanes, wars and work stoppages – events that had an impact on the supply of the raw material in question, or at least on the reliability of its distribution. A few years ago, to use oil as an example, OPEC could turn the “supply tap” on or off, controlling oil prices fairly closely.

Supply constraints and disruptions are still important, but they have been overshadowed by the sheer power of demand to bid prices higher.

 

“The next billion” is fueling demand…

This demand is largely the result of the emergence of a new middle class in the developing world, soon comprising about one billion people worldwide.  India alone is expecting a dramatic surge in the size of its middle class, from 5% of its total population in 2005 to 41% in 2025 – an increase of 550 million new consumers, according to a 2007 article in The Hindustan Times.

Increased urbanization and increased consumerism will be the twin motors behind rising commodity prices for many years to come.

Urbanization means greater demand for infrastructure and housing, while consumerism means more demand for durable goods such as cars, refrigerators, TVs and the many other energy-consuming appliances that Western households have taken for granted for years.  Producing more of this infrastructure and all the goodies demanded by the newly affluent will require more steel, more copper, more rubber, more timber, more cement… and of course, more energy.

Take cars, for example.  China recently overtook Japan to become the world’s second largest market for new cars after the USA.  In the next 11 years, the number of privately owned cars on the road in China is forecasted to increase almost sixfold, from 25 to 140 million.  In Thomas Friedman’s book The World is Flat, he notes that in Beijing alone, 30,000 new cars were being added to the roads a month – one thousand every day.  Obviously, with more cars comes demand for more gasoline.

 

… but supply is not keeping pace

Meanwhile, production of base metals is not keeping pace with global demand. Although there are some exceptions to this gloomy outlook, the main reasons why we can expect a long-term supply crunch can be summed up as follows:

  • lack of current supply due to years of underinvestment;
  • shortage of projects and a skills shortage to build them;
  • falling grades/production; lower quality;
  • higher costs and delays;

According to UBS, grades for many mined materials, for example copper and iron ore, are falling. Meanwhile, the mining operations that extract these materials are becoming more geo­logically challenging, as they must go deeper underground than before. What’s more, compared to today, future mines are likely to be located in remote, higher-risk countries such as Congo or Russia.

The United Nations foresees that within a few years, countries will go to war with each other over access to scarce natural resources. Always keen to justify its existence, the UN is determined to save the day if that should happen, with a specially formed peacekeeping force, the greenhelmets!

As far as oil is concerned, many observers think a price tag of $200 a barrel is a realistic possibility in the next five years, so I don’t think I’m sticking my neck out by saying that an even higher price is imaginable 11 years from now.

But even at $200, there will still be too much demand and/or too little supply.  What could be the consequences of such a situation?  Three or four main scenarios come to mind (all of which could occur, by the way):

  • Gasoline rationing, either by official fiat or simply market-driven (i.e. financially less well-off consumers no longer being able to afford to fill their tanks).  This would almost certainly reduce demand for thirsty cars, which would in turn have an impact on the automotive industry: the 1970s all over again.  Maybe this time with some class-warfare elements, as the “have-nots” get very annoyed at the “haves” who can still afford their gas-guzzling SUVs.
  • Higher inflation, as increased energy costs are passed on to consumers in higher prices for a wide range of goods (including food) and services.  Travel and tourism would be especially hard hit, as would any industry whose production costs contained a substantial transportation component.
  • A political consensus to do what it takes to increase the supply of oil, e.g. by open­ing environmentally protected areas to drilling, and/or bring alternative energy sources onstream much quicker, for example by returning to nuclear power (or is this a dead issue once and for all, thanks to the Japanese tsunami of March 2011?), or massively gearing up renewable alternatives - biofuels, solar, wind, wave energy, etc. - even at the cost of enormous subsidies.
  • Increased political tensions between countries producing oil and those consuming it.

Meanwhile, China will probably become the driving force behind the production of electric cars. The country’s burgeoning demand for more cars, coupled with the realization that a very high price of gasoline at the pump could threaten economic growth and stability, will focus minds and innovative energy in China to mass-produce inexpensive battery-powered cars. These cars will then become one of China’s most successful exports, although some markets such as the USA will probably not be interested in the entire car but will import the battery technology instead.

We’re hungry!

The “next billion” also want to eat better.  Rising incomes mean changing diets, especially more meat consumption.  Total meat consumption 11 years from now will be about 65% higher than it was in 1993.

 

 

Total meat consumption (in million tons)

 

 

1983

1993

2020

Developing world

50

88

188

Developed world

88

97

115

Total

139

184

303

Source: FAO

To meet this demand, world agricultural production needs to increase.  But that won’t be easy, for several reasons:

  • Biofuel production (thanks entirely to misplaced political incentives) has shifted a good-sized portion of the world’s agricultural commodities out of the food chain and into energy production. In the USA, for example, the amount of the corn crop that went into ethanol production in 2010 surpassed the amount going to animal feed for the first time.
  • Urbanization has reduced available acreage in many countries, and the amount of arable land per capita is dropping.
  • Although more land needs to come onstream, quality of the land is a critical issue.  If that quality is not high, agricultural yields may be lower.
  • Fertilizer supplies are also a factor in production, and they remain tight. Demand – and prices – are on the rise.
  • Meanwhile, the politicization of agricultural markets will continue. Rice is a good example. Panic over high prices in 2007-8 led some countries (for example India, Thailand, Japan, Indonesia, Vietnam and China) to restrict exports in an attempt to counter domestic inflation and ease potential unrest over shortages. Together with modest supply growth, all this accomplished was to tighten the fundamentals further and drive global prices even higher.

The combination of all these factors has pushed food prices higher.  For you and me, this is an inconvenience.  But for the hundreds of millions of people in the world who already spend most of their disposable income on food, this is a disaster.

It’s also a disaster for the governments in these parts of the world, because food shortages cause instability.  Food price inflation was a factor in the unrest that ultimately led to the recent revolutions in Tunisia and Egypt, for example.

Should food prices continue to climb, particularly in the developing world, we may see calls for inter­vention in the markets on humanitarian grounds – and this will result in more artificially induced price distortion, although potentially we will also see less human suffering.  The problem is, once you start circumventing market forces, can you ever stop?  Where does this end, politically speaking?

Meanwhile, here’s one possible solution: 11 years from  now, we will eat more bugs!

 

China: Gimme gimme gimme!

As in so many of these “11 Changes” essays, the player to watch over the next 11 years will be China.  China’s galloping economic growth, coupled with rapid urbanization (by 2025, China’s urban population will grow by nearly 300 million people) mean that the country’s ravenous hunger for building materials, energy, food, and consumer goods will only continue.  To put it bluntly: China is going to gobble up the lion’s share of the world’s basic raw materials.

To take food as an example, China's changing eating habits mean that the country is bumping up against limits to its agricultural productivity.  Once self-sufficient in soybean production, China now imports 75% of its needs. Wheat will probably be the next commodity that China will have to import, followed by corn and rice.  Consumption of dairy products is growing rapidly there as well, and the country plans to meet increased demand by adding millions of cows to the country's dairy herds. These cows will have to be fed, increasing demand for their feeds.  The result: over the next 11 years, world food prices will continue to be pushed higher, without a doubt.

Looking at building materials, China already consumes one quarter of the world's copper, compared with one tenth a decade ago, according to Barclays Capital.  It accounts for more than 90% of the global growth in demand for aluminum.  It also accounts for about 10% of global oil demand, up from just 3% twenty years ago.

In fact, China’s appetite for these commodities is so huge that the country’s foreign policy is largely dominated by its relentless need to secure supplies of oil and other natural resources.  China’s president recently went on a natural resources shopping safari across the continent of Africa, resulting in a 45% stake in a Nigerian offshore oil block and a deal to mine up to $12 billion of copper ore in Congo – a sum which happens to be more than three times Congo’s annual budget.

11 Changes - China: Gimme

China is also investing in oil explora­tion and mining opportunities in Canada, Venezuela and Peru, and sugar refining in Australia.  It lends money to Russia and Brazil in exchange for commodities it needs.

So far, China has bought the raw materials it needs.  But could it simply take them?  As I mentioned here, I believe that in the next 11 years, we may see the map of Asia redrawn as China takes control over parts of Siberia, which it has already been exploiting for some time.  (Incidentally, both Mao and Deng Xiaoping claimed publicly that Vladivostok and Khabarovsk were actually Chinese cities.)

China is also playing hardball with one of the natural resources it actually controls within its own borders, namely various rare earth elements.  These materials – scandium, yttrium and lanthanum, plus 14 other so-called lanthanides – are essential in the production of various high-tech products such as flat-screen TVs, lightweight electric motors, catalysts and rechargeable batteries for cars, as well as in many military applications.  China supplies a whopping 97% of the world’s demand for these strategically important metals.  Just recently, China decided to cut its rare earth exports, which assures that many manufacturers outside China who need these materials will no longer have access to metals exported from China and will have to turn to existing stockpiles.  The problem is that these stockpiles are not huge and are calculated to run out, worldwide, in about a year.  In the words of The Economist, “The result has been panic throughout industrial countries.”

The upshot of all this: in the next 11 years, if China’s economic growth continues (and there are some reasons to think it may not), the country’s relentless hunger for raw materials and agricultural commodities will push world prices higher and higher.  There can be no doubt that this will have an impact on all of us.

 

© 2011 Wade & Co. SA

 

(Parts of this essay have been adapted from “Commodity Trading: A critical look at trends and cycles”, a report I wrote for the series UBS Outlook in 2008.)