As the world economy hurtles
into its worst recession in over a generation, output and
commodity prices are being dragged inexorably down too.
The super-cycle, which saw oil prices surge in recent years,
was driven by a combination of factors, including responses to
global growth prospects. But it was amplified in part by the
role of financial investors, as commodity derivates emerged as
an alternative asset class.
The subsequent global deleveraging combined with the
unexpectedly sharp deterioration in global economic forecasts
has led to the precipitous fall in commodity
Demand from emerging markets, particularly China, in many ways
also underpinned the preceding era of high prices. But when
growth collapsed, commodities were left exposed. The resulting
correction has forced oil prices down to less than $40/barrel,
while other commodities have also come crashing back to earth.
It has also come as a seismic shock to the industry and
commodity exporters alike.
To many, the era of abundance has ended in tears. The
combination of high oil prices and high leverage has proved a
dangerous one for the global economy, says Merrill Lynch
in a research report.
According to Paul Horsnell, head of commodities research at
Barclays Capital, there may be numerous factors at play
not simply one cycle but rather several cycles progressing at
While energy prices have probably bottomed,
Horsnell believes base metal prices may experience further
weakness and will be the last in the cycle to
recover. In contrast, he notes that precious metals
are generally pretty strong while agricultural
commodities have a much shorter cycle and so could even
shift higher through 2009. There is no common thread that
runs right the way through commodities as a whole, he
Nevertheless, the magnitude of the global economic slump is now
so severe that commodity prices may remain depressed for the
medium term, after many years of robust demand increases.
In a recent report the Organization of the Petroleum Exporting
Countries (Opec) predicts further pressure on prices as global
recession reduces demand for energy.With continued
economic deterioration and demand erosion as well as the
impending low demand season, there is likelihood of renewed
pressure on prices.
Yet the return of wild swings in the longer term cannot be
ruled out, according to some economists. The cyclical downturn
in energy prices is pushing investment out of the sector at a
time when global oilfield decline rates are accelerating.
Indeed, price volatility has already made a comeback:
commodities surged mid-March after the US Federal Reserve
announced plans to buy $300 billion of US government debt.
Investors switched into commodities as a hedge against the risk
of higher inflation.
While commodity investors by and large dont assume a
return of the super-cycle any time soon as structural
factors in the global economy still point to a long period of
healing many experts believe asset demand could rebound
sharply in the medium term, against a backdrop of limited
The cycle will start again, argue Ricardo
Caballero, Emmanuel Farhi and Pierre-Olivier Gourinchas in a
recent survey issued by the National Bureau of Economic
Research (NBER), a Cambridge, Massachusetts-based research
The world economy entered the crisis with a chronic
excess demand for financial assets. The sharp rise in oil
prices following the subprime crisis nearly 100% in just
a matter of months and in the face of recessionary shocks
was the result of a speculative response to the
financial crisis itself, in an attempt to rebuild asset
supply, say the economists from MIT, Harvard and
If and when economic conditions improve and real conditions
recover, asset demand is likely to rise back, recreating
the chronic shortage of assets, and the cycle will start
again. Regulation, they say, will be hard-pressed to
contain market forces.
Still, the consensus view is that there will be no return to
the super-cycle any time soon.
We think it is over definitely, for a couple of
years, says Ruchir Kadakia, associate director at the
Cambridge Energy Research Associates (Cera) Global Oil
Group. If you go back and look at history, the periods
when you had the greatest spikes in oil demand is when you had
spare capacity. And that is not much the case anymore.
It is going to take a number of years to erode all this
excess spare capacity, and that alone is going to make it very
difficult to get back oil prices to the $150 range, says
Kadakia, who argues that we are now in the middle of the
Oil prices will probably bottom out this year, but the
key question is: will we go sideways for a number of years or
do we recover? he asks.
There is no longer room for complacency as prospects for the
global economy look increasingly gloomy, and GDP forecasts are
repeatedly revised downwards.
Global oil demand is expected to fall further this year by over
1 million barrels per day (b/d) as the global economic crisis
undermines consumption and investments in new oilfields. Both
Opec, which has withdrawn over 4 million b/d from the market,
and the Paris-based International Energy Agency (IEA) assess
global demand at around 84.5 million b/d.
Morgan Stanley is even more bearish. The magnitude of
weakness plaguing emerging market economies champions of
oil demand growth since 2000 together with continued
weakness in OECD economies leads to our belief that oil demand
will fall by 1.5 million b/d in 2009, says the
banks head of commodities research Hussein
But in the 1979 oil price shock, demand shrank by 2.5 million
b/d in the first year, and then fell for another two years.
That alone suggests the effects of this recession are still to
Yet this does not mean that the world economy is now spared the
challenges that emerged during last summers fuel and food
crisis, which saw prices spike to record highs.
Horsnell notes that the threat of a major energy crisis has
hardly subsided and could lurch back when the global economy
recovers especially as non-Opec supply has been
declining steadily. In retrospect, 2008 can just be
looked back on as a kind of early warning signal, he
says. I dont think the energy problem is over. It
could rebound quite dramatically in the course of the next five
to 10 years.
He argues that a lot of very dangerous things are
happening at the moment as policy-makers make assumptions
based on low prices, companies tear up investment plans and
alternative energy investment falls off a cliff. We are
taking precisely the actions that are likely to lead through to
a full-blooded energy crisis in the next few years, he
The current decline in capital expenditure is critical. Last
years sharp price swings demonstrated that the global
economy could not maintain its previously robust growth given
the existing energy mix, says Horsnell. It was
impossible; it could not happen.
The solution, he says, is proper investment across the energy
spectrum, but instead where we are heading is [towards]
less investment in oil, less investment in alternative
energies, less investment in research and technology at
precisely the time in the cycle when 2008 really told us we
should do more of that.
In terms of a major energy crisis, last year was just a
small appetizer for what might happen, he warns.
Both Merrill Lynch and Barclays Capital have pointed to the
risks of a return to great volatility. It is all a matter
of policy choices of what the world wants. If it wants $40 a
barrel of oil now, that means $150 sometimes again further down
the path, and it does mean a more serious energy crisis,
Any rebound in global activity growth will likely be felt
in commodities first, according to Merrill Lynch. In a
report, the research team led by Francisco Blanch nonetheless
points to the risk of a crisis in one or more feeble
emerging markets and the potential contagion to more stable
While highly leveraged central and eastern European
economies have been sucked under by the financial crisis, one
of Latin Americas main weaknesses is its high dependency
on commodity exports. The regions endemic
vulnerability to commodity price swings bodes ill for the
future, say Julia Sweig and Shannon ONeil from the
Council on Foreign Relations, a New York-based
The collapse in prices has had a severe impact on large oil
producers, such as Mexico and Venezuela. Mexico is also
suffering from a continuous slide in output. Ecuador has
already defaulted twice on its sovereign debt in the past three
Low prices have a potentially destabilizing effect for
oil dependent countries, says Sophie Aldebert, Latin
Americas Cera energy director in Rio de Janeiro, who sees
social tensions rising in Bolivia and possibly in Venezuela. In
the meantime, one possible consequence is that harsh
rhetoric is going to face difficulties to be financed as
revenues decline, she says.
More diversified economies, such as Brazils, may prove
relatively better protected from commodity price volatility,
but all will be affected, says Aldebert.
For the time being, the general picture remains bleak against a
fragile global financial background. With lower
hydrocarbon prices, tight credit markets and higher cost of
capital, aggressive capital budgets might be curtailed, putting
the oil and gas production in the region at risk, says
Fitch Ratings, the credit rating agency, in a recent report.
The higher cost of capital and limited access to both the
domestic and international debt markets are likely to drive
downward revisions in national oil companies.