Sunday, October 25, 2009

Perspective On Energy & Commodity Prices

Liam Halligan provides a perspective on the Chinese car industry and its potential and its implications for the prices of oil and other sources of energy. Here is the particularly interesting part:

"Transport accounts for 70pc of global oil use. And China's car market just became the world's largest – with sales reaching 9.7m during the first nine months of 2009, a jaw-dropping 34pc above the same period last year.

As Chinese workers get richer, such growth is set to continue. There are still only 30 cars per thousand Chinese people – compared to over 800 in the US."

This factor would seem to favor a big increase in the price of oil. However, because of the substitution away from oil caused in part by the price increases, and in part the widespread belief that oil causes harmful forms of "climate change", demand will not increase as much as this implies.

However, that will only mean that demand for other sources of energy will increase. As it is unrealistic that wind or solar power will account for more than a fraction of that increase, this will mean higher prices of agricultural products used for biofuel, for uranium and even for coal (though the aforementioned concern for "climate change" will limit demand for coal).

Another point in the column worth noting is the decreased relationship between commodity prices and the Western business cycle that the boom in China and other emerging markets implies. Because commodities are much farther away from final consumption than finished products or services and therefore more sensitive to interest rate changes, (Austrian) economic theory predicts that they will be more cyclical than finished products or services.

Empirical data certainly supports this conclusion, but it should be emphasized that the "business cycle" relevant here is the global business cycle. If there is a global slump, then commodities will drop quickly in price, as we saw late last year. This is as true now as it was in the past. The difference between now and the past is that in the past, it was really only the Western business cycle that mattered because it accounted for almost all final global demand. Now however, if the Asian business cycle "decouples" from the Western, it means that commodity prices might rise even though the Western business cycle hasn't turned around. And that is exactly what we've seen now as the Asian economies led by China are booming, while the recovery in the West is feeble at best, or even non-existent as in the case of the U.K.