Tuesday 20 August 2019

Consumer heaven, farmer hell as commodity prices plunge

Commodity price indices
Commodity price indices
Dan O'Brien

Dan O'Brien

The volatility of food, energy and other commodity prices over the past dozen years has been extraordinary.

For most people and businesses, the huge swings in prices have been bad - and sometimes threatening to their existence. The surge in global food prices in 2010, for instance, tipped millions of people in the developing world into desperation. It led to food riots in some countries, and has even been cited as one of factors that triggered the Arab spring.

As the charts show, the past 15 months have seen a crash in prices across the board. For Ireland, plunging prices since the summer of 2014 have been generally positive, as we import most of our commodity needs with the exception of food.

The multi-billion euro oil import bill, for example, declined by 22pc in the first eight months of this year compared to the same period last year.

The sharp decline in most commodity prices in the past year and more has several causes. The slowdown of the Chinese economy, which has become the largest single consumer of most commodities in the world, is central. Weaker demand in the manufacturing superpower, and in other emerging markets, explains why the world is facing gluts in many commodities.

The supply side naturally matters a lot too. The extraction of natural resources, and planning for extraction, usually takes time. A herd is not grown overnight and years are needed to plan and realise complicated extraction projects, as the Corrib gas saga illustrates so well.

High prices in recent years made returns on investment in the commodities sector look juicy. Companies piled in to invest in capacity in order to produce more. With the resultant increase in supply coming on stream just as Asian demand weakened, both sides of the price equation contributed to the recent plunge.

Now many of those who invested are in trouble as much lower prices blow a hole in their profit projections.

The boom in unconventional shale oil in North America is a case in point. There, many companies invested - but because extracting oil from shale is much more costly than taking it from most conventional wells, the price of a barrel of oil must remain high by historical standards for them to break even. With the price below that level for many companies, bankruptcies have become commonplace.

Another factor driving oversupply has to do with states' strategic interests. Oil prices have been pushed down by the fact that a number of OPEC states have kept the spigots open, rather than collectively crimping supply in order to push prices up, as they have often done in the past. As well as aiming to keep market share, the global "swing producer" Saudi Arabia is hoping that lower oil prices will hurt its rivals - most particularly Iran - and kill off new competitors, notably shale oil producers in the Americas.

While these global trends are outside Ireland's control, they have large and direct effects on our companies and consumers.

Many businesses will doubtless have welcomed the big falls in commodity prices this year. As illustrated in the second graph, there has been a decline in the industrial input price index - a category that includes raw materials and metals. This can only be good for Ireland-based manufacturers' bottom lines

Another benefit comes from the reduction in energy and fuel costs. Ireland is especially vulnerable to changes in world prices - with only 11pc of our energy needs coming from indigenous sources, we are among the most import dependent in Europe.

Owing to more than a decade of fluctuations, bigger firms may have hedged against price changes. Ryanair, for example, fixes most of its huge aviation fuel contracts well in advance. On this occasion, it has lost out, as nobody expected the decline in the oil price to be so huge. That said, the carrier's very strong profit performance in the first half of the year, which was announced last week, show it was far from detrimental.

As a result, there are probably fewer expletives issuing from behind Michael O'Leary's desk than would otherwise have been the case.

Lower commodity prices should translate into lower prices for a range of consumer goods, giving Irish consumers less to grumble about too. Recent developments have been similar to a tax cut, allowing people to spend more money on home-produced goods and services, thus boosting domestic demand.

One obvious case is to be seen when you fill your tank. The price of petrol is down 15pc and diesel down 20pc compared to this time last year (although thanks to the taxman's taking of 68pc of the pump price, the impact of the halving of crude oil prices over the same period has been much reduced).

But falling commodity prices have not been without downside for Ireland. Earlier this year, while giving a presentation on Irish and global economic prospects to an audience of farmers, I was struck by their interest in China - it was by a distance the issue we discussed most in the question and answer session.

The reason for the interest is the sector's investment in new dairy capacity to service that enormous market. The slowdown in China over the past year or so, and the fears that its economy could crash, keep some farmers awake at night.

For others it is worse. Writing in Tuesday's 'Farming' supplement in the Irish Independent, Dr Dan Ryan noted that some farmers were descending into clinical depression such is the confluence of negative factors they face.

It is not hard to see why. Global dairy prices have halved in the past year, thanks to weaker demand from China and Russia (the latter owing to Ukraine-related sanctions) allied with increased supply - including in the EU, where milk quotas were abolished earlier this year.

A recent report by the OECD and the UN noted that a central determinate in future dairy prices will be whether the China opts a more self-sufficient dairy industry or remains dependent on imports. Irish farmers will be keeping a nervous eye on Beijing for some time to come.

As the second graph shows, the fall in food prices was not quite as severe as other commodities, but it will impact on farmers nonetheless. For example, meat prices reached record levels in 2014, largely driven by the price of beef. Following other commodities, prices have also declined in the past year.

As with any area of economic forecasting, predicting where commodity prices will be in the future is nigh-on impossible. The recent fall in oil prices caught many by surprise, and the same could be said for the much increased volatility in almost all commodity prices since early in the last decade.

In a globalised world with more sources of supply and demand, and with the joker in the pack of increased financialisation of commodities, there is little reason to think that a period of more stable prices is at hand.

Sunday Indo Business

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