High Commodity Prices:

1
High Commodity Prices Just a Bad Dream or a
Wake-up Call?

Samarendu Mohanty Social Sciences Division IRRI
2
Increase in Commodity Prices
Percent
3
Crude Oil Prices
Current Price
Iranian Revolution Iraq War U.S. Price Control
4
From The Times (May 22, 2008)They're wrong
about oil
Rip up your textbooks, the doubling of oil prices
has little to do with China's appetite

• Gulf crammed with supertankers to hold the
  inventories of oil they are pumping but cannot
  sell
• There are few buyers for physical oil cargos at
  todays prices, but there are plenty of buyers
  for pieces of paper linked to the price of oil
  next month or next year.
• This situation is exactly analogous to the bubble
  in credit markets a year ago, where nobody wanted
  to buy sub-prime mortgage bonds, but there was
  plenty of demand for financial derivatives that
  allowed investors to bet on the future value of
  these bonds.

5
Crude Oil The Mother of all Commodities

• Recently extended her motherhood to agricultural
  commodities through ethanol.
• Now, agricultural commodities will inherit some
  volatility from the crude oil market.

6
World Crude Oil Production and Consumption
Million Barrels
Source U.S. Energy Information Administration
7
U.SOPEC Crude Oil Inventory and Price
Million Barrels
/barrel
Source U.S. Energy Information Administration
8
Market Trends

• No major shifts in supply and demand in the last
  three years.
• Demand growth from China is nothing new to the
  market
• As a matter of fact, the growth rate has been
  declining
• 0.3 million barrels a day (mbd) in 2007 as
  compared to 0.9 mbd in 2004 (source Timesonline)
• Global demand growth has also declined
• 3.6mbd to 0.7 mbd during the same period (source
  Timesonline)

9
Why Oil Prices are Ridiculously High?

• Sticky Demand
• Not much response from the consumers in response
  to price increase
• Weak dollar has somewhat worsened the situation
• Between Jan. 2007 and June 2008 60-136 vs Euro
  45 to 86
• Financialisation of the Commodity markets
• A new breed of market participants are demanding
  commodities only on paper Institutional
  Investors
• These are pension funds, endowments and other
  corporate investors.

10
Institutional Investors

• Invest in commodity index funds (Index Investors)
  
• Always long in the market
• Never leave the market
• Liquidate the expiring contracts and buy the next
  contract

11
Commodity Index Funds

• Major Commodity Index Funds
• Standard Poors Goldman Sachs Commodity Index,
  1991
• Dow Jones-AIG Commodity Index, 1991
• Deutscehe Bank Commodity Index, 2003
• Lehman Brothers Commodity Index, 2006
• Merril Lynch Commodity Index, 2006
• Rogers International Commodity Index, 2005
• CX Commodity Index, 2006

12
SP GSCI Components and Weights (24
Commodities)June 12, 2008
13
DJAIG Components and Weights (19
Commodities)Jan. 2008
14
The commodities included in SP GSCI

• Aluminium
• Brent Crude Oil
• Coffee
• Copper
• Corn
• Cotton
• Crude Oil
• Feeder Cattle
• GasOil
• Gold
• Heating Oil
• Lean Hogs
• Live Cattle
• Natural Gas
• Nickel
• RBOB Gas
• Silver
• Soybeans
• Sugar

15
Source Mike Masters Congressional Testimony
16
Source Mike Masters Congressional Testimony
17
Significance of Commodity Index Funds

• In the last five years, investments in commodity
  index funds have increased from 13 billion to
  260 billion
• 70 billion in Jan. 2006
• For corn, soybeans, wheat, cattle and hogs Index
  fund investment amounts to 47 billion, up from
  10 billion just two years ago
• Number of energy funds have increased from 180 in
  2004 to 634 now
• This is big enough to influence the commodity
  prices
• Commodity market is much smaller than the capital
  market (2004 180 billion (outstanding
  contracts) vs 44 trillion dollars)
• Source Mike Masters Congressional Testimony

18
Why so much interest in the commodity markets?

• Hedge against weak dollar
• Volatile stock market
• Low interest rate in the U.S.

19
From The Times (May 22, 2008)They're wrong
about oil

• Gulf crammed with supertankers to hold the
  inventories of oil they are pumping but cannot
  sell
• There are few buyers for physical oil cargos at
  todays prices, but there are plenty of buyers
  for pieces of paper linked to the price of oil
  next month or next year.
• This situation is exactly analogous to the bubble
  in credit markets a year ago, where nobody wanted
  to buy sub-prime mortgage bonds, but there was
  plenty of demand for financial derivatives that
  allowed investors to bet on the future value of
  these bonds.

20
Monthly Crop Prices
/Mt
21
World Corn Production and Consumption
000 MT
1998/99
22
U.S. Biofuels Production
Million Gallons
Source FAPRI, 2008 Agricultural Outlook
23
Why Such Growth?

• U.S. Ethanol Subsidies
• 0.51/Gallon of Blenders Tax Credit
• 54 cents-a-gallon tariff on imported ethanol
• Total ethanol subsidies amount to 7 billion a
  year or 1.90 per gallon (Economist)
• High Crude Oil Prices
• The Renewable Fuel Standards Specifies minimum
  biofuels consumption in the U.S.
• 9 billion gallons in 2008 to 10.5 billion gallons
  in 2009.

24
U.S. Biofuels Production
Million Gallons
Source FAPRI, 2008 Agricultural Outlook
25
U.S. Corn for Ethanol
MMT
26
24
Source FAPRI, 2008 Agricultural Outlook
26
Can We reverse the Price Trend by Eliminating
U.S. Ethanol Policy?

• Answer is NO.
• Some decline in corn price
• As long as oil prices are high, ethanol
  production will keep expanding.

Source Farm Business Management University of
Illinois
27
World Wheat Production and Consumption
000 MT
2002/03
28
World Milled Rice Production and Consumption
000 MT
2000/01
29
Rice Price and Stock-to-Use Ratio
/MT
30
Monthly Rice and Wheat Prices
/Mt
India, Vietnam, Egypt, Brazil, and Indonesia
Export Curbs Scramble to Build stock
Bangladesh, Philippines, Costa Rica, Singapore
31
Is there a Bubble?

• Definite signs of bubble in the oil market
• Chinese demand for petroleum increased from 1.88
  billion barrels to 2.8 billion barrels in the
  last five years, an increase of 920 million
  barrels
• During the same period, index investors demand
  for petroleum futures increased by 845 million
  barrels (source The Edmund Sun)
• Corn, Soybeans and Wheat prices are also inflated
  by the commodity index funds
• Panic in the rice market was largely responsible
  for the price increase in May

32
When will the Bubble Burst?

• Softening of Oil Demand
• Home buying practices adjust to high gas prices
  (Associated Press, June 19)
• People ditching suburbs to move closer to the
  city
• More demand for houses near train/bus stations
• Many U.S. cities are expanding their mass transit
  services
• China to raise fuel prices by as much as 18
• Closing off the loopholes
• Bumper Crops

33
Bad Dream or a Wake-up Call?

• Definitely a timely wake-up Call

34
Thank you