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Past investments are boosting the supply of industrial commodities, potentially ending the supercycle

Since early 2011, industrial commodity prices have been weakening, a process that appears to be intensifying in 2013, despite signs that the global economy is gaining strength (figure 18). Indeed, since their peak in early 2011, the price of metals and minerals is down 30 percent and that of energy is down 14 percent, with prices off 12 and 5 percent, respectively, between January 2013 and the end of May 2013. This price weakness has sparked discussion about whether a supercycle in commodity prices is coming to an end—particularly within the metals industry, where large increases in supply are coming on stream in response to investments spurred by the high prices of the past several years.FN8

Figure 18
Since early 2011, metals and energy prices have been weakening

Source: World Bank, Datastream

While the baseline assumption of a gradual easing in prices over the projection period remains the most likely outcome, a steeper decline cannot be ruled out. Table 5 reports the results of two simulations. The first scenario examines the impacts on developing-country GDP, current accounts, and fiscal balances of a scenario where oil prices, reach the real long-term supply cost of $80 per barrel (industry experts’ current estimate of the cost of profitably extracting oil from the Canadian tar sands) by mid-2014 rather than declining gradually to that price by 2025, as in the baseline. The faster decline is assumed to come from a shift in expectations about future prices brought about by increasing production and reserve discoveries in the United States and other nonmembers of the Organization of Petroleum Exporting Countries (OPEC). In this simulation, the price of other commodities react in line with historical cross-price and output elasticities (energy is a major cost factor in the production of both metals and agricultural commodities). As a result, metals and food prices also fall, by about 7 and 3½ percent, respectively, relative to the baseline.

Table 5
Impact of a more rapid supply-induced decline in industrial commodity prices
Scenario 1: Oil price gradually declines to $80/bbl real by June 2014, other commodity prices react endogenously
Table 5A
Scenario 2: Metal prices gradually decline by a cumulative 20% by June 2014
Table 5B
Source: World Bank

In this scenario, global GDP is positively affected (up 0.4 percentage point in 2014 relative to baseline), because the positive effects on oil-importing economies outweigh the negative impact on oil-exporting countries. The GDP of developing-country oil exporters is projected to decline by a relative modest 0.4 percent in this scenario in 2014, but the effects on current account and fiscal balances are larger—-1.4 and -1.1 percent of GDP, respectively. The simulation assumes that exporters are able to finance the deterioration in these balances. If they were unable to do so, GDP impacts would be substantially larger. For the most part, developing-country oil exporters are still running current account surpluses, but fiscal deficits exceed 3 percent of GDP in 6 of 16 countries for which data exist. If countries could not finance additional deficit, they could be forced into a procyclical tightening of policy that would exacerbate the cycle.

The second simulation analyzes the impact of a more rapid decline in metals prices, which are assumed to fall by a further 20 percent by June 2014 relative to the baseline, in response to additional capacity coming onstream following past investments (see earlier discussion). In this scenario, the effects on global and oil-importing country GDP are broadly unchanged, in part because, unlike oil, the share of metal and minerals in the imports of most countries is small (even in China, which consumes a disproportionate share of the world’s metals, metals and minerals represent only 16 percent of total imports). The impact on metals exporters is more severe. Among Sub-Saharan African metal exporters, GDP could fall by as much as -0.7 percent in Sub-Saharan Africa, balance of payments declining by 1.2 percent of GDP, and the fiscal balance by nearly 1 percent.

Unlike oil exporters, these impacts are more likely to be binding for developing metals exporters whose average government and current account deficits are equal to 2.7 and 6.3 percent of GDP. Assuming that increases in government deficits above the 3 percent level cannot be financed, GDP impacts would increase to -0.5 percent for the metal exporting countries facing financing constraints, versus –0.2 percent for countries where there are no financing constraints.

Notwithstanding the 16 percent decline in oil prices between their March 2012 peak and May 2013, commodity prices are much higher than they were at the turn of the century. For example, between their 2001 record lows and 2012, nominal oil prices are up more than 300 percent, while metals and agricultural prices are up 225 and 157 percent, respectively.

8. Heap (2005) argues that industrial commodities go through a super-cycle where prices are likely to stay high for an extended period of time. Jerrett and Cuddington 2008 have empirically visualized the hypothesis for a number of metals. Erten and Ocampo (2012) identify four super-cycles in real commodity prices during the period 1865-2009, ranging between 30-40 years with amplitudes 20-40 percent higher or lower than the long run trend (similar cycles have been identified by Cuddington and Zellou (2013) for metals).

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