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Commodity Prices: The End of a Historic Boom

Global Economic Prospects 2009: Commodities at the Crossroads

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The supply of oil and metals did not keep up with stronger demand, resulting in a price boom. In grain markets, demand was relatively stable but diversion of some grains toward biofuel production had a ripple effect, contributing to price rises for other crops.

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From 2003 to early 2008, the world witnessed the most marked commodity price boom of the past century. The price of oil, metals, food grains, and other commodities rose sharply, and over a sustained period.

Like earlier commodity booms, this one was associated with strong global growth, but was exceptional in its duration and in the range of commodities affected. By mid 2008, energy prices were 320 percent higher in dollar terms than in January 2003, metals and minerals were 296 percent higher and internationally traded food prices 138 percent higher — mainly due to higher grain prices.

Typically, commodity booms end as global economic growth slows. This one lasted as long as it did mainly because developing countries continued to grow rapidly even in the face of fast rising commodity prices.
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But the long boom has finally come to an end, with prices falling in response to slower growth, increased supplies, and revised expectations. As of late November 2008, the dollar price of crude oil had fallen more than 60 percent, but was still 76 percent higher than in early 2003. Food prices were also much lower in November 2008, but still much higher than in January 2003.

Although World Bank economists expect that food prices will fall a further 20 percent in 2009, these prices are likely to remain much higher over the next 20 years than during the 1990s — partly because of higher energy prices and the influence of biofuel demand for food crops.
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Graph: The recent commodity boom was the largest and longest of any boom since 1900

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Oil and metals

During the recent period of sustained growth, demand increased for oil and metals. However, it was a lack of supply capacity in the two sectors rather than rising demand, that caused prices to go up. Global demand for oil fell sharply following the 1980s oil shock, and in the 1990s demand among former Soviet bloc countries for oil, metals and minerals also fell by almost 50 percent as these countries began to allocateresources according to market signals.

This idle capacity helped depress commodity prices in the 1990s and meant that firms did not invest in new capacity. Demand was rising relatively quickly outside the former Soviet bloc, but supply capacity grew much less rapidly because about a third of the increased demand was met by reviving idle capacity. When idle capacity was finally absorbed in the first half of the early 2000s, supply could not keep up, and prices surged.

Metals demand was also boosted by a dramatic rise in the amount of metal used per unit of GDP that began in the mid 1990s, reversing a 30-year period of declining metal intensities. The main reason for this reversal was the recent investment, manufacturing, and export booms in China. An expected easing of demand for metals over the next 20 years depends on the stabilization and subsequent decline of metal intensities in China, as the high investment rate declines and expansion of manufacturing capacity slows.

The future balance between extracted commodity supply and demand looks healthy if policies continue to support conservation and efficiency measures. Efficiency gains in car technology will be a critical determinant of future demand for oil. Over the next 20 years, supplies of extracted commodities are likely to remain ample, but if fossil fuel resources become scarce, ample alternatives exist. Moreover, rising oil prices in response to slower supply will make alternative sources of energy more competitive and encourage greater conservation and technological change.  
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 Commodity Prices Falling with Slower Growth

All commodity prices were falling as of November 2008, with slower GDP growth and increased supplies. World Bank economists project that GDP growth in developing countries will slow to 4.5 percent in 2009. Real food prices are expected to fall by 26 percent between 2008 and 2010, oil prices by 25 percent, and metals prices by 32 percent.

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Graph: Slower population growth should result in weaker GDP and commodity demand

Speculation that the global economy is moving into a new era of relative shortage and ever-rising commodity prices is unlikely to be borne out.

Over the next 20 years, slower population growth and weaker (though still strong) income growth are expected to ease global growth and future demand for commodities.

The extent to which demand slows and supply meets demand will depend on policies, technological change, and other factors like climate change.
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Grain markets

The story in agricultural markets is quite different. Demand for food has been relatively stable, but demand for grains as inputs into biofuel production has increased sharply. Between 2003 and 2007, two-thirds of the global increase in maize production went to biofuels. The effect spread from maize markets to wheat and soybean markets as farmers diverted their fields away from these crops to maize production. Higher oil and fertilizer prices also made it costlier to produce food in some countries. A final complication was a series of poor wheat crops in Australia.

Food demand is likely to grow less quickly in the future because of slower population growth. However, crop demand could expand quickly due to biofuels. Assuming no change in the economics of ethanol production, the International Energy Agency (IEA) suggests that biofuel demand for grain could increase by 7.8 percent a year over the next 20 years.

While this would make future food supply more expensive, it is unlikely to generate long-term food shortages. Global agricultural productivity growth has outpaced food demand for decades. Even if a much larger share of production goes to biofuels, increased investment and utilization of unused cropland should ensure adequate food supply.

However, countries with rapid population growth may become increasingly reliant on imported food unless productivity is improved.  
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