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  • Long Term Drivers of the Commodity Super-cycle

    Commodity prices remain high, and Dambisa Moyo says we better get used to it. Moyo, author of Winner Take All: China’s Race for Resources and What it Means for the World , has a piece at Project Syndicate in which she outlines how long term factors will continue to drive commodity prices. One key factor: the rise of emerging economies and their growing hunger for oil, copper, iron, and other commodities: Worst-case estimates have China’s real GDP growing at around 7% per year over the next decade. Meanwhile, the supply of most commodities is forecast to grow by no more than 2% annually in real terms. All else being equal, unless China’s commodity intensity, defined as the amount of a commodity consumed to generate a unit of output, falls dramatically, its demand for commodities will be greater this year than it was last year. As long as China’s commodity demand grows at a higher rate than global supply, prices will rise. And the rapid economic growth that China’s leaders must sustain in order to lift enormous numbers of people out of poverty – and thus prevent a crisis of legitimacy – places a floor under global food, energy, and mineral prices. To be sure, intensity of use has fallen for some commodities, like gold and nuclear energy; but for others, such as aluminum and coal, it has risen since 2000 or, as is the case for copper and oil, declines have slowed markedly or stalled at high levels. As the composition of China’s economy continues to shift from investment to consumption, demand for commodity-intensive consumer durables – cars, mobile phones, indoor plumbing, computers, and televisions – will rise. There is also the issue of the so-called reserve price (the highest price a buyer is willing to pay for a good or service). The reserve price places a cap on how high commodity prices will go, as it is the price at which demand destruction occurs (consumers are no longer willing or able to purchase the good or service). For many commodities, such as oil, the reserve price is higher in emerging countries than in developed economies. One explanation for the difference is accelerating wage growth across developing regions, which is raising commodity demand, whereas stagnating wages in developed markets are causing the reserve price to decline. By implication, if nothing else, global energy, food, and mineral prices will continue to be buoyed by seemingly insatiable emerging-market demand, which commands much higher reserve prices. Read Commodities on the Rise here .
  • QE3, 'Fat Fingers,' and the Price of Oil

    At Econbrowser , James Hamilton has yet another instructive post on oil prices. Last week, he noticed this dip in the price of West Texas Intermediate crude oil: Hamilton wondered to what extent this drop could have to do with supply and demand. He writes: Those who doubt that oil prices are determined solely by fundamentals would naturally ask, what aspect of the supply or demand for oil could have possibly changed in the course of less than a minute last Monday? The obvious and correct answer is, there was no change in either the supply or the demand for physical oil over the course of that minute. The minute-by-minute price of a NYMEX contract is determined by how many people are wanting to buy that financial contract and at what price, not by how much gasoline motorists burned in their cars that minute. But since changes in the price of crude oil are the key determinant of the price consumers pay for gasoline, doesn't that establish pretty clearly that the whims or fat fingers of financial traders are ultimately determining the price we all pay at the pump? In one sense, the answer to that question is yes-- last week's decline in the price of crude oil will soon show up as a lower price Americans pay for gasoline. But here's the problem you run into if you try to carry that theory too far. There are at the end of this chain real people who burn real gasoline when they drive real cars. And how much gasoline they burn depends in part on the price they pay-- with a higher price, some people use a little bit less. Not a lot less-- the price of gasoline could change quite a lot and it would take some time before you could be sure you see a response in the data. That small (and often sluggish) response is why the price of oil can and does move quite a bit on a minute-by-minute basis, seemingly driven by forces having nothing to do with the final users of the product. But if the price of oil that emerges from that process turns out to be one at which the quantity of the physical product that is consumed is a different amount from the physical quantity produced, something has to give. Indeed, the bigger price drops we saw on Wednesday followed news that U.S. inventories of crude were significantly higher than expected . Read Fat fingers and the price of oil here .
  • Key Factors in Gas Prices from State to State

    When we look at how much the cost of a gallon of gas varies from state to state, the first cause that comes to mind is the different tax rate for gas from state to state. But while that explains part of the cost variance, it does not account for all of it. At Econbrowser , James Hamilton breaks down the key factors in state gas prices in a series of helpful maps. First, there is this map from GasBuddy.com that shows how different gas prices can be from state to state, or even county to county: So while taxes are a major factor, Hamilton cites a number of other key factors, like state requirements for the quality of fuel, and the cost of crude oil at regional refineries: For example, sweet crude in Louisiana is currently fetching $125 a barrel, or $27 more than its counterpart in Wyoming. If the refined product market in Wyoming were completely separate from that in the rest of the country, we might then expect gasoline in Wyoming to be 68 cents/gallon cheaper than on the coasts as a result of differences in the cost of crude alone. But the refined markets are not completely separated, and no producer would want to sell gasoline in Wyoming if you had an easy way to get it to somebody willing to pay 68 more cents per gallon for it. Although America's pipeline system for transporting crude oil is not up to the task of moving all the crude available in Wyoming to refineries in Louisiana, the infrastructure for transporting refined products is somewhat better. The result is that Americans in the middle of the country pay more and those on the coasts pay less than they would if the product markets were completely isolated geographically. The equilibrium price differential is the one that equalizes the return from selling in different markets after taking into account transportation costs. Read Why do gasoline prices differ across U.S. states? here .
  • Gallup: Economic Optimism 'Volatile'

    After reaching a 4 year high the previous week, Americans' optimism in the state of the economy dropped again last week, according to Gallup . The Gallup Economic outlook rating and Current conditions rating both dropped last week: From the report: The exact reason for the slight deterioration in confidence last week is difficult to determine. One proximate cause could be -- at least to some degree -- continually increasing gas prices at the pump. Gas prices are not only approaching the psychologically important price of $4.00 a gallon, but are expected to exceed $5.00 a gallon in some areas in the months ahead. Gallup finds that Americans on average say they would not significantly change their lifestyles until gas prices reach the tipping point of $5.30, suggesting that the true impact of current gas prices on economic confidence is difficult to assess with certainty. Further, despite the latest decline in confidence and the surging gas prices, economic confidence remains better now than it was during the same week one year ago (-31). Read the full report here .
  • Impact of Rising Oil Prices Big on Political Rhetoric, Small on US Economy (so far)

    Wall Street Journal Economics Reporter Ben Casselman says to try and put the idea that there is a key "threshold" for gas prices--a price at which the economy "comes to a halt." Meanwhile gasoline prices keep climbing--though not to levels of a year ago. Yet. And the key questions to consider now are how fast are prices rising, and what is the impact on consumer behavior rather than what consumers are saying about prices. Here is Casselman speaking on what economists are focusing on as they watch oil prices climb:
  • Impact of Oil Prices on Gas Prices: or What drivers can expect to pay at the pump

    With Iran cutting off its oil from Britain and France, oil prices have climbed to a nine-month high this week . So what will the impact be on gas prices here in the US? The answer may not be quite as simple as "gas prices rise when oil prices rise," says Econbrowser 's James Hamilton . There's speculation involved, and the price fluctuations do not always follow as we expect: Here's a closer look at the data over the last year. Average U.S. gasoline prices fell more than you would have predicted based on the Brent price. They have since come back up. But Brent has surged another $10/barrel over the last two weeks, and gasoline prices have yet to catch up to that latest move. Based on the historical relation, we might expect to see the average U.S. gasoline price rise from its current $3.59/gallon up to $3.84. One factor that's been driving Brent and WTI up over the last few weeks has been rising tensions with Iran. But why should threats or fears alone affect the price we pay here and now? Phil Flynn, a senior market analyst at PFGBest Research in Chicago, offered this interpretation: We're seeing panic buying in Europe and Asia because they're absolutely convinced that they're not going to be able to buy Iranian oil or there's going to be some kind of conflict that disrupts the transport of oil through the Strait of Hormuz.... there is a lot of hoarding in case the worst-case scenario happens. Asian buyers have been buying up West African crude like it's going out of style. Does it make sense for consumers to suffer now just because of something that may or may not happen in the future? If there are significant disruptions, the answer will turn out to be yes. We'll be glad that we used a little less today, and left a little more in storage, to help us better cope with the huge challenges we'll be facing in a few months. If the answer turns out to be no, then this is all just a lot of pain for nothing. Read Crude oil and gasoline prices here . Also see Oil Prices and Consumer Spending from the Richmond Fed .
  • James Hamilton: Signs the US Economy Will 'Hang in There' In 3rd Quarter

    At Econbrowser , James Hamilton lays out the case for the economy to stabilize somewhat in the second half of 2011. He can't quite bring himself to say that it will get better, instead saying that he doesn't "expect things to get a whole lot worse." A major culprit for the slowing recovery has been oil prices--and specifically the impact of oil prices on new car sales. But Hamilton expects car sales to pick up as retail gas prices come down. He shares this look at the trend in car sales: Hamilton argues that the recent trouble for auto sales were very different from the back in 2008. Read his analysis here .
  • Interactive Map: Tough Oil

    The era of Tough Oil is here, according to our friends over at Marketplace . To mark the 1 year anniversary of the BP oil spill, they put together a terrific interactive map that tells the story of global oil production over the last half century. We have a snapshot of it below, but you must click here to see the map in full size and full effect.
  • Economist: 'Oil and the Arab Uprisings'

    Yesterday White House Chief of Staff William Daley said the Obama administration is considering tapping into the strategic oil reserves , signaling that the White House is concerned that the unrest in Libya might set off a case of supply shock. Libya is the 13th largest oil exporter, according to The Economist . As of now, the top oil exporter, Saudi Arabia, is increasing its output to make up for Libya's. But if that stops, and/or we see a cut in the supply from other countries in the region, like Algeria, we would be in for a big jump in oil prices. The Economist offers up this narrated slide show to explain the potential impact of an extended shutdown of Libyan oil exports on oil prices:
  • Tim Duy on Potential Impact of Commodity Price Shock on Economic Outlook

    With historic change taking place across North Africa and the Middle East over the last month, oil prices are, not surprisingly, rising. In his latest Fed Watch , Tim Duy tries to determine how much of an impact commodity prices will have on previously rising optimism about the US economy. He shares an exercise that he used in a recent class: The question: What is the impact of a commodity price shock? To gain some direction, construct a four variable vector autoregression of commodity prices, core PCE prices, real GDP, and the federal funds rate. For a commodity price measure, I used the PPI measure for Crude Materials for Further Processing: To implement the model, I took the first difference of the natural log of each of the first three variables (DIFFCOM, DIFFPRICES, DIFFGDP), multiplying each by 100 to convert to percentages. The commodity price measure is quite variable: I estimated the model with 5 quarterly lags over the period 1984:1 to 2010:4. I then generated impulse response functions to examine the impact of an unexpected shock to commodity price inflation: The results suggest that a roughly 8 percentage point increase in commodity prices yields virtually no impact on core inflation, but, after four quarters, drives real GDP growth down .17 percentage points. Monetary policy responds with a .23 percentage point decrease in the fed funds rates after 7 quarters. Of course, in the current zero interest rate environment this response would need to be mimicked with a fresh expansion of the quantitative easing (I have yet to find a satisfactory replacement for the federal funds rate to take into account the zero bound. Topic for future research). Read Duy's bottom line conclusions from the exercise, and more analysis, here .
  • Roubini Warns of W-Shaped Recession

    Nouriel Roubini is more concerned about looming inflation than Alan Blinder (see previous post). The NYU economics professor and chair of RGE Monitor sees a looming "W-shaped"--or "double-dip"--recession for both Europe and the United States. And today, speaking to CNBC from the Paris Conference on Long-Term Vlue and Economic Stability , Roubini warned of the effect of rising oil prices.