Oil and Other Commodity Prices

I haven't had time to write for a while, but now I'm back with this year's first post.

One of my favourite bloggers, Stefan Karlsson, wrote about rising commodity prices today. I feel I have to comment on what he said, but since this comment is much longer than his blog post, I post it here on my own blog instead.

Stefan says "anyone who tells you that the commodity price boom reflects the alleged 'peak oil' doesn't know what they're talking about". I would instead say they are parallel developments.

Now why does Stefan say "alleged" peak oil? Isn't Stefan Karlsson convinced yet about the imminence of peak oil? I'm not saying he has to believe all the doomer stuff you can read on many peak oil sites, but I do hope he has read enough facts to understand that peak oil is here, and will most probably have profound effects on our lives.

In my opinion, the oil price does (partly) reflect "peak oil", because demand has outpaced supply. Take a look at the second chart at http://oljepris.se/statistik and you will see that world production has been essentially flat since April 2005, after rising until then. Many experts who have studied oil production, e.g. Matt Simmons, argue convincingly that the world has passed peak oil and is now on a "plateau" of oil production. Even if the peak is a number of years away, most of the "easy" oil is already taken out of the ground. What is left is (on average) much harder to extract (e.g. in remote regions, have to use more advanced techniques to extract, under deep seas etc). Extracting a barrel of oil on average costs much more now than 10 years ago. There are also other factors involved in oil prices, e.g. military conflicts etc. But price action alone does not refute the fact of "peak oil". Not even when compared to other commodity prices.

But peak oil definitely plays a strong part in oil prices. The inability to increase production in spite of rising demand and sharply rising prices over several years confirms this. If you want more detailed analysis of peak oil, you can get all the information you want (and more) from The Oil Drum and Energy Bulletin.

So why have other commodities shown strong price gains too?

1. Just like for oil, demand has outpaced supply for many commodities (e.g. metals). Starting up new mines is a long process. It takes years of prospecting, government permits etc. The global economic boom of the last few years seems to have caught miners by surprise, with a demand for commodities that by far exceeded most predictions (remember, most "predictors" are notably bad at predicting things like this in advance).
2. Many other commodities are probably also near their global production peaks, e.g. platinum. The production of any finite resource can be Hubbert linearised to get an approximation of the production curve. A notable example of "peaked" commodities is uranium. Just take a look at a graph of global production and you will see that global production seems to have peaked in 1980, and since 1985 the shortfall in production has been made up by using military stockpiles (see for example the chart at the bottom of this article). The price action of uranium over the last few years confirms this situation.
3. Just like for oil, the "best" ores for other commodities have been extracted first. Take the example of copper. When copper was first discovered during the stone age, naturally occuring pure copper was used. Then somebody discovered how to extract copper from certain ores, and the best ores were mined first. Gradually over the years, ores with lower and lower percentage grades of copper have been mined. During the last century we have rapidly mined our way through most of the good ores for most commodities, at a pace never seen before in history.
4. As for food prices, we seem to have reached "peak food" rather close to "peak oil". It seems that the world is simply not capable of producing more food simply for reasons of ecological limits. Global grain stockpiles are now at something like 27-year lows. And population still growing. And demanding more and better food.
5. Increased affluence among large parts of the world's population has created a stronger demand for everything from meat to diesel to microwave ovens. This is actually strongly connected to number 1 above.
6. Food prices have become (loosely) connected to oil prices because of the grain-to-ethanol boom.
   

Now, even if we have passed "peak oil" (which I believe we have), that does not mean that oil prices cannot sink from current levels. Since the margins for world oil supply are so tight today, small differences in production or demand make big differences in price. With the coming recession, I think we will see a lot of "demand destruction", as it is euphemistically called. I therefore guess that oil prices will decline substantially later this year. $65/barrel is not impossible. This is of course blasphemy to many of my fellow "peak oilers", most of whom seem to be convinced that we will see $150 or $200 per barrel oil soon. But I predict that "demand destruction" over 1-2 years will be faster than production declines. Of course a swift economic downturn might also have a similar effect on many other commodities. Though not uranium, I suppose, because nuclear reactors will not be shut down, even if we have an economic crisis.

Harvests, Floods and Droughts

News is just out that North Korea has been hit by floods with hundreds dead and widespread damage. Tens of thousands of hectares of farmland have been destroyed. This means a bad harvest this year for a country that already needs to import grain during good years. North Korea usually does not readily admit having problems, so the fact that they ask for help probably means the situation is really bad. Read more about it in IHT.

The floods that have hit two-thirds of Bangladesh for the last three weeks are now receding, but have destroyed nearly 133,000 tonnes of rice that was about to be harvested. Read more about it in Daily India. These floods have also hit nearby Bihar in India, damaging crops on more than 1 million hectares and destroying food grain stocks. Read more about it in Daily India.

On the bright side, it can be noted that Afghanistan has doubled its production of cereals in the six years since the Taliban regime fell, according to an article from FAO.

However, global stockpiles of wheat are at 30-year lows, and the price of wheat has climbed 34 percent this year. Maize (corn) and wheat are being used as feedstocks for ethanol plants both in Europe and USA, which has driven up the price of these grains. Other food crops have also increased in price, either because they are used to produce biodiesel, e.g. canola/rapeseed, or because higher prices for corn and wheat have made farmers sow more of these and less of other crops. The prices of meat and dairy products have also risen, because the animals are fed on grain. All this will of course lead to higher food prices, which will have a number of effects.

- Emergency food relief programs for places like Bangladesh, Bihar and North Korea will cost more, leading to tight budgets for aid organisations.

- Higher food prices mean higher inflation. "Core" inflation in the USA excludes both food and energy, but this inflation measure is a scam - who can survive without food and energy? Look at the real price inflation figures instead.

- Higher food prices lead to consumers having less money left to buy other stuff. Good for mother nature, because less consumption means less resources used up. Bad for our consumer-driven economy.

The current trends of more grain converted into ethanol and harvest problems in many places in the world are likely to continue, sending food prices still higher. Add an ever-increasing world population and things are starting to look pretty grim.

Now one of the easiest things the world could do to improve the current food situation would be to stop the whole grain to ethanol business. I doubt whether the grain to ethanol industry would actually survive if it were not for government subsidies.

Additionally, it is doubtful that converting grain to ethanol actually produces any net energy gain to speak of. To produce the ethanol you need a lot of energy. Diesel to run the tractors, natural gas to produce fertilisers, more diesel for transports, etc. An important concept for all fuels is EROEI (Energy Return On Energy Invested), i.e. how much energy you need to put in to get your fuel. For crude oil EROEI is very high, about 10 to 1 for good fields. This means that you need to use the energy equivalent of one barrel of oil for every ten barrels produced. This energy is used for drilling, transports, etc. There are a number of studies of the EROEI of grain to ethanol, and they all show an EROEI close to 1. This means that you actually have to input nearly as much energy as you get out of the whole process. Some studies show an EROEI of 1.2, which means that the ethanol only contains 20% more energy than all the inputs. Is it really worth all the adverse side effects of rising food prices to get that measly extra energy? Other studies (e.g. by Patzek and Pimentel) even show that grain to ethanol has an EROEI below 1, which means you actually loose energy in the process!

In any case, even if it turns out grain ethanol has an EROEI greater than 1, we would need so much farmland to grow enough grain to feed all our cars that there simply isn't that much farmland!

So, please, could all governments stop their subsidies to the grain to ethanol business now.