Renowned economist Daniel Yergin recently had an opinion piece, China’s Big Commodity Chill, in The Wall Street Journal that’s worth a read for
anyone who wants to know what really drives price changes. You may know Yergin from his book The Prize: The Epic Quest for Oil, Money and Power, a number-one bestseller and Pulitzer Prize winner.
Yergin’s article discusses the effects of the end of the commodities “supercycle” that has been driven by that country’s rapid industrialization and urbanization. Yergin states that China’s economy grew two and a half times in the last decade, and at the beginning:
“The world’s commodity-supply system, accustomed to excess capacity and weaker demand for its products, was not ready. Something had to give, and that something was price. Commodity prices took off at a breathtaking pace. There was a stumble at the beginning of the recession in late 2008. Then, as Beijing’s massive stimulus kicked in, China’s economy roared back and so did the hunger for commodities.”
A sample of how that excess demand affected prices:
“Copper prices reached their peak in 2011—six times higher than in 2003. China was consuming about 40% of the world’s copper, up from less than 20% in 2003.”
When a huge new customer increases demand but it takes years to add supply – you can’t open a copper mine overnight — prices are going to rise.
More recently, China’s growth rate has moderated. The country is beginning to move from an export-driven model (which requires lots of commodity inputs) to a model more reliant on domestic consumption for growth. And thus, there will be fewer commodity purchases by China:
“China will still be the biggest market for industrial commodities—but without the same accelerating growth in demand. Meanwhile, global production capacity has been greatly expanded to service the supercycle. Just as China did so much to fuel the supercycle, so its slowdown, more than anything else, is what has brought the supercycle to an end. The change is registered in prices.”
“Copper prices are down 30% from their 2011 peak, iron ore 32%. Overall, the IHS non-oil commodity index is down 27% since 2008.”
Similar things have happened with oil:
“A decade ago, the general expectation was that oil prices would stay in the $20-$28 a barrel range. Or lower. At an OPEC meeting in February 2004, one oil minister warned that “The price can fall, and there is no bottom to it.” But then demand started to rise, and oil prices took off. China alone accounts for 60% of the growth in world oil demand between 2003 and 2012. China is overtaking the U.S. as the world’s largest oil importer. But oil prices were also driven up by the “aggregate disruption” in the last decade from a number of diverse countries, including Iraq, Venezuela, Nigeria and the U.S. (after Hurricanes Rita and Katrina).”
So there was added demand from China, and disruptions in supply from major producers that continue to the current day. The result?
“Oil prices today, in a general range of $105 to $110 per barrel, are more than four times higher than they were a decade ago.”
Yergin essentially reiterates an important fact: Fundamentals drive prices. If demand is high, and supply is limited, prices rise. Demand from China, whether running hot or cold, has an outsize effect on commodity prices, and that will be worth keeping in mind whenever we see headlines about abrupt changes in prices in the years to come.