Replies to post #11493 on The Trading Floor

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Commodity prices being driven upwards by urbanization and emerging markets
By: Tessa Kruger
Posted: '13-DEC-06 19:00' GMT © Mineweb 1997-2006



JOHANNESBURG (Mineweb.com) --Rapid urbanisation in the developing world and the integration of emerging market labour in the global economy are driving a structural, favourable shift in natural resource prices relative to manufactured goods and traded services.

Emerging market countries are dominant in ownership of natural resources, which gives them substantial pricing power and strategic opportunities, says Jonathan Garner, global emerging markets equity strategist of RMB Morgan Stanley in a new report on Emerging Market Strategy Initiation.

Garner said in his view, urbanisation in the emerging world and the integration of emerging market labour into the global economy are crucial to understanding the strong recent price gains in natural resource prices.

“Returns will tend to rise to any factor of production where supply does not expand as quickly as the time period of bringing a labour-intensive manufacturing plant into being.

“For this reason, we are living in a world where prices of manufactured goods and services are falling, but commodity prices are on the rise. And we expect this to continue over the medium term.”

While much market commentary focuses on absolute commodity prices, it is relative shifts that reflect true underlying economics and determine financial market outcomes.

The biggest gain in relative prices has been in upstream products. The price relative of the oil price against US autos rose by 175% since late 1998, the relative copper price charted against the price deflator for US telephony services increased by 120% over the same period, and steel, a midstream product, rose 77% in price relative to US household goods.

The large relative price shifts are the result of demand factors, such as urbanisation in the emerging world, but also the “inelastic” supply response of primary commodity markets – relative to manufactured goods and services markets.

Garner said that governments and companies who control resource assets have considerable market power. Barriers to enter this market, includes the geography and availability of natural resources and the funding and skill resource necessary to generate additional supply.

These barriers are not present in manufactured goods and traded services, which are generally characterised by low barriers to entry and the abundance of skilled emerging market labour.

“This is a deep structural feature of the modern global economy.

“Unless or until price signals are strong enough to prompt technological innovation that will do away with hydrocarbons in energy supply, the use of copper in phones or platinum in catalytic converters, the trend for relative prices to continue to shift in favour of upstream resources seems set to continue.”

Emerging market countries possessed 94% of global proven oil reserves in 2005, but consumed only 32% of current production. Saudi Arabia, Kuwait and Iran combined possess 42% of proven reserves.

In contrast, the United States consumed 25% of current production in 2005, while it possessed only 2% of reserves.

There is also an imbalance between China’s reserves at just 1.3% of global total reserves, and its consumption at 8.5% of the global total.

“Our analysis does not take into account the diverse forms in which global oil and gas majors develop and exploit resources in co-operation with emerging market governments.

“But it reflects the reality that as relative prices shift in favour of oil, and reserves dwindle in the developed world, emerging market governments are increasingly able to exercise market power in their relationships with global oil majors.”

Both the Saudi Arabian and Russian governments, buoyed by strong fiscal positions, have felt able to review oil major access to domestic expansion projects.

Emerging market countries are also dominant in natural gas. They possess 85% of reserves but consume only 32% of current production. Russia alone has 27% of global gas reserves, the majority of which is controlled by Gazprom, while the US has just 3% of reserves but consumes 23% of annual global production.

As in the case of oil, global gas majors are seeking access to the resource base of the emerging world. The Qatari government has been open to foreign investment by Exxon Mobil, Total and the Japanese trading companies Mitsui and Marubeni holding minority stakes in both the upstream production assets and downstream LNG plant

But in other countries, there is very little foreign involvement in the sector, or, access appears to become more difficult.

For example, the Russian government has rejected Shell and its Japanese partners’ projections of cost over-runs for the Sakhalin-2 project, threatened criminal prosecution for environmental damages and sought a 25% stake in the project for Gazprom.