Tuesday, February 9, 2010

Grain and Oil Commodities in Light of Peak Oil


The Commodities Issue

Since I've been devoting space on this site to agriculture as well as general economics, that causes me to pay extra attention to commodities.

My interest in all of these subjects began with my peak oil awareness and reading which began, for me, in 1995. This subject seems timely today, as I ran across the Marc Faber interview, to follow, in which he states that right now it costs $70 to find oil, so if the oil price drops below $50 nobody will go look for oil. This is a very frightening subject, well intertwined with our developed economies.

Agricultural commodities share a similar economic dynamic to oil production. If the producer doesn't get paid to cover input costs, he will not go out and produce that crop the next year. If reimbursement is strong, he will produce. Supply and demand. (Keep in mind that governmental price support subsidies come into play here, too.) Recent case-in-point: Back in 2007, there was a wheat shortage. Prices shot up, so supply quickly rebounded in 2008 and 2009 to the point now, in 2010, where the world is awash in wheat. So, contrary to what many seem to believe, agricultural commodity production is incentivised by the promise of profit, not global population levels.

Where it becomes interesting is in the transition between our bubble economies which have an illusion of appearing more affluent than they really are, to global bubble popping economies which, by necessity, are forced to cut slack from the system. Right now, there is nothing more desired by economically challenged nations than the desire to export. In OPEC's case, this means producing oil, and going against production quotas in a selfish "get more" for "me" mentality. Oil demand is lessened during a recession, so the oil price falls. Over time, less investment money goes towards future oil production.

By the same token, agricultural commodities are an important export product for many nations. Input costs are closely tied to oil costs. Currently, there is slack in the system as production continues to increase and is adequate for growing global populations. We have a policy of poorly utilized productive land going towards biofuel production, and we have a large amount of livestock production which supports far fewer human populations than grain-based diets could.

As nations are financially weakened, governmental farm policies will require cutting fiscally unproductive programs. This may result in an ability to produce more edible grain commodities for a while, if, for example, the corn ethanol program is abandoned. But, as this happens, there may be less demand, as less affluent populations switch to grain-based diets, plus there will be less money for food aid, evidenced already in our current crisis. Oil price levels will be key in input costs, which will further determine policy and production levels.

In timing, grain and agricultural commodity production levels may likely lag and reflect escalating oil costs inversely. This means that consumers will be squeezed by food and energy costs at about the same time, depending upon how much slack can logically be worked out of the grain commodity production system. Increased costs of these basic necessities may be timed to coincide with the transition from a deflationary environment to a hyper-inflationary one.

In conclusion, I'd expect agricultural grain surpluses during this deflationary time period to result in lower agriculture commodity prices. This will be followed by lower production, which will lead to higher prices, which will further cut nonessential uses by economically weakened nations. Input costs will grow, further reducing output. If resulting decreased production is accompanied by a transition from a deflationary to an inflationary environment, then commodity prices will be set to go through the roof and become dangerously unaffordable sometime down the road.

Everything occurring up until then is just a sideshow.

Which brings us to the Olduvai graph, in case I find any readers unfamiliar with it. read more The interpretation would mean that by 2025 we will be back to where our ancestors were in 1930. A picture is worth a thousand words, isn't it?

To follow, are two videos and an article presenting some of the latest thoughts concerning Peak Oil.

Here is the Faber interview. (five minutes)


Branson warns that oil crunch is coming within five years
UK Guardian

Sir Richard Branson and fellow leading businessmen will warn ministers this week that the world is running out of oil and faces an oil crunch within five years. The founder of the Virgin group, whose rail, airline and travel companies are sensitive to energy prices, will say that the ­coming crisis could be even more serious than the credit crunch.

"The next five years will see us face another crunch – the oil crunch. This time, we do have the chance to prepare. The challenge is to use that time well," Branson will say. "Our message to government and businesses is clear: act," he says in a foreword to a new report on the crisis. "Don't let the oil crunch catch us out in the way that the credit crunch did."

....Chris Skrebowski, an independent oil consultant who prepared parts of the peak oil report for Branson and others, said that only recession is holding back a crisis: "The next major supply constraint, along with spiking oil prices, will not occur until recession-hit demand grows to the point that it removes the current excess oil stocks and the large spare capacity held by Opec. However, once these are removed, possibly as early as 2012-13 and no later than 2014-15, oil prices are likely to spike, imperilling economic growth and causing economic dislocation."....

Discussing the probability of an oil shortage in 2015, with John Kilduff, Round Earth Capital, and Dr. Robert Hirsch, Management Information Services.

The Oil Export Crisis Has Arrived
GetRealList - Chris Nelder
In fact, of the top five oil exporting countries to the U.S., representing 63% of our crude imports, only Canada posted an increase, of 0.2 mbpd.
The combined annual net oil exports from our top three exporting countries–Canada, Mexico and Venezuela–illustrate our situation:
oil exports us%2C canada%2C mexico
Combined Annual Net Oil Exports From Canada, Mexico and Venezuela. Source: Jeffrey J. Brown, Samuel Foucher, PhD, Jorge Silveus.
Given the very modest increases from unconventional domestic production and Canada, the decline of imports from Mexico and Venezuela means the U.S. will be increasingly forced to depend on suppliers farther afield–the very same suppliers that China has been buying into in size....The oil export crisis has arrived. We just haven’t felt it yet.