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Doubt about the commodity benefit
Greta Steyn
Posted: Fri, 30 May 2008
[miningmx.com] -- COMMODITY prices have been booming: ranging from oil, maize, rice and wheat to gold and platinum. These price increases have brought both costs and benefits to emerging markets such as South Africa.
The costs depend on the extent to which a country is a net importer of commodities and the benefits relate to the extent to which a country is an exporter of commodities. South Africa is somewhere in between: it has high demand for expensive oil but is a heavy exporter of minerals and metals.
According to the South African Reserve Bank, non-gold mining products accounted for about 52% of the value of merchandise exports in the first half of 2007. That means mining is crucial for South Africa's export performance. However, gold mining has become progressively less important but still accounts for around 7% of all South Africa's exports.
The question for
South Africa is whether it's benefited on a net basis from the commodities price boom of the past few years and also what the future holds. Do foreign exchange receipts from the export of commodities exceed payments for oil imports? What about knock-on effects from high oil, coal and food prices in the form of higher inflation stemming from hikes in the fuel price, electricity tariffs and global food prices?
Commodity prices have been especially newsworthy in 2008. Earlier this year saw the gold price spike to more than US$1 000/oz and platinum to $2 034/oz on supply concerns due to South Africa's electricity supply problems. Though both metals have since come down from their heady heights, at the time of writing the gold price was still 7% up since the start of the year and platinum 29% up. However, the spot price of Brent crude oil was up 20% since the start of the year.
Econometrix economist Azar Jammine says people complaining about high fuel and food prices
often don't realise the very factors driving those prices higher are driving South Africa's export prices higher. He's conducted an analysis of the balance of payments (BoP) for 2007 and found South Africa was a net beneficiary of commodity prices.
Jammine says food isn't really significant for the BoP. The big-ticket items on the trade balance show that South Africa was a net beneficiary of commodity price increases last year. He notes the increase in South Africa's oil bill last year was R21bn, while the increase in export of metals and minerals was R67bn.
Looking ahead, much depends on your assumptions and timing. Jammine says then there's also the important factor of carry-over implications - say, from oil to inflation to disposable incomes and interest rates. "It would be very difficult to quantify those to weigh against the BoP benefits. However, looking at the BoP we have to bear in mind the global surge in commodities prices has given South Africa the foreign exchange with which to expand its infrastructure spending."
Bureau for Economic Research economist Hugo Pienaar has made projections for this year, taking into account the decline in mining production resulting from electricity blackouts. His assumptions are that the US dollar/rand exchange rate will average US$1/R8 this year, the oil price will average $91/barrel, the
gold price average $889/oz and the platinum price average $1 800/oz.
Assuming that mining production plunges 20% this year and SA's oil imports remain the same as last year's, South Africa will benefit by a net R20bn on its current account balance. If you assume that oil imports increase by 5%, then the oil bill comes to R121bn for 2008. Assuming at the same time that gold and platinum output is 15% lower, that yields gold and platinum exports of R143bn - so we're still a winner. Obviously, the less the decline in gold and platinum output, the bigger the net benefit to South Africa.
Pienaar emphasises that his conclusion that South Africa is a net beneficiary is based on specific assumptions that might not hold. If his oil price assumption doesn't hold and mining output is significantly down, South Africa might be a loser.
What the economists don't mention - but what's also an important factor - is that South Africa's mining output made a negative
contribution to gross domestic product last year. So wealth creation in South Africa isn't a beneficiary of the commodities price boom.
It's worth revisiting the reasons for the commodities price boom, which looks as if it's here to stay. The International Monetary Fund's publication Finance & Development (F&D) says the current commodities price boom is more broad based and longer lasting than usual and contrasts noticeably with the Eighties and Nineties, when most commodity prices were on a downward trend.
The price boom has brought a sea change, F&D reports. Commodity exporting countries have benefited from rapidly growing export revenue. In fact, a number of analysts see high commodity prices as an important reason for the buoyant growth in emerging and developing economies. At the same time, investment in the commodities sector has accelerated after a long period of lacklustre performance.
And in financial markets, commodities are now an
established part of a wider class of alternative assets. Concomitantly, commodity importers and consumers have begun to feel the pinch from higher commodity prices - with widespread concern about the impact on the poor in emerging and developing economies. The IMF finds that higher commodity prices have begun to pose inflation risks and may lead to external financing challenges for some countries, particularly low-income net commodity importers.
Why are commodity prices so high? The IMF provides a number of reasons for the phenomenon. First, emerging economies have driven demand for various commodities - a trend that's likely to continue. China, India and the Middle East, where there's been strong per capita income growth and rapid industrialisation, are key countries in that regard.
In the oil market, demand from China, India and the Middle East accounted for more than 56% of the growth in oil consumption between 2001 and 2007. That growth was driven partly by
the increasing vehicle ownership associated with higher per capita incomes. For example, passenger car sales in China increased more than fivefold between 2001 and 2007. At the same time, particularly in China, industrialisation and urbanisation boosted demand for fuel-based electricity. Consequently, prices of other fuels - particularly coal, which is used to generate power - have also risen sharply.
Emerging economies are also playing a key role in the boom in non-fuel commodity markets. China's industrialisation is raising demand for base metals. Between 2000 and 2006, China alone accounted for around 90% of the world's consumption of copper.
And as emerging economies become more affluent they're consuming more food and shifting their diet towards high-protein foods, such as meat, seafood, edible oils and high quality fruits and vegetables. In 2006, China accounted for one-fifth of global consumption of wheat, maize, rice and soybeans.
Second, the
IMF notes that bio-fuels have boosted the demand for specific food crops. That's a prominent factor underpinning the difference between the current commodity price boom and previous ones.
Bio-fuels production is seriously affecting food markets: 20% to 50% of feedstocks, especially maize and rapeseed, in major producing countries are being diverted from food to bio-fuels - but aren't affecting petroleum product markets. Bio-fuels constitute less than 1,5% of transportation fuel supply.
The 2007 Energy Bill in the US almost quintupled the bio-fuels target, to 35bn gallons by 2022, and the European Union has mandated that 10% of transportation fuels must be bio-fuels by 2020. That means upward pressures on the price of some major food crops will continue for some time.
Third, slow supply responses have amplified price pressures.
Slow supply adjustment has been particularly acute in the case of oil, where capacity growth in response to
persistently higher prices has been disappointing in recent years. And as the pessimistic prospects for capacity growth have seemed more certain those expectations have further fuelled price pressures.
Fourth, important linkages across commodities transmit to higher prices. One example is that demand for bio-fuels has propelled not only prices of maize but also those of other food products, as maize is used as an input in their production (such as meat, poultry and dairy) or as a close substitute.
Higher oil prices have also had an important effect on other commodities: for example, oil is an input in agriculture and in the production of metals, such as aluminium. The price of coal prices has also increased due to switching from more expensive fuel oil to coal for power generation.
Fifth, low interest rates and effective US dollar depreciation have been a supporting factor. A key point is that investors outside the commodities sector can now use
commodities to diversify their portfolios. Favourable conditions associated with low interest rates tend to increase the asset demand for commodities (partly because low-yielding Government bills are less attractive.)
The US dollar's depreciation has made commodities less expensive for consumers outside the dollar area, thereby increasing demand. On the supply side the declining profits in local currency for producers outside the US dollar area have put upward pressure on prices. A decline in the effective value of the dollar also reduces the returns on dollar-denominated financial assets in foreign currencies, which can make commodities a more attractive class of "alternative assets" to foreign investors.
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