IMFSurvey Magazine: IMF Research
COMMODITY PRICE OUTLOOK
Oil and Food Prices Expected to Ease Only Moderately
By Thomas Helbling
IMF Research Department
July 1, 2008
- Food prices expected to respond more quickly than oil prices
- Prices driven by high demand in emerging, developing countries
- Difficult to establish lasting impact of speculation on markets
Oil and food prices are expected to ease only moderately from recent highs in coming months because of the time needed to develop additional supply, according to an IMF analysis.
Even then, the extent of easing will vary across commodities.
Price declines will depend, among other things, on developments on the demand side—including, for example, the extent of pressure from biofuels policies in advanced economies or the effects of potential changes in the pass-through of international prices to domestic prices—inventories, harvest or production outcomes, and the time needed to increase capacity.
Wheat prices, for example, have declined by some 30 percent from their peak in March 2008 on expectations of a better harvest this year, but corn and soybean prices have stayed high because of harvest concerns. Provided that appropriate policy incentives are in place, food prices should ease more substantially in the medium term because, in principle, the constraints on expanding food supply are less lasting than in the oil sector.
Dramatic hikes in prices
Since early 2003, when global growth started to recover definitively from the 2001 downturn, oil prices have quadrupled; metals prices have tripled; and food prices have doubled. The very strong, commodity-intensive growth in emerging and developing economies has been an important common factor behind these price increases. As a result, slowing growth in advanced economies has had less of an impact on commodity prices so far than in earlier global cycles.
Despite common driving forces, magnitudes and pace of price changes have varied noticeably across commodities.
Little spare oil capacity
The low level of spare capacity from the onset of the global recovery has been a key force behind rising oil prices. It is well known that demand or supply shocks can trigger explosive commodity price responses when spare capacity or inventories are limited, particularly if price elasticities—that is, the responsiveness of demand or supply to price changes—are low.
Indeed, one of the implications of our paper is that oil demand in many countries appears to have responded less to world market prices over time because the extent of pass-through of changes in these prices to domestic prices has decreased.
The supply response to higher prices has been more sluggish than expected—in other words, a decrease in the price elasticity of supply—because of shortages of equipment and labor, greater geological and technological constraints, and uncertainty about policy regimes affecting oil investment. This has led to the perpetuation of very low spare capacity and tight market conditions.
The role of financial factors in the recent price increases of oil and some other commodities continues to be hotly debated. Some financial variables, notably interest rates and exchange rates, can affect prices of oil and other commodities through their impact on physical oil demand and supply. The issue of whether the increasingly prominent role of oil and other commodities as an asset class has had an effect on commodity prices remains controversial.
IMF analysis to date suggests that purely financial factors, including shifts in market sentiment, have short-term price effects, but that a lasting impact on recent price trends remains difficult to establish.
This conclusion is based on several pieces of evidence. For the oil market, the following items are particularly relevant.
• First, if current spot prices were driven primarily by expectations of ever-rising prices in the future, we would need to see rising inventories over time or, alternatively, reductions in supply. However, all producers have been broadly operating at capacity. While data on oil inventories are not timely and lack global coverage, there is no compelling evidence to suggest that the sharp increase in oil prices in recent months has led to sustained, significant oil inventory accumulation.
• Second, the shape of the oil price futures curve does not suggest expectations of ever-increasing prices, as longer-dated futures prices have typically been below those of near-term contracts since mid-2007.
• Third, the direction of changes in investment flows into oil financial markets has not always been consistent with the direction of price changes over the past year or so. For example, over the past month, data suggest that noncommercial futures traders have reduced their oil market exposure.
Nevertheless, the issue of the role of real and financial factors in recent oil price increases will be examined further in the coming months. [See Appendix 1.1 in the September 2005 World Economic Outlook, Box 5.1 in the September 2006 World Economic Outlook, and Box 1.4 in the April 2007 World Economic Outlook for a fuller discussion.]
Food: A confluence of factors
The food price surges since 2006 reflect a confluence of factors. Demand growth has generally outstripped supply growth for many food commodities over the past 10 years or so, particularly for edible oils and major grains—including corn, rice, soybeans, and wheat. Correspondingly, global inventories of these crops have declined to relatively low levels last seen in the mid-1970s over the past several years.
The upward pressure on prices from rising net demand has been reinforced strongly by developments since 2006. First, unfavorable weather conditions in a number of countries led to reduced crop production in 2006-07, particularly wheat. Second, the demand for corn increased sharply in 2006-07 as a result of the sharp increase in corn-based ethanol production.
On top of this, the rising oil prices over the past year and a half have added substantial broad cost pressures. In a seller's market, such cost increases are passed on fully to producer prices.
Finally, a growing number of countries have imposed export restrictions in response to rising food prices, which added to international price pressures. As usual, these developments not only pushed up the prices of the foods directly affected, but also those of close substitutes. In addition, rising food prices have led to cost pressures elsewhere along the food chain, notably poultry and meats
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