The world economy has been through several cycles where different sectors have predominated. Most recently, the age of telecoms and high-tech that ended with the dotcom crash of the early 2000s and the age of financial services that came to an abrupt halt with the global financial crisis of 2008.
We are now in the age of commodities, particularly, for oil, gas, metals and minerals. Whilst in many ways the markets around technology and financial services are intangible, commodities are very tangible. They are fundamental to economic growth over the next decade and the continuing progress of the BRIC countries, especially India and China, whose appetite for commodities is insatiable.
This is part of a fundamental shift in the global economic balance of power. The BRIC countries and others such as Indonesia have large populations that are demanding an increase in their standard of living.
Securing the future growth of these countries depends on the availability of key commodities. The demand is not just restricted to industry and manufacturing. There has also been a surge in demand for diamonds in China and gold in India.
Vast swathes of India’s population do not have access to electricity on a daily basis. Access to electricity and motor vehicles – and thus supply of oil, gas and coal – are critical for the populations of these countries to realise their aspirations. The most basic way of achieving this lift in living standards is through the provision of personal transport and all the benefits of the provision of electric power.
The changing balance of power
At the same time, economic surpluses in these countries now give their oil and mining companies the ability to buy upstream assets in the energy and resources sectors. As a result, Chinese and Indian corporations have been acquiring assets in markets such as Africa at an amazing rate. This marks a shift in the balance of power away from the traditionally dominant forces in the mining and energy sectors – Western companies such as BHP Billiton, Rio Tinto, Exxon Mobil, Shell and Total – to state-owned companies that don’t have a high profile in the West.
These state-owned companies are also able to offer host countries benefits that publicly-listed companies are unable to. The advance of Chinese companies in Africa has been coupled with large loans from the Chinese government to countries such as Sudan.
Commodity markets have been volatile for the last few years, but demand has driven an upward trend in prices. In 2004/05, oil prices hovered around $40 per barrel. During the financial crisis, they fluctuated between $40 and $150, before eventually settling in to a new range of $70-$90. This step-change in the long-term oil price is driven by the demand for commodities in emerging markets – the pattern is similar for coal and metals such as copper and iron ore.
This demand pressure makes the market very responsive to developments that affect supply. Strikes in South Africa and Chile have hit the copper price while the oil price is vulnerable to government responses to the Gulf of Mexico disaster. It is possible to envision a return to $100 per barrel of oil in 2011. Commodity prices have always been subject to volatility, of course, but the price level around which they trade is now much higher.
Managing higher commodity prices
So far, the world has coped with higher commodity prices without an excessive rise in inflation or restrictions on economic growth, partly because the scale and breadth of global economies is much bigger than during previous periods of rising prices such as the oil shock of 1973. How the global economy reacts in the future depends partly on government policies. In India, for example, the government has spent a huge amount subsidising fuel prices, a policy that is gradually being phased out. In the UK, oil price increases were managed by moderating the tax take. As economies develop, they become less prone to increases in the price of individual commodities.
The age of commodities has been reflected in structural changes in the FTSE 100 over the last five years. The number of oil and mining stocks in the index is about double what it was five years ago as international energy and mining groups such as ENRC, Kazakhmys, Vedanta Resources and, most recently, Essar chose to list in London. They now make up about 32% of the index.
This means commodities companies now have a real impact on the UK economy, even if most of their operations are elsewhere. Because many pension funds and other investors with tracker funds or exchange-traded funds have to hold these constituents in their portfolios, many people’s pensions depend on the future performance of the sector.
The end of the age of commodities looks to be some way off, given the scale of development that is still needed in many emerging markets.
Expanding domestic consumption
The end of the age of commodities looks to be some way off, given the scale of development that is still needed in many emerging markets. While the cost advantages of the emerging markets will be eroded over time, reducing export-led growth, domestic consumption is set to expand rapidly, maintaining demand for commodities.
The biggest challenges for the sector are regulation – such as can be expected as a result of the Gulf of Mexico crisis – and attempts by governments to increase the level of taxation on resources, such as Australia’s now maligned Henry tax.
Governments have to strike a balance between taking a fair share of the economic rent for their resources and imposing a burden that is seen as punitive. This is not easy to do and can have far-reaching consequences. Investors have a choice of jurisdictions where they can invest and may avoid investment in a particular country if they feel its tax burden is unfair.
Energy security and access to commodities are huge issues for many economies and it is for these reasons that Deloitte has invested in a strong cross-disciplinary practice in oil and gas, mining and power over many years. Governments, markets and companies need professional advisers who understand the dynamics of energy and commodity markets and the mechanisms of global energy and commodity trading. This knowledge and these skills are a fundamental part of our business.
For many years, insufficient attention has been given to energy and commodity supply issues by governments. These issues unfold over a relatively long time frame and policymakers need to balance long-term needs against short-term political considerations to get markets working efficiently. In the age of commodities, if we do not press ahead with the investments in energy and commodities that we need, there is a significant risk that we will not have sufficient capacity for our needs.
This is not just an issue for China, India and other rapidly growing economies. It is equally a significant issue for the UK – developing policy and market mechanisms which secure our energy future, especially in terms of power generation, in a manner which is both affordable and sustainable. Policymakers have much to address with energy suppliers. We intend to continue to play a key role in shaping this future.