Commodity and Oil Price Shocks

Mar 7th, 2011, in Business & Economy, Featured, News, by

Headwinds for the economy as the price of oil skyrockets.

While some put the unrest in the middle east down to a popular yearning for the ability to vote the Muslim Brotherhood and similar groups into power the reason is more prosaic: rising prices, especially food and other basic commodities.

One year corn price chart:

Corn Futures

One year wheat:

Wheat Futures

Not just food:

Cotton Futures

Importantly for Indonesia, rice, has not quite joined the party, yet, although famed investor Jim Rogers is 'bullish' on it, which is a bad sign...

Rice Futures

And now oil; three month crude oil futures:

Crude Oil Futures

Now above the key $100 level, with some, such as Jim Rogers again, forecasting $150 oil soon.

Background: the 2008 stockmarket crash in the US was preceded by a massive liquidity shortage among large banks; the US Federal Reserve's response to this was "quantitative easing", a policy to increase liquidity, basically print more and more dollars, to encourage fearful banks to start lending again, spur on economic activity and prop up the stock market; when liquidity increases, so does inflation, and because the dollar is still the world's reserve currency, this inflation gets exported all over the globe, resulting in the rising basic commodity prices as above.

Back to oil. 'Premium' fuel is subsidised to the tune of about 40% at the pump in Indonesia. The 2010 budget allocated 88.9 trillion rupiah for subsidies, while at this year's budget the subsidy had to be increased to 95.9 trillion, but this figure was based on an average oil price of $85 per barrel, well below the current level.

Hatta Rajasa, the coordinating minister for the economy, said in late February that a plan to reduce the subsidy had had to be shelved, due to the rising cost of oil, thereby guaranteeing a much higher burden for the state.

In neighbouring Thailand they have a similar issue with fuel subsidies, but seem to be coming to the reverse conclusion as to what to do about it: Thailand may remove oil subsidy as fund runs out

Thailand's state Oil Fund has fallen to about 7 billion baht ($230 million), the Energy Ministry said on Friday, suggesting the government may soon remove a fuel subsidy

So there is a bind: reduce the subsidy to save money/maintain finances (possible Thai route), or maintain the subsidy to.... lighten the burden of the people/prevent civil unrest (Indonesia).

We shall see which is the wiser policy.


4 Comments on “Commodity and Oil Price Shocks”

  1. avatar Odinius says:

    David,

    There’s a lot more to rising commodities prices than just liquidity in the US market, which I don’t even think is all that important for a place like Indonesia, really. Even as dollar prices rise as a result, the value of the dollar decreases in relation to currencies in commodities-exporting countries, e.g. Indonesia. The US thus gets stuck with a double rise in commodities prices; Indonesia gets one upward pressure and another downward one.

    Another part of the equation, which really can’t be ignored, is new large-scale sources of demand for once cheap commodities. Corn, for example, is being bought up in large quantities for production of ethanol, which drives the price up. China and India would be the other major sources of demand. The Chinese export-driven economy is historically thirsty, and only the necessary commodities for its export industries can quench this thirst. With more product going to China and India, there’s more competition for existing supply. More demand without more supply = rising prices.

    Finally, there’s certain environmental pressures on the supply-side unique to this year. Very unpredictable weather in the US, Europe and Asia have created much smaller-than-usual crop yields for a lot of things. Aren’t domestically-produced cabe rawit now something like six times their normal price? Unprecedented political turmoil in the Middle East, meanwhile, has ratcheted up the pressure on oil prices.

  2. avatar David says:

    Right I didn’t mean to say it’s the only reason, certainly there are the weather issues, etc and ethanol for corn, rising demand. I didn’t put up the cocoa chart but there it’s political problems in Ivory Coast playing a large role. But I do think the liquidity issue is very important, all those extra dollars have to go somewhere, they are going into general stock prices to some extent but the major ‘beneficiary’ of it is the commodities area. This is the commodity chart, at all time highs

  3. avatar ET says:

    If economic forecasts would be as reliable as the weather forecasts we would all be rich.

  4. avatar realest says:

    bad weather, bad harvest => exporter turns to net importer for food. threat of revolution causes massive stockpiling to ward off hungry poor masses increasing demand and price. commodities futures speculators jacked the price up, didnt help. corn, wheat – animal feed. mid-year harvest period hopefully successful. exporter feeling heat at 8700 idr appreciation, would riot at 8200(i hope not). hatta rajasa should crawl back to that hole of a dump he came from. keep 30% portfolio xau bullion, tracking 150 ma closely, still smiling since sept 😀

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