Transcript Trends and Cycles in Metal and Energy Prices

Trends and Cycles
in Metal and Energy Prices
– with a Quick Look at Industrial Sand*
John T Cuddington
William Jesse Coulter Professor of Mineral Economics
Colorado School of Mines
94th Annual Conference – May 20-22, 2012
Casting Industry Suppliers Association - CISA
Bonita Springs, Florida
* Motivated by Chuck Fowler’s presentation late on Day 1 of the conference
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Overview
SWhy do metal and energy prices matter to the casting industry?
SHow can economic analysis help us organize our thinking about
trends, cycles and volatility in prices?
SWhat does the empirical evidence on metal and energy prices
show?
SWhat are the implications of metal/energy price dynamics for
the casting industry?
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The Importance of Metals and
Energy Prices to the Casting
Industry
S Prices are important to casting industry
S Metal and energy prices are key inputs into the casting process
S Casting is energy intensive
S Metal and energy prices have significant impacts on:
S Profitability
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Competitiveness vis-à-vis other forms of casting
S Prices provide key information in decision-making:
S Capacity expansion and upgrades
S Strategic planning
S Input substitution
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Economic Analysis
of Price Behavior
S Standard economic research methodology
S Develop/refine theories
S Study empirical evidence, ‘stylized facts’
S Repeat
S Supply and Demand -- starting point for most analyses of prices
S Nonrenewable resources – are they different? Exhaustible?
S How can anything involving nonrenewable resources be
sustainable?!
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Nonrenewable Resource Markets:
Supply-Side Considerations
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Metals and Energy - multi-step, multi-product production process
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Reserves of nonrenewable resources are intermediate inputs into mining and
milling
Exploration produces ‘inventories’ of reserves of varying quality (ore grade,
multi-ore content, accessibility)
Bulk metals are intermediate inputs in production of either final consumption
goods and/or capital equipment (often involving foundries)
Reserves of nonrenewable primary products change over time
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Discovery and depletion (via mining activity)
Economic value changes as prices and technology change
Reserve/production ratios have not dropped in spite of large increases in
global production
“Fixed stock” view of nonrenewable resources is not particularly useful.
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Supply-Side Considerations Continued
S Mining is very energy and capital intensive
S Short-run supply is often (capital) capacity constrained (i.e.
vertical SR supply curves); input substitution is limited
S Long-run supply is very price elastic (i.e. horizontal LR
supply curves)
S Implication: Long-run price analysis focuses on primarily on
supply
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Technological Change –
‘Drilling for Ideas’
S Technological change occurs at each step of the
multi-step production process
S Increasing globalization due to falling transport costs
and improvements in communication
S Globalization spread multi-step production process
across several countries
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Drilling for Ideas vs. Reserves
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The production process to generate new productivity-enhancing ideas is
similar to the exploration for reserves
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Production process is highly uncertain
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Quality of output varies
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Incentives and property rights are important for stimulating production
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There are often free-rider problems and first-mover advantages
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Secrecy sometimes helps in gaining a competitive advantage – at least for
a while
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To be successful, you can’t rest of your laurels.
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Nonrenewable Resource Markets:
Demand-Side Considerations
S Long-Run minerals demand depends on:
S Population growth
S Growth in per capita income
S Structural transformation that accompanies economic development
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Shifts in the composition of demand (agricultural goods, manufactures, and
services)
Shifts in composition of global supply affects the derived demands for metals
and energy
S Technological change; input substitution Structural transformation is
a key component of ‘super cycle’ hypothesis
S Short-run metals/energy demands are strongly pro-cyclical (global biz
cycles matter)
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Role of Formal Exchange
Markets
S Some mineral product prices are so-called producer prices that change
gradually over time in response to supply-demand imbalances
S Others are ‘flex price’ goods traded on formal exchanges, often with
both spot and forward pricing
S The latter are ‘hybrid assets’ – part real asset, part financial asset
S Forward-looking expectations and ‘news’ drive pricing of financial
assets
S Introduction of formal markets facilitates price discovery and
transparency, but also raises (apparent) price volatility
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Simple Mineral Supply-Demand Model
P
$/unit
D0
D1
SSR
SLR
MC
capacitySR
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Q units/period
What Does the Empirical Evidence
on Metal/Energy Prices Show?
S Looking at longest available data spans:
S Average growth rates in real metal and energy prices are small
S Year to year variability is huge
S Little evidence that world is running out of nonrenewable
resources
S Over 20-70 year periods:
S Prices may drift up or down – reflecting the tug-of-war
between depletion and technological change
S Some evidence of ‘super cycles’ especially in the post WWII
period
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Nominal and Real Oil Prices
400.0
40.0
4.0
0.4
1875
1900
1925
1950
1975
2000
Nominal oil price (BP series) in log scale
Real oil price using the CPI as a deflator in log scale
Real oil price using the PPI as a deflator in log scale
‣ Nominal vs. real crude oil prices using two different price deflators: CPI
and PPI
Trend and Cycle Decomposition
1.0
0.5
0.0
6
-0.5
5
-1.0
4
60
70
80
90
00
10
20
30
40
50
60
70
3
Business Cy cle Component=BP(2,8)
2
+
80
90
00
10
.8
1
BP(2,70)
=
0
.4
.0
-1
-.4
60
-2
1875
1900
1925
1950
1975
70
80
90
2000
Trend component = BP(70,infinity)
Oil price in log terms = BP(2,70) + BP(70,infinity)
BP component = BP(2,70) = BP(2,8) + BP(8,20) + BP(20,70) = BC + IC + SC
00
10
20
30
40
50
60
70
80
90
00
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Intermediate Cy cle Component=BP(8,20)
+
1
P
P
P
P?
P?
0
T?
T?
T
T
T
-1
60
70
80
90
00
10
20
30
40
50
60
70
Super Cy cle Component=SC(20,70)
80
90
00
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Super Cycles in Oil Prices
1.2
SC 1
~1850-1884
Uncertain Period
1884-1966
SC 2
1966-1996
SC 3
1996-?
0.8
0.4
0.0
-0.4
-0.8
1875
1900
1925
1950
1975
SC in real oil price using the CPI as a price deflator
Principal component in the super cycle of metals prices
‣ Trend increased by roughly 125% over the past 65 years (real terms) 
~2%/year
‣ Comparison to Metals, correlation coefficient:
pre-WWII 0.71, post-WWII 0.88
2000
Trend and Super Cycles in Coal Prices
400
SC1
???
18??-1845 1845-1871
???
1871-1918
SC2
1918-1963
SC3
1963-1998
SC4
1998-20??
200
160
120
80
60
40
20
1800
1850
1900
1950
2000
Real price of coal ($/short ton)
Super cycle of the real coal price super imposed on the trend
Trend in real coal price
‣ Downward trend of about -1.3% annually from the Great
Depression to 1972 and -0.5% afterwards
Super Cycles in Energy and Metals Prices
After WWII
1.2
0.8
0.4
0.0
-0.4
-0.8
1950
1960
1970
1980
SC coal prices
SC oil prices
SC metals prices
‣ Especially after WWII
1990
2000
2010
Huge variation in medium-term
trends; Huge Volatility
S Slides that follow show monthly data on nominal U.S. dollar
prices from IMF
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…More on Empirical Evidence
S Metal and energy prices are strongly pro cyclical
S Rise sharply in biz cycle upturns
S Fall fall sharply during recessions
S Metals and energy products traded on formal exchanges are
‘hybrid assets’
S Part financial asset where expectations about future conditions
are key drivers
S Part real asset where supply, demand and inventories are
fundamental determinants of prices
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A More Granular Analysis: Real Price of
Industrial Sand with LT Trend – 1902-2010
(USGS)
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A Super Cycle in Real Sand Prices – 19022010 (USGS)
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Implications for the Casting Industry
S Long-term contracts to supply casted products are risky when long-
term trends (20-25 years) in key input prices are difficult to predict
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Long-term investments in capacity and/or new technologies are risky
‘Real options’ to adjust production mix, capacity, input supply sourcing,
etc. are valuable
S Link between nominal mineral price movements and general inflation
is surprisingly weak
S Some input price risk can be passed on to consumers of your products
S Short-term price risks can be addressed with financial hedging
strategies
S Exchange rate effects on dollar metal and energy prices can be large.
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Thank You!
S Your hospitality in this beautiful setting
S Opportunity to learn more about foundries, the casting
industry, and its suppliers
S Please explore collaborations with faculty and graduate
students in our Mineral and Energy Economics Program
S My e-mail: [email protected]
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