Global downturn leave costly empty vessels
The global shipping industry is associated with huge internal economies of scale and where demand is closely tied to the fortunes of industries such as iron ore, oil and coal but also to the world economic cycle. Things are looking grim for shipping operators who have bet hundreds of millions of dollars on expanding a fleet for which there is now substantially less demand.
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OPEC’s biggest cut
The oil export cartel OPEC has announced the biggest ever cut in planned production in a bid to rebalance supply and demand in a market where crude oil prices have fallen by over two-thirds (> $100) within the space of a few months.
OPEC is reducing output by 2.2 million barrels per day – on top of the 2 million contraction in supply announced earlier on this autumn. The total cut in production is equivalent to lowering global oil production by around 15 per cent. OPEC – which accounts for forty per cent of world oil production – has a supply target of 24.845 million barrels per day
It was significant that Russia – the world’s biggest oil producer outside of OPEC was invited to attend the meeting. But in the immediate aftermath of the announcement they said that they will not join the attempts to restrict supply and that they do not wish to consider joining OPEC at this stage. The first reaction of international commodity markets to the OPEC supply cut was to reduce prices still further!
Demand and supply forces
OPEC’s attempts at stabilising the price through lowering output quotas will only have a marginal impact on the world price. Demand-side factors have taken over as the dominant driver of the price of crude oil in the short term and with the global economy set to suffer a recession in 2009 there is precious little that OPEC can do for the moment.
Price and marginal cost – the value of extracting oil from the ground
This short quote from the Saudi oil minister reveals some important microeconomics:
“You need every producer to produce and marginal producers cannot produce at $40 a barrel.”
Extreme price volatility in the markets for primary commodities such as oil, gas and iron ore creates headaches for producers who must commit huge and expensive resources to exploring, drilling, extracting and then refining their basic output
Marginal cost is the change in total cost resulting from supplying one extra unit to the market – in our example, the marginal cost is the expense of extracting an extra barrel of crude oil from below the ground. It is a widely held belief among economists who specialize in commodity prices that the long-run market price of something is determined fundamentally by the marginal cost of production. The resources that can be tapped at lowest cost are often done so first, and then as it becomes progressively harder to unearth such resources the market price must rise to provide an economic incentive to do so.
One immediate problem is that, because oil is a non-renewable resource lying in geological structures that vary enormously in location, weather, depth and many other variables, the cost of extracting new supplies is hard to determine. Many OPEC countries – especially Saudi Arabia – have access to relatively cheap and elastic supplies of oil. But the same cannot be said of crude oil producers in Canada’s tar sands and oil companies who have sunk huge amounts of money into exploiting the oil available in deep-water facilities off the west coast of Africa or in Brazil.
The fact is that for many oil-exporting countries, the price for each barrel of crude oil extracted needs to be higher than the marginal cost of production for national governments to generate sufficient income to pay for ambitious public spending projects.
So whereas the Saudi government can expect to balance its budget when world oil prices are hovering at around $55 per barrel, prices need to be closer to $70 a barrel for the Russian government to earn enough oil revenues to pay for their state spending. And that figure rises to more than $95 a barrel for countries such as Iran and Venezuela.
If prices fall below the marginal cost of production will we see a sharp contraction in supply? Economic theory would suggest yes for, if crude oil prices slump to below $60 or $50 a barrel, petroleum companies with above-average production costs may decide that the price has fallen below the short run shut-down point and opt instead to mothball oil wells, because pumping oil out of the ground has become a licence to lose money.
Indeed the fall in production may be much larger than this – because exploration and development is an expensive business. Oil companies need to know that the price they can command in the market will be persistently above the marginal extraction cost in order to cover the fixed costs of production and the expected rate of profit demanded by shareholders.
It looks like OPEC is targeting a price of $75 a barrel as a ‘fair price’ for oil producers. Given the weakness of the world economy, that might take some time to happen.
Suggestions for further reading:
The Times: OPEC makes largest ever cut to oil production
BBC: OPEC agrees record oil output cut
Coal and CO2 emissions - Poland
Almost all of Poland’s power comes from coal and much of the cheap brown coal is very expensive in terms of CO2 emissions.
This level of dependency on a dirty fossil fuel has been headlined this week as the climate change conference in Poland confronts how best to cut emissions. The BBC environment correspondent David Shukman has been at Poland’s largest mine in Belchatow and his report provides a good resource on the issue of how best to encourage some of Europe’s emerging market economies to lower their emissions.
Half of Chinese toy exporters go under
A year or so ago the super-container ship Emma Maersk slipped in Felixstowe Harbour and started to unload - for thousands of British kids, Christmas had arrived because the vessel was carrying perhaps the biggest ever consignment of Chinese maufactured toys en route for specialist toy stores and supermarkets across the land.
Now the picture seems to be changing with remarkable speed. An official Chinese news agency has stated that more than half of China’s toy producers have gone bust over the last twelve months. If accurate, it is a staggering statistic. Most have gone under because of falling demand from Western markets, the impact of a rising Yuan most notably against the US dollar. And also because of the damage to the reputation of Chinese manufacturers from the expensive recall of toys by suppliers such as Mattel. Tougher safety standards are increasing the production costs of Chinese exporters at a time when demand for toys is being hit by the credit crunch.
Following the fears over the safety of Chinese toys, many Western government have raised safety thresholds and also revoked the export licences of producers. China’s supremacy in making ultra-low cost toys (which still sell in retail stores at a sizeable mark-up) seems to be coming to an end. Yet another reason for a marked slowdown in the Chinese economy in the months ahead.
Sharp fall in commodity prices
Whilst the media’s attention has been focused on the turmoil in the global financial markets, one of the key developments in recent weeks has been the steep decline in the prices of a basket of commodities as measured by the Economist Commodity Price Index. Palladium is down as world car manufacturing starts to contract, the global price of wheat has halved since April, oil prices have declined although steel prices continue to surge higher.
The fall in commodity prices will provide welcome relief for countries suffering from the prospect of stagflation but will also impact on many developing countries whose terms of trade improved sharply when the recent surge in prices took hold.
The links between commodity prices and real economic cycles are well established. But how are commodity values affected by persistent news of financial distress in the money and capital markets?
I have put a selection of price charts into this word file
Back to the cave or a brave new world?
I popped over to a meeting of Eton’s Geography Society tonight to hear a talk from Mike Mason, the climate change entrepreneur and founder of Climate Care the carbon offsetting business which has recently been swallowed up by JP Morgan Chase to form part of their JPMorgan’s Environmental Markets group.
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China’s cut price export machine misfires
How much longer will China’s export machine - built on selling low cost manufactured products to the rest of the world - continue to grow at double digit rates? In an important article in today’s Sunday Times, Michael Sheridan argues that
“The fabled “China price” of cheap consumer goods has kept global inflation low, undercut workers in every industrialised nation and brought millions of Chinese peasants into a raw capitalist economy. That phase of globalisation may now be coming to an end, economists say. The export machine that powered China’s spectacular growth is slowing as the cost of manufacturing in China and shipping goods to Britain goes up daily.”
Rampant wage inflation, the huge rise in global shipping costs and an appreciating currency - all of these are having an impact on China’s cost competitiveness. The OECD for example is forecasting that the annual growth of Chinese exports will halve in 2008 and 2009.
Here is the rest of the article
My Chinese economy chartroom poster set is now available.
read more...»Investing the proceeds of the oil bonanza
This BBC article focuses on the ways in which the Brazilian government is seeking to use the revenue from oil exports to boost the economy’s long run economic growth potential and reducing poverty. There is a neat line in here about the importance of value added - from moving away from dependence on exporting crude oil to selling derivatives of oil that carry a higher value in world markets. Yet another country looks poised to establish a sovereign wealth fund to manage some of the assets that come from selling black gold to the rest of the world.
China’s currency manipulation to soften the slowdown
Perhaps fearful of a steep slowdown in exports to a weakening global economy, the Chinese monetary authorities appear to be engaging in another bout of active manipulation of the Yuan in the foreign exchanges.
read more...»Globalisation and the skills bias of world trade
The latest edition of the Economic Journal contains new research by Paolo Epifani and Gino Gancia that focuses on the skills preium for highly skilled workers in an age of globalisation. Whilst increasing economic integration between countries has undoubtedly contributed to a process of income convergence across nations, one of the paradoxes it that it can also lead to greater pay and earnings inequalities within countries - this research helps to explain why.
“Since the mid-1970s, the wage gap between high-skilled and low-skilled workers has widened. At the same time, world trade has increased dramatically: between 1980 and the late 1990s, the share of countries ‘open to trade’ rose from 35% to 95%, and the volume of trade of the average country rose from 59% of national income to 74%....Globalisation increases the size of the market firms can access. Some industries can take advantage of a larger market more easily than others as they benefit from ‘economies of scale’.The study argues that those industries that take advantage of a larger market are more likely to employ skilled workers, and so the wages of skilled workers will rise faster than unskilled workers in a period of globalisation.”
The rest of the media briefing on this new research is available here
From supplier to buyer - China’s impact
Jack Ma (chairman of Alibaba Group) writing in the Financial Times reminds us of an important shift in trade flows between China and the rich advanced nations. Although growth in the Chinese economy is slowing down her export growth will continue to remain strong because of fundamental comparative advantages - but supporters of protectionism often fail to look at the other side of the ledger - the very fast growth of import demand into the Chinese economy - China is becoming a powerful global buyer and not just of mineral supplies from other developing nations.
“While there is a lot of competition from cheaper alternative markets, such as India, Bangladesh and Vietnam, nothing can beat China’s vast choice of products and suppliers. Over the years, Chinese suppliers have redefined themselves beyond pricing and sharpened their advantage in terms of quick turnround, good infrastructure, speed to market and compliance with international standards…..China’s role as top supplier, and now a leading buyer, is causing a new economic phenomenon that should be embraced rather than feared.”
Moscow coffee had better be good!
Over £5 for a standard cup of coffee would stagger most of us but it has become the norm for expats living in Moscow - officially the world’s most expensive city and a fact already well known to the thousands of Manchester United and Chelsea fans who travelled to the Champion’s League final last May.
read more...»Plenty of room at the Beijing Inn
The long awaited financial bonanza for Beijing’s hotels during the forthcoming summer Olympic games seems less likely to materialise with the news that many 3 and 4 star hotels remain vastly under-occupied with the games just a few days away. It seems that the expected influx of nearly 500,000 visitors from overseas will prove to be an over-estimate - tourists appear to have been put off by the cost of travelling, fears over security and the time and expense of arranging visas. Domestic visitors from elsewhere in China seem to have been affected by the massive earthquake in south-west China and the snowstorms that struck the south in February.
The response of hoteliers when market demand turns out to be lower than forecast is a classic form of second degree price discrimination - reducing rack rates in a bid to increase the take up of unsold rooms. Given the travel distances involved, it would appear unlikely that the price reductions will have much impact in enticing people onto planes bound for Beijing this August. Most of the four or five star hotels will already be full of Olympic dignitaries most of whom wont have to pay a penny for their time at the Games.
Jim O’Neill on Globalisation
Jim O’Neill the Chief Economist of Goldman Sachs writes on the benefits of globalisation for the UK economy in today’s Sunday Telegraph
“For the nation that provided the English language to the world, that provides the link between east and west in terms of time zones, globalisation - the major structural trend of our generation - is going to become an ever greater bonus….At the heart of all of this is the expansion of the so-called BRIC economies. The emergence of Brazil, Russia, India and particularly China, closely followed by another group of emerging economies with large populations that we have dubbed the “Next 11”, will drive our future.”
Jim spoke at the Keynes Society in February and there is a report here
Dancing with Dragons
One of my students, newly retired from the school Economics department, is venturing across China to experience first hand, the manifestion of China’s phenomenal economic growth - not to mention having a lot of fun too! Judging from his excellent blog from his journey across India last year, it should be a great read. Here is his travelogue / blog.
Nostalgia wont help central bankers
Stephen King has been pushing hard the view that central bankers in developed countries (with the possible exception of the ECB which last week raised interest rates) have been too slow to react to the seismic change in the balance of power in the world economy. He has read the copious minutes of the monthly meetings of the US Fed and the Bank of England and has found rather scant reference to any of the economic developments in emerging markets. The world is changing and perhaps our monetary policymakers are not giving sufficient weight to the likelehood that commodity prices will remain much higher than their forecasts risking embedding a worsening trade-off between economic growth and inflation.
He writes:
“The biggest single economic problem facing the developed world is the deteriorating trade-off between growth and inflation. This is happening primarily because of the impact of strong emerging economic expansion on global commodity prices ............China has become the world’s most important marginal consumer of energy in recent years. It now consumes more energy than the whole of the European Union and isn’t too far behind the US. If China’s economy overheats, it’s no longer an internal Chinese prob-lem: through global commodity markets, China’s overheating becomes a problem for the rest of us as well.”
The rest of his article is here
High oil prices threaten Asian trade model
Ambrose Evans-Pritchard is on good form in the Telegraph today looking at how the spike in oil prices is theatening the very basis of the Asian trade model. In a world where distance now costs money - ever-rising freight charges are acting like an import tariff for countries whose export-led growth has been built on mass volume manufacturing and the ability to transport these products in huge bulk around the world’s shipping lanes at a relatively low cost.
“The manufacturing revolution of China and her satellites has been built on cheap transport over the past decade. At a stroke, the trade model looks obsolete. Asia’s intra-trade model is a Ricardian network where goods are shipped in a criss-cross pattern to exploit comparative advantage. Profit margins are wafer-thin. Products are sent to China for final assembly, then shipped again to Western markets. The snag is obvious. The cost of a 40ft container from Shanghai to Rotterdam has risen threefold since the price of oil exploded….........globalisation has passed its high-water mark. The pendulum will now swing back from China to America. The mercantilists will have to reinvent themselves.”
The rest of the article is here
A View from China’s Middle Kingdom
Tom White has been in China in the last few days and I recommend his post over at the Business Studies blog. Here is the link.
Infrastructure and Growth
Two recent stories published by the Economist are useful in understanding the significance of investment in critical infrastructure and sustaining long run economics growth
read more...»Tariff taken to the cleaners
Tyler Cowen’s Marginal Revolution alerted me to this neat story about the unintended consequences and costs of import tariffs
read more...»IMF and HSBC Economists on Global Shock Absorbers
Students revising for essays on globalisation might like to take a quick look at this new article by Charles Collyns and Krishna Srinivasan from the IMF and published in the Singapore Business Times. The article focuses on three structural changes in the balance of power and influence in the world economy which link to the reduced influence of the USA on global economic activity.
read more...»China’s Inflation Problem
China’s inflation rate has climbed to a twelve year high with consumer prices 8.5 per cent higher than they were a year ago. Much of this is the result of the spiraling cost of food (22 per cent higher over the last twelve months).
read more...»Renault-Nissan announce entry into low-cost car market in India
The battle is intensifying to develop, manufacture and sell low priced family cars to meet the burgeoning demand from consumers in emerging markets. Renault and Nissan announced today that they are entering into a joint venture with the India firm Bajaj Motors to jointly build a $2,500 car to compete with Tata Motors’ Nano mode. A new 400,000 capacity plant is being built in Chakan, Maharashtra and the aim is to bring the car to the market in 2011.
read more...»Brazil - on course to be a superpower?
The Independent carried an article on the development of the Brazilian economy last Friday - here is the link - the BRIC analysis from Jim O’Neill and his team at Goldman Sachs continues to carry much weight and we tend perhaps to focus too much on China and India!
“The Brazilian stock market, already buoyed by the boom in prices for the country’s commodities and other exports, has surged to a record level this week on news that Standard & Poor’s, the credit rating agency, has declared the country to be “investment grade”. Specifically, that is a stamp of approval on Brazilian government debt, but it is also the culmination of Brazil’s long slog away from financial crisis, hyper-inflation and democratic sclerosis. The country might finally be about to deliver on its promise as an economic power.”
World Bank Development Indicators 2008
The latest World Bank Development Report is now available here. As usual there is a veritable cornucopia of interesting and revealing evidence on the changing shape of the global economy. A lot of the data is available for free as are pdf versions of selected chapters from the main report.
Brazil’s widening wealth gap
Gillian Lacey-Solymar, Business correspondent for BBC Newsnight has a piece on tonight’s show about the rising inequality in Brazil as her economy continues to experience breakneck growth. Expect an excellent video clip to be available from the BBC web site immediately after the Newsnight programme has aired. Excellent for highlighting the links between growth and income and wealth distributio, especially with a tax system that appears to have regressive effects on the lowest income earners.
Revision: China and the UK Economy
Events and developments in one country inevitably have spill-over effects onto others. Your economics revision should consider some of these inter-relationships wherever possible. It will certainly help your analysis and evaluation. In this revision note we look at China
Revision note:
Revision_China_Effect.pdf
Asian Rice Crisis
The credit crunch is rivalled, arguably, by increasing food prices as a cause of economic (and human) concern in 2008.
This article from the BBC looks at some of the implications and you can watch/show videos on the rice crisis here.
read more...»Chart of the Day: China’s imports of primary goods
We often read about the size of the ‘China effect’ on the demand for and prices of primary commodities traded around the world. This over-simplification ignores the impact that other emerging market economies are having on the consumption of primary products – indeed a much greater proportion of global economic growth is being provided by the resource-intensive emerging economies. Added together, the emerging economies account for 23% of global GDP whereas the US accounts for around 29%.
read more...»Chart of the Day: $6m per minute - hot money flows into China
The Chinese stock market is down and property prices have been falling in many of the major cities and the Chinese trade surplus is starting to diminish. But short term capital flows are surging into the Chinese economy at the moment - according to research from HSBC Global Economics,
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