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These are just two of the headlines we have been seeing in publications both locally and globally over the past couple of months. Recently, oil and copper prices have increased substantially and in this article we take a closer look at some of the drivers responsible for these increases.
Oil
Year to date the price of oil has gained 19.25 percent, with prices increasing from $95/barrel to over $113/barrel. Oil price movements are not only a function of supply and demand, but are at times also driven by fear. A combination of these two factors resulted in the increase that was recently seen in the oil price.
The "fear" factor materialised when political unrest broke out in the North of Africa. As a result, this affected the basic supply and demand factor as oil production started to decline which in turn caused markets to panic, resulting in an increase in oil prices.
Political unrest first broke out in Tunisia and fears of contagion were then realised when political unrest migrated east into the neighbouring countries of Egypt and Libya. With the unrest now moving closer and closer to the world’s biggest oil producer, Saudi Arabia, it’s easy to understand why markets are starting to feel uneasy.
According to the International Monetary Fund (IMF), a general guideline is that a 10 percent increase in the price of oil reduces global GDP growth by between 0.2 percent and 0.3 percent. If one follows this guideline, then the year to date increase in the oil price of roughly 20 percent will result in the decline of global GDP by between 0.4 percent and 0.6 percent. A secondary consequence is that higher oil prices will put upward pressure on inflation.
It’s likely that oil price increases will affect emerging markets such as China and India more so than some advanced economies such as America due to their already high inflation rates. The impact of oil price increases will also generally be felt more in some emerging markets as the weighting to energy and food in their inflation basket is much higher, compared to that of some advanced economies.
However, this does not mean that advanced economies will not be affected. Advanced economies such as the UK, that are currently struggling with already high inflation rates and weak economic growth, will most definitely be affected resulting in even weaker economic growth and placing additional upward pressure on inflation.
Besides the factors contributing to a possible increase in the oil price, the recent natural disaster in Japan, the world’s third largest economy, might have an adverse effect on economic growth, and as a result affect demand going forward.
Copper
Copper is classified as an industrial metal and is very efficient in conducting heat and electricity. This metal also has other characteristics which include durability, strength and being corrosion resistant. All of these factors contribute to copper being an extremely versatile metal that has a variety of uses.
Demand for copper is correlated to per capita GDP growth which, in layman terms, means that as an economy expands and urbanisation rates are increasing one tends to see the demand for copper increase. The graph below illustrates the correlation of copper prices to Chinese GDP growth.
Global demand for copper is also driven by spending on infrastructure, electronics, household products, industrial products and automobiles. Although developed markets demand a substantial amount of copper it is emerging markets, such as China, who demand such vast amounts of copper that they can actually influence copper prices. As a result one might say that copper demand is mainly driven by emerging markets as opposed to the more advanced economies.
The world consumes on average 2.7kg of copper per capita on an annual basis. India consumes on average 0.47kg of copper per capita on an annual basis. China, on the other hand, consumes on average 5.4kg of copper per capita on an annual basis. This means that China consumes, on average, twice the amount that the rest of the world consumes and a staggering 11 times more than India.
What is even more extraordinary is the fact that China is expected to increase its current annual copper consumption from 5.4kg per capita to a massive 10kg per capita in the future.
Copper prices have increased significantly over the past eight months, with prices increasing by 51.3 percent from $6515 at the beginning of Q3/2010 to $9857.5 at the end of February 2011.
Globally, a copper supply deficit of between 500 000 and 600 000 metric tons per annum is forecasted. Rio Tinto, one of the biggest mining companies in the world, commented that copper supply might not be able to meet world demand over the next decade.
There is a negative correlation of copper prices to copper stock levels. Over the long term copper prices have generally been higher when copper stock levels declined and declined when copper stocks increased.
More recently we have seen a positive correlation between copper prices and copper stocks. This can mainly be attributed to fears of supply shortages and the fact that even though copper stock levels have increased, demand has outstripped supply.
China recently released its 12th five-year plan for National Economic and Social Development. Some of the development projects mentioned in the report include:
- Upgrading of existing ports as well as building new ones
- New airport
- New hospitals
- Spending on highways, conventional rail and high speed rail
- Investing in both nuclear and hydro-power plants
- Developments in fuel pipelines
- Spending on transmission networks
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