Supercycle or Not, Expensive Oil Is Unavoidable

In an upcoming article in the journal Resources Policy, David Humphreys, former Chief Economist at Rio Tinto and Norilsk Nickel, argues that skeptics are right to question the notion that mineral prices in the 2003 to 2008 period were rapidly uptrending as part of an emerging multi-decade supercycle.

He argues that the rise in demand underpinning steep mineral price increases had two distinct causes: (1) an "extended economic upswing" driven by an ample supply of cheap credit (we know now where that got us); and (2) a "deeper-rooted structural shift in the economy" resulting from the growing industrialization and urbanization of emerging markets, driven in large part by a labor cost advantage.

While Humphreys agrees that mineral resource prices may not continue to increase sharply - once the world emerges from recession - for the next 20 or 30 years as would be the case if we were engaged in a supercycle, he nonetheless disagrees that once supply catches up to demand things will go back to "normal".

Supply catching up to demand means prices reflecting the industry's marginal production costs, or the costs of extracting each incremental unit of resource. Although the increase in mineral prices may not go on for decades, the author argues, there is nonetheless a high probability that the new "normal", when marginal production costs stabilize, will mean substantially higher prices than the old "normal", and that this will become the new reality.

The insight provided by Humphreys applies equally well to oil and gas. Unconventional resources such as oil sands, shale gas and deep offshore drilling, while they will certainly help alleviate the supply-side impact on prices of declining production in conventional fields, will appreciably raise the industry's marginal production costs, thus contributing to higher long-term prices even if stabilization occurs in a matter of years rather than decades.

Either way - whether we are engaged in a supercycle or not - we can now be fairly certain that we are entering a world where some of the natural resources that were essential to our becoming industrialized and wealthy will no longer be cheap, save for the odd recessionary period.

The impact on the prices of final goods will vary based on how labor-intensive they are; for many manufactured goods, cheap labor in emerging markets will continue to limit the price impact of more expensive commodities, whereas for goods where commodity costs account for the bulk of final price the impact will be much more direct.

One of the industries that will be most heavily impacted by this is the car industry because of high gasoline prices. Given all of the hurdles that currently stand in the way of electrification, there is a good chance that we reach, within the next few years, a point where drivers are hit really hard in the wallet by high gas prices but not quite hard enough to justify the much higher expense - both in terms of money and foregone conveniences like trunk space and unlimited range - of an EV or PHEV.

The most likely winner from this, in my view, will be mass transit. As I argued in an earlier article on Obama's high-speed rail plan, mass transit is to transportation what efficiency is to energy; although a renewable kWh is good, an avoided one is even better, and so it goes for EVs/PHEVs.

There are three stocks that I see as potentially major beneficiaries from a growth in mass transit - two rail stocks and one bus stock. The two rail stocks are Bombardier (BDRBF.PK) and Alstom (AOMFF.PK), which I profiled earlier this year. The bus stock is New Flyers Industries (NFYIF.PK), which Tom profiled last year. All three stocks will see material positive earnings impacts from growing expenditures on mass transit, unlike Siemens (SI) that, despite a strong position in rail, is highly diversified outside of transit and unlikely to see success in rail move the needle substantially on the earnings front.

As Tom pointed out in his article on New Flyers, it will take a lot for Americans to change their lifestyles and driving habits. However, all signs point to the fact that "a lot" is what we have coming our way - in fact, it will become the new reality and will have crippling economic impacts if we don't find a way to adjust. Moreover, Americans are no longer the only consumers that matter - North American cities are growing more slowly than Asian ones, our population will most likely begin to decline sometime in the next few years and wealth creation is increasingly shifting to Asia. Many emerging markets are already embracing mass transit and will have a much bigger stake than we do in trying to limit the impact of secularly high oil prices on their economic development.

Disclosure: None

Comments

[Alan Young:]

Sadly, there is no sign that Americans are going to change their transit patterns anytime soon. The Obama administration could have designated stimulus funds on transit projects, but gave us "cash for clunkers" instead--hundreds of thousands of NEW CARS. This doesn't bring us closer to giving up our cars, or moving back from suburbs to cities to reduce transportation costs.

Aug 25 08:14 PM

[kmi:]

Hmm...

I think higher commodity costs will force developing nations to strengthen their currencies even if they don't want to and will create a more level playing field - over time - in global trade.

Likely it will also increase their costs of production and additionally hurt their competitiveness. It makes sense that China is trying to buy up international resources and resource companies before they are forced into that new reality or forced to offload dollars en masse.

I remember reading somewhere that as India became wealthier and their currency strengthened, they both didn't want to do a lot of the grunt work being offshored there from the West as well slowly ceased being competitive.

If I was a developing nation I'd try and hoard up commodities and buy up international companies in the current environment too, it just makes too much sense.

But frankly, I don't see perma higher commodity costs as the new norm, eventually those too will fall... I agree with super cycle theory since it makes too much sense in ways too numerous to write in a post... Higher commodities will stay for a bit until say if the global economy double dips or China offloads dollars or the dollar collapses... but plenty room left to go from the looks of things.

Aug 25 08:43 PM

[31October:]

New cars bought on CREDIT. Even better.


On Aug 25 08:14 PM Alan Young wrote:
> Sadly, there is no sign that Americans are going to change their
> transit patterns anytime soon. The Obama administration could have
> designated stimulus funds on transit projects, but gave us "cash
> for clunkers" instead--hundreds of thousands of NEW CARS. This doesn't
> bring us closer to giving up our cars, or moving back from suburbs
> to cities to reduce transportation costs.

Aug 25 09:52 PM

[chap08:]

The marginal cost of oil will increase, but the price will average even higher than that, assuming we have any global growth. This will stay the case until we discover either massive new reserves, or an economically viable replacement for oil.

Higher oil may or may not change transportation in America. If you want an industry where there is an immediate impact, look at agriculture.

Aug 26 07:45 AM

[Road Runner:]

Charles Morand, Your article has some problems that make your conclusion that expensive oil is unavoidable suspect. Unless you believe that $130 oil is expensive. I don’t. That’s my medium term (10 years) price estimate for oil, though I could see spikes approaching $200 a barrel due to speculation.

First. The link in your article, “hurdles that currently stand in the way of electrification” references to the article “Debunking The PHEV Mythology” by John Peterson. This article should not be taken as the truth. There are many challenges to his premises that can be read at seekingalpha.com/artic....

Second. 45% of oil is used for gasoline in the US, and the US uses about 20% of current world production. We Americans are very wasteful with gasoline. It won’t have much negative effect on our lifestyles and personal economics if we move to much more fuel efficient vehicles. At $130 a barrel (about $3.90 gasoline), there will be plenty of incentive to move to more fuel efficient vehicles, that are available today, even if plug-in vehicles aren’t available at a reasonable price.

Third. The oil sands of Canada cost only about $70 a barrel to extract. And, the cost is dropping with cost improvements and scale. Canadian companies are increasing yearly production at a strong pace. The Canadian oil sands are second only to Saudi Arabia in known oil reserves. Also note that Iraq is not fully online with its oil.

Forth. Much of the current price of oil, around $70, is speculative. Oil is now an investment asset class used to hedge against inflation and the falling dollar. Thus, the “real” price of oil is far below $70. This artificially high price for oil promotes increasing supply and finding alternatives to oil.

Fifth. If is conventional wisdom that oil must move higher. Most people think this. Like with the housing bubble where the conventional wisdom was that housing prices will always continue to increase, oil has the potential to be run up to a very high price (over $150 a barrel in my mind) before the bubble pops.

Aug 26 11:26 AM

[Snitzer:]

America's love affair with the automobile is on the rocks, no matter the loud commercials and so-called "deals" being hawked by dealer/hucksters. The coming demise of "big auto" will be at the hands of mass transit, telecommuting and people simply looking at transportation in new and more rational ways.

Aug 26 11:46 AM

[Road Runner:]

Snitzer, I don't believe American's love affair with the automobile is "on the rocks" at all. In fact, I don't see much life style change as we, Americans, transition to higher mileage and plug-in vehicles.

There is no reason, except vanity, to own a 6 cylinder Toyota Camry. I know this personally. Modern engines and transmissions are far better in mileage and performance than in the past. The 4 cylinder Camry I used to own could be fully loaded with people and luggage and still drive 85 mph in 100 degree heat.

I see plug-in vehicles of the future being the preferred choice because electric drive vehicles perform better than engine/transmission vehicles. Just like the American cool car evolved from the suped-up V8 muscle cars of the 1970s, to the sleek sedans of the 1980s, to the SUVs of the 1990s and now, so it will continue to evolve to the quiet, smooth, and super-peppy plug-in electric drive cars and SUVs of the 2010s.

The American love affair with the automobile will continue strong.

Aug 26 05:07 PM

[Delojozafado:]

America's love affair with the auto is driven by the Gov't which we must suppose is a reflection of the will of the people, not having any national policy to support mass transit. On the other hand we see such things as AMTRK being made a whipping boy for not being able to operate at a profit.

The whole profit thing needs to be taken out of the mass transit issue. If we want to have a national policy reducing oil dependence then we need to do what other nations do and make the riding of mass transit "Too cheap to meter". If you provide adequate service and frequencies then mass transit that costs 1/3 to 1/4 th of what driving a car costs then the consumer will gravitate to a less convenient transportation mode. As it is now even the parking lots at many mass transit stops charge a parking fee. Parking has to be vastly expanded and made free of charge. Increasing costs of labor,maintenance and operation have to be mostly borne by the Gov't to foster the delta of driving to work vs using the bus and train economically disadvantageous. This means toll roads and higher tolls as well ,and high gasoline taxes to subsidize mass transit.

In the end only the Vegan types are willing to vote for that agenda. What do you do for the parts of the country that are thinly populated?
Create a population density coefficient to apply to the higher gas taxes?

Sep 23 08:01 AM