Agricultural Commodities in Light of Peak Oil

by: Kay McDonald

The subject of Peak Oil seems timely this week, as it has been pointed to in a number of news-worthy articles and video interviews. It is imperative to stay informed on this issue. This article hopes to provide some of the latest pertinent information on the subject while tying together how agricultural and oil commodities may relate to Peak Oil.

Similar Economic Dynamics

Agricultural commodities share similar economic dynamics to oil production. There is supply and demand. There are important policy drivers including subsidies, taxations, and price supports. There is slack in both systems. Profit motivates each sector to produce product. Unpredictable variables are contained in each including weather, politics, and unrest. Each reacts similarly to macro economic conditions.

As the Bubbles Pop

Where it becomes interesting is in the transition between our bubble economies, which have an illusion of appearing more affluent than they really are, to global bubble popping economies which, by necessity, are forced to cut slack from the system. Right now, there is nothing more desired by economically challenged nations than the desire to export. In OPEC's case, this means producing oil, and going against production quotas in a selfish "get more" for "me" mentality. BBC news reported recently that OPEC compliance with production targets fell to 55-56% last month compared with 80% a year ago.

Oil demand is lessened during a recession, so surpluses cause the oil price to fall. Producers revenues fall, resulting in less investment going towards future oil production.

And what might that lower oil output time frame be?

From the UK Guardian, Chris Skrebowski, independent oil consultant, estimates a decrease in oil supplies to hit the danger zone frighteningly soon. He says,

The next major supply constraint, along with spiking oil prices, will not occur until recession-hit demand grows to the point that it removes the current excess oil stocks and the large spare capacity held by Opec. However, once these are removed, possibly as early as 2012-13 and no later than 2014-15, oil prices are likely to spike, imperiling economic growth and causing economic dislocation.

In a recent Marc Faber interview, he states that right now it costs $70 to find oil, so if the oil price drops below $50 nobody will go look for oil. Costs and efforts to drill deep water projects and other difficult to access fields are escalating, making the energy returned on the energy invested less and less. With our currently lower oil prices and lower energy company profits, less investment is going on to promote future production. The energy sector is struggling.

Another viewpoint is from Chris Nelder, who says,

...the decline of imports from Mexico and Venezuela means the U.S. will be increasingly forced to depend on suppliers farther afield–the very same suppliers that China has been buying into in size....The oil export crisis has arrived. We just haven’t felt it yet.

He uses this graph to illustrate his statement:

The combined annual net oil exports from our top three exporting countries–Canada, Mexico and Venezuela–illustrate our situation.

oil exports us%2C canada%2C mexico

Source: Jeffrey J. Brown, Samuel Foucher, PhD, Jorge Silveus.

To follow, CNBC interviewed Dr. Robert Hirsch and John Kilduff on February 9th, on this subject of peak oil, in which Dr. Hirsch says,

Oil prices are going to go up dramatically and GDP is going to go down and there will be no quick fixes because we can't print oil.

Back to Agricultural Commodities

By the same token, agricultural commodities are an important export product for many nations. Input costs are closely tied to oil costs. Currently, there is slack in the system as production continues to increase and is adequate for growing global populations.

As nations are further weakened financially because of debt burdens, governmental farm policies will require cutting fiscally unproductive programs. (Look at Greek farmers positions today if you want a preview.) This may result in an ability to produce more edible grain commodities for a while, for a number of reasons. One, biofuels programs may be abandoned. Two, there may be less demand as less affluent populations switch to grain-based diets. Three, sadly, there will be less money for food aid, evidenced already in our current crisis. Oil price levels will be key in input costs, which will further determine policy and production levels.

In timing, grain and agricultural commodity production levels may likely lag and reflect escalating oil costs inversely. This means that consumers may be squeezed by food and energy costs at about the same time, with high energy costs slightly preceding high food costs. It will depend upon how much slack can logically be worked out of the grain commodity production system, as well as the slack in the oil use system.

Whereas the agriculture commodity production is affected by variables such as weather, there is the political instability wild-card in oil production. Increased costs of these basic necessities may be timed to coincide with the transition from a deflationary money supply environment to a hyper-inflationary one.

In Conclusion

I'd expect agricultural grain surpluses during our current deflationary time period to result in lower agriculture commodity prices, as I wrote here last July. This will be followed by lower production, which will eventually lead to higher prices after slack is removed from the system, as with oil. Input costs will grow, further reducing profits, which, in turn, will reduce output. Governmental farm policy in a debt laden nation will be forced to cut back subsidy supports for production and protectionism may come into play. If resulting decreased production is accompanied by a transition from a deflationary to a hyper-inflationary environment, then commodity prices will be set to go through the roof and become dangerously unaffordable sometime down the road for both oil and food commodities.

Everything occurring up until then is just a sideshow.

Which brings us to the Olduvai graph, in case any readers here are unfamiliar with it. The interpretation would mean that by 2025 we will be back to where our ancestors were in 1930. A picture is worth a thousand words, isn't it?

The Olduvai Theory of Industrial Civilization

Disclosure: No stocks, commodities, or ETFs held.