Commodity supply constraints and demand from emerging markets mean it’s premature to talk about the death of the super cycle that brought a longer-than-average period of rising prices, McKinsey & Co. said.
Energy, metal and agricultural prices that more than doubled since 2000 are still close to highs reached before the financial crisis, even after commodities from gold to wheat dropped into bear markets, McKinsey said in a report today.
The surge in raw-material output in the past two years and signs of cooling economic growth in China, the world’s biggest consumer of everything from cotton to zinc, prompted Goldman Sachs Group Inc. and Citigroup Inc. to say the super cycle ended. McKinsey said producers are being forced deeper into remote areas to secure supplies that require increasingly sophisticated technology to extract as consumption expands.
“When we look forward, we see a separation between new technology and productivity on the one hand, and emerging-market demand and supply constraints on the other,” Fraser Thompson, a senior fellow at the McKinsey Global Institute, said in a telephone interview from London. “We don’t want to bet against technology, but what we think often gets overlooked is the scale of the challenge we’re facing.”
The Standard & Poor’s GSCI Spot Index of 24 raw materials has dropped 2 percent this year. Since 2000, the gauge posted only two annual declines.
Production expenses continue to escalate for many commodities, according to the report.
Arable land in China is being built over as the nation urbanizes while in Brazil prices for farmland have jumped as much as sevenfold in some regions over the past decade because of rising global food demand, stricter environmental laws and expansion of protected areas.
McKinsey cited offshore oil fields that require more sophisticated equipment and mineral resources developed in politically unstable regions.
While there are no imminent shortages, higher marginal costs “appear to be pervasive and put a floor under the prices,” McKinsey said. Volatility is increasing amid evidence of a “structural supply issue,” according to the report.
“Supply appears to be progressively less able to adjust rapidly to changes in demand because new reserves are more challenging and expensive to access,” McKinsey said.
The inflation-adjusted average cost of starting a new oil well doubled in the past decade, according to McKinsey. Metal mines now take as much as 20 years to develop, from six to 10 years in the 1980s and 1990s, Thompson said.
Natural gas extracted from shale is an exception as new technology lowered costs, McKinsey said. Increased efficiency in drilling and hydraulic fracturing make it economical to tap gas trapped in shale formations, such as the Marcellus in the U.S. Northeast. Gas futures on the New York Mercantile Exchange have dropped to $3.493 per million British thermal units from a record $15.78 in 2005.
Slower growth In China may do little to alleviate the outlook for tight supplies in other materials because the size of the Asian nation’s economy means that it is using more resources than a few years ago, Thompson said.
Population shifts to cities will also drive consumption, according to McKinsey. The firm estimates that 750 million more people will live in cities by 2030 in China and India. As incomes increase, China may add floor space every year that amounts to 2.5 times the entire residential and commercial square footage in Chicago, according to the report.
“Even if China’s economic growth rate slows down from where we originally thought it would be, it matters less for resource demand than many people assume,” Thompson said. “China and India are a lot bigger than they were at the start of the century.”
McKinsey, founded in Chicago, has 102 offices around the world. The consulting company didn’t provide price forecasts.