March 14, 2013

Resource Scarcity and Economic Growth

Gregor McDonald dissects two recent forecasts, deeply conflicting, on the relation of resource constraints and economic growth, “A Tale of Two Forecasts,”, December 20, 2012: 

Despite declaring in 2008 that the age of cheap oil was over, the International Energy Agency (IEA) surprisingly announced last week that the United States would become the largest oil producer in the world by 2020. Hooray! This superlative declaration titillated U.S. media organizations, who understand quite well that Americans love to secure a #1 ranking in just about any category (save for prison incarceration, divorce rates, and obesity) . . . . However, the IEA has done little more than produce an attention grabbing headline here. Simply ranking the ‘top oil producer’ in 2020 may mean much less than the public currently understands. 

This announcement has since led to the magical thinking that we can somehow take ownership of this future “extra oil” not 8 years from now, but rather…. today. In other words, the additional 3 mbpd (million barrels per day) of crude oil and the 1 mbpd of NGL (natural gas liquids) that the IEA forecasts for 2020 have suddenly been booked into the “readily-available” column and are already being factored into U.S. growth projections. That is premature, to say the very least. 

In contrast to the IEA’s report was the grim outlook recently offered up by legendary investor Jeremy Grantham, of GMO in Boston. Mr. Grantham has been increasingly sounding the alarm on a future of significantly lower growth rates for some years now. It is rather obvious, as well, that Grantham has been methodically making his way through the reading list of resource scarcity scholarship over the past five years, taking in the views of everyone from Joseph Tainter to Jared Diamond. Combined with the available data, Mr. Grantham has come up with the rather unsurprising conclusion that the rate of future growth is set to be much lower than most anticipate. In Grantham’s view, there will be no return to normal growth as was enjoyed in the U.S. in the post-war period (after 1945). 

Reactions to Grantham were predictable. Has he lost his mind? And of course: Grantham goes Malthusian was another common refrain. . . . .

It’s clear that very few understood what Grantham was really saying.

Moreover, many were mistaken that Grantham has adopted an ethos of negativity or that he has become ideological in his views. Quite the contrary. He is working with the same data observed by many hedge funds, international organizations, and academic research that shows that, as we entered the past decade, the extraction and production rates of many critical resources began to slow – and slow significantly. 

Just to kick off this discussion, let’s start with the master commodity, oil: 

In the ten years leading up to 2004, global crude oil supply grew at a compound annual growth rate (CAGR) of 1.71%. This rate of supply growth started during the strong economic phase during the 1990s, and only strengthened after the recession of 2000-2002 when countries like Russia came online with fresh oil supply. 

However, in the years since 2004, the rate (CAGR) of supply growth has dropped sharply to just 0.53%. This deceleration in the extraction rate — which is also seen in many other resources, such as copper — is the secular change that has drawn Grantham’s attention. This is empiricism, not ideology. 

Just when the world needed oil and copper the most — as China’s and India’s industrialization kicked into high gear — world supply growth flattened. Hence, the upward price revolution in commodities. What Grantham is saying – observing, really – is: the price revolution in critical resources will not be reversed. Accordingly, economy-wide input costs are now structurally higher, which will lead to structurally lower growth. I mean, really; it’s not that complicated. . . .


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