Category Archives: Natural Resources

Fishing – Tragedy of the Commons

The Tragedy of the Commons was a title of an article by Garrett Hardin in 1968 although the phrase is more commonly used to name the effect which it describes. It explains what can happen when a number of individuals share a common resource and each individual is presumed to act rationally and in his own interest.

For instance if there 10 different farmers grazing a piece of land then there is an incentive to add one more cow to your herd as you gain all of the benefit of this extra cow and you only have to suffer 1/10 of the cost resulting from the increased degradation of the land. Thus although it is in each individual’s self interest to increase the size of your herd, in the long run the land use will be depleted. This concept can also be transferred to CO2 emissions where countries emit emissions in order to grow their economy but don’t consider the long-term impact of global warming on drought and disease.

Recently a lot of attention has focussed on the fishing industry which is worth $16 billion annually. International law states that 64% of the surface of the oceans are defined as ‘the common heritage of mankind’ although with the advent of technology and bigger and faster fishing trawlers the last 50 years has seen a significant depletion of stock. Approximately 90% of fishing areas are fished to sustainable limits or beyond.

Stopping overfishing

The Economist – 22nd October 2020

Property rights has been the traditional policy to try and overcome the tragedy of the commons. This gives exclusive rights to coastal states to police and maintain territorial waters but the looting still continues – since 2010 the proportion of tuna and tuna-like species being overexploited has increased from 28% to 36%.

Reducing subsidies is seen as the most pressing policy as they come to $35 billion a year of 70% are given to more developed countries. It is estimated that $22bn of the subsidy helps destroy fish stocks. In giving subsidies you reduce the running costs of operators but it also brings certain fishing fields within reach for trawlers from developed economies. Only 10 countries received the money from high-seas catches between 2000 and 2010 and that is with Africa having more fishermen than Europe and America combined.

Closing off more areas fishing is another alternative and it has been suggested that 30% of oceans should be designated as ‘marine protected areas’. Countries could also take responsibility by creating marine reserves within their territorial waters. However technology has provided an opportunity to limit the over fishing. Compulsory cameras on board fishing vessels which can identify suspicious behaviour and illicit species should be compulsory especially in exclusive economic zones that define a country’s control over resources such as fish. Australia, America and New Zealand have invested heavily in this this area of surveillance. For example, reports of interactions with seabirds and mammals increased 7 times when electronic monitoring was introduced to Australia’s longline fisheries in 2015. Overall reported catch remained the same. In New Zealand regulations for on-board cameras on commercial fishing vessels came into effect in 2018 – they applied to vessels from 1 November 2019 in a defined fishing area on the west coast of the North Island. To mitigate the overfishing governments could agree on some policies:

  • National regulators to set basic standards for crew – no forced labour
  • Countries failing to follow rules – banned from fishing
  • Countries should only import fish from law abiding nations
  • WTO to scrap subsidies that encourage over fishing – see above
  • Outlaw bottom-trawling
  • Subsidies to fish farming – it now accounts for approximately 50 percent of the fish consumed globally

Source: The Economist July 16th 2016 & October 22nd 2020

China and global energy – it has the wind at its back.

Since 2010 there has been a significant increase in US oil production which has made them much less reliant on other oil producers – oil and gas production has increased over 50% and the US is the biggest producer of both. Being less reliant on oil imports means that the US can now have greater power of nations that they used to import oil from – Iran, Venezuela and Russia. According to The Economist being the biggest producer of gas and oil doesn’t mean as much today for three reasons:

The Economist: – The changing geopolitics of energy. 17th September 2020.
  • There is no longer fossil fuel scarcity as the demand for oil might have already peaked and with an abundance of supply prices have dropped significantly.
  • Countries that are reliant on fossil fuels now realise that for the sake of climate change they need to change their energy source to a more natural option of power.
  • Solar panels and wind turbines generate electricity instantly whilst fossil fuels provide energy to a medium which then generates the electricity.

In considering the above this paradigm shift does more for China than the USA. Even though China is the biggest importer of fossil fuels it is a leading exponent of renewable energy at gigawatt scales. However China is in a very good position to secure oil imports as:

  • The increase in supply from new sources – Brazil, Guyana, Australia (LPG), and shale from the US – has meant a buyers market and this has suited the Chinese.
  • China is also in a very strong position with those struggling oil producing countries in that it has given them oil-backed loans.
  • China Development Bank lent two state-controlled Russian companies, Rosneft, an oil producer, and Transneft, a pipeline builder and operator, $25bn in exchange for developing new fields and building a pipeline which would supply China with 300,000 barrels of oil a day.

China energy sources:

  • Coal-fired – more than 1,000 gigawatts (GW) of generating capacity which makes it the world’s biggest carbon-dioxide emitter. Coal use is set to expand in the years to come.
  • Wind and solar capacity – 445GW, vast though it is by most standards, But China also has Hydropower capacity – 356GW of more than the next four countries combined.
  • Nuclear power – building plants faster than any other country; nuclear, which now produces less than 5% of the country’s electricity, is set to produce more than 15% by 2050.

Wind and Solar

Both wind and solar power require raw materials to be functional – non-ferrous metals like copper. Batteries require zinc, manganese and potassium. Although there is a lot of supply of these commodities it is the difficulty of getting them to the market that is the problem. China has helped here through domestic investment – it now produces 60% of world’s ‘rare earths’. It now looks overseas to Chile to secure lithium on which batteries now depend on.

China – produces more than 70% of the world’s solar modules and can produce over 50% of its production of wind turbines. It dominates the supply chain for lithium-ion batteries – 77% of cell capacity and 60% of component manufacturing. In 2019 China eased restrictions on foreign battery-makers – costs of solar panels and batteries have dropped by more than 85% in the past decade.

To maximise its electrostate power China needs to combine its renewable, and possibly nuclear, manufacturing muscle with deals that let its companies supply electricity in a large number of countries.

Source: The Economist – The changing geopolitics of energy. 17th September 2020

Carbon Footprint – NZ v UK primary industry

Useful video on Food’s true carbon cost from the FT – mentions New Zealand apples being sold in the UK not necessarily having a greater global footprint. Apples kept in cold storage would cause a greater carbon footprint than apples being shipped from New Zealand.

Previously food miles (the total distance traveled as food is transported from its place of origin to the consumer’s plate) was one measure of the global footprint and New Zealand is particularly vulnerable due its large quantities of agricultural exports and its geographical isolation. However, transport had been taken out as it was difficult to single out one part of the food system and conclude that because it has come from thousands of miles away it is automatically less sustainable. Therefore, the food miles argument for favouring domestic produce was only valid if food is produced using identical processes around the globe.

In order to reduce CO2 emissions, merely taxing imported food can’t be seen as the answer. As CO2 is emitted at roughly all stages of the process of transporting food to the dining room table, an appraisal of the environmental cost of devouring food from different countries should assess CO2 emissions throughout the product’s complete lifecycle. Stages in a food’s lifecycle include sowing, growing, harvesting, packaging, storage, transportation and consumption. Every phase uses energy and consequently create CO2. These include; Direct Inputs, Indirect Inputs, and Capital Inputs. A simplified flow chart representation of these inputs and the farm outputs, including environmental impacts, but excluding the transport occurring outside the farm gate is shown in Figure 1. Although it was done in 2006 a study by Saunders et al assessed the total CO2 emissions released in the supply of four New Zealand and UK food products to British markets. The report showed (see Table 1 for report data) that in the case of dairy and sheepmeat production NZ is by far more energy efficient even including the transport cost than the UK, twice as efficient in the case of dairy, and four times as efficient in case of sheepmeat.

In the case of apples NZ is more energy efficient even though the energy embodied in capital items and other inputs data was not available for the UK. Onions – where transport emissions account for around two-thirds of all CO2 resulting form the supply of New Zealand crops – are the only product for which UK consumers can reduce CO2 emissions by favouring domestic produce.

A major contributor to New Zealand’s relative CO2 efficiency in dairy production is that New Zealand agriculture tends to apply less fertilisers (which require large amounts of energy to produce and cause significant CO2 emissions) and animals are able to graze year round outside eating grass instead large quantities of brought-in feed such as concentrates. European dairy farms involve housing animals for extended periods of time. The fact that New Zealand farmers do not require subsidies to be internationally competitive, unlike their British counterparts, indicates these efficiencies of production.

Covid-19 hits oil prices hard

With the demand for oil dropping over covid-19 and the over supply in the market, oil prices have collapsed. Brent crude fell by more than half in March to below $23 per barrel. For many years OPEC – Organisation of the Petroleum Exporting Countries – has manipulated supply to maintain higher prices. Since 2017 both Saudi Arabia and Russia have been working together to prop up oil prices but have had a falling out over Saudi Arabia’s insistence on cutting oil supplies by 1.5 million barrels per day.

The Economist – 26th March 2020

Cost of extraction v Price of a barrel

Like any business you need to consider costs relative to the price of your good or service. Some shale oil wells in the US may have a break-even point of $40 a barrel despite the high fracking costs. However some sources say that it is above $60 a barrel with the higher-cost wells coming in at over $90 a barrel. These industries cannot survive in this environment of such low oil prices. Also the Canadian tar sands are another costly method of extracting oil and this could lead to a shut down of production.

By contrast in Saudi Arabia the extraction cost is around $9/barrel with Russia coming slightly higher at $15/barrel. The Middle East and North Africa are also very efficient, producing oil as cheaply as $20 per barrel. Worldwide, conventional oil production typically costs between $30 to $40 a barrel.

Nevertheless countries like Venezuela and Nigeria depend hugely on oil revenue for their spending. Although Russia and Saudi Arabia have significant foreign reserves the more the virus persists and demand keeps falling the greater the damage. Useful video from Al Jazeera below.

Saudi Arabia and Russia – oil price war

Below is a very good video from the FT outlining the latest disagreement between the USA and Saudi Arabia. Since 2017 both Saudi Arabia and Russia have been working together to prop up oil prices but have had a falling out over Saudi Arabia’s insistence on cutting oil supplies by 1.5 million barrels per day.

China the biggest importer of oil has cut back on oil consumption because of the coronavirus outbreak was bringing the economy to a standstill. Oil prices had their biggest one-day fall since the 1991 Gulf Crisis – some are expecting prices to go to $20 a barrel. What is at the heart of the fallout? Russia’s anger over sanctions targeted at its oil giant, Rosneft Trading. Washington imposed the sanctions last month over its continued support in selling Venezuela’s oil. Moscow was hoping to get Riyadh on its side to inflict economic pain on US shale producers, who Moscow feels have been getting a free ride on the back of OPEC+ production cuts. Shale production has pushed the United States into the number one spot as the world’s biggest producer of oil. Moscow hopes it could lead to the collapse of some of those businesses, if oil prices remain below $40 a barrel.

Source: Al Jazerra- Counting the Cost.

Why dearer oil impacts developing economies more.

It wasn’t long ago that $100 for a barrel of oil was the norm but with the advent of the shale market the production increased which depressed prices. It was felt that the flexibility of large scale shale production from the USA could act as a stabiliser to global oil prices.

Oil shocks – supply or demand?

Oil shocks are not all the same. They tend to be associated with supply issues caused by conflict or OPEC reducing daily production targets. In the case of an increase in global growth there is the demand side for oil which increases the price. However this doesn’t have a great effect as in such cases the rising cost of imported oil is offset by the increasing export revenue. However today’s increase has a bit of both:

Demand – global consumption has increased as the advanced economies recover after the GFC especially China
Supply – supply constraints in Venezuela from the economic crisis. Also tighter American sanctions on Iran and OPEC producers are not increasing supply with the higher price.

Higher oil prices do squeeze household budgets and therefore reduce demand. Lower prices are expected to act as a stimulus to consumer spending but it can also have negative effects on the petroleum industries.

Emerging economies the impact of higher oil prices

Oil importing emerging economies are badly impacted by higher oil prices:

  • Terms of trade deteriorate as the price of their imports rise relative to their exports
  • Exports pay for fewer imports = importers’ current-account deficits widen.
  • Normally this leads to a depreciation a a country’s currency which makes exports cheaper and imports more expensive.

However this is not the case today. World trade is slowing and with it manufacturing orders therefore higher oil prices make the current account worse which in turn depreciates the exchange rate. For emerging economies who have borrowed from other countries or organisations a weaker exchange rate intensifies the burden of dollar-denominated debt. Companies in emerging economies have borrowed large amounts of money being spurred on by very low interest rates but they earn income in the domestic currency but owe in dollars – a weaker exchange rate means they have to spend more of their local currency to pay off their debt. Therefore indebted borrowers feel the financial squeeze and may reduce investment and layoff workers.

Another problem for emerging economies, as well as higher oil prices, is that central banks are looking to tighten monetary policy (interest rates) with the chance of higher inflation.

Source: The Economist – Crude Awaking – September 29th 2018

Clean energy – winners and losers

The impact of energy flows on the power and influence of nations has mostly been about the need for oil. Securing oil supply by ensuring its shipment, protecting the countries that produce it to the extent of going to war in an oil producing country has been prevalent in the 20th century. Oil being inelastic in demand has meant that as it becomes more scarce the price increases will result in higher revenue for the oil producing oligopoly. Countries dependent on the importing of oil have been at the wrath of higher oil prices caused by embargoes, wars, a financial crisis to name but a few – see graph below.

In fact the USA has been the most aggressive in protecting its oil supply to the extent that it saw it as their right to use military force in the Middle East – 2003 – second Iraq War. The reason given was to remove Saddam Hussein but this just disguised their real motive was to protect the oil fields. If they were so concerned about Saddam Hussein’s regime why didn’t they do anything about Robert Mugabe in Zimbabwe? The answer is Zimbabwe doesn’t have oil. Remember the Gulf War in 1990 was a UN sanctioned operation involving many countries not just the USA and UK.

However the idea of scarcity is coming to an end thanks to 3 big developments.

  1. The shale revolution in the US has lead to them being the biggest combined producer of oil and gas – the US now pumps 10m barrels a day and it is making the country less reliant on imported oil. Also increases in US supply has added to the global market reducing the price.
  2. China is now moving to a more service based economy and in the process is moderating its demand for coal and oil, slowing the consumption of electricity. More importantly though it is deploying gas and renewable energies and stopping the growth of carbon-dioxide emissions. It’s dependence on imported fossils fuels has been the catalyst to develop more of its own wind and sunlight for energy sources as well as it planner more electric vehicles.
  3. Climate change requires low-carbon energy and the Paris accord of 2015 is a start to fight climate change. To achieve this goal trillions of dollars will have to be invested in wind and solar energy, batteries, electricity grids and a range of more experimental clean-energy sources. Ultimately this creates significant competition between countries in developing these technologies but also but at risk the access to rare earths and minerals to make the hardware. It seems that energy is now driven by the technology not the natural resource we are so used to.

Energy transitions since the Industrial Revolution has seen the following:

Coal ——> oil ——> technology and clean energy.

The obvious losers from this change will be those who have an endowment of fossil-fuel reserves and have relied for too long on oil without reforming their economies.

Traditional energy system (oil etc) is constrained by scarcity
The abundant renewable energy system is contained by variability

Ultimately the challenge for countries in future will be who can produce the most energy and who has the best technology. Those that don’t embrace clean-energy transition will be losers in the future.

Source: The Economist – Special Report ‘The Geopolitics of Energy’ 17th March 2018

Oil price rises a sign of a healthy global economy.

Oil prices have been irregular over the last four years with the price of a barrel of oil being over $100 in 2014. This price had been suggested as the new $20 due to scarcity of oil reserves. However by 2016 the price had dropped to $28 a barrel the talk was that there was a global glut. Today the price is around $70 and analysts have been perplexed as to what is behind this increase. According to The Economist three significant questions arise:

1. Why has the oil price more than doubled in the space of two years against all expectations?

The 2016 slump in prices ($28) was in part due to the weak demand and an abundance of supply – simple economics. But demand recovered quickly and in particular the Chinese economy quickly pepped up its economy with fastest growth rates. On the supply side OPEC were able to restrict output and stocks of oil in the US started to fall. This saw D > S = P↑. Usually when there is an increase in price it attracts other sources of oil which are more expensive to extract – eg shale oil in the US and the tar sands in Canada. This is in turn will increase the supply and lower the price. But small suppliers are finding it harder to increase output as the financiers want more focus on profit rather than output. It can take months before oil actually comes on-stream.

Source: The Economist 20th January 2018

2. Why have stockmarkets been pleased with higher oil prices when it is usually associated with economic crisis?

The overall impact of higher oil prices has been to reduce aggregate demand in the global economy. With higher prices one might expect that the profits would be pumped back into the circular flow and therefore stimulating AD. However the Middle East producers tend to be big savers of oil profits at the expense of oil consumers in the West. Also countries have become less reliant on oil – demand peaked in 2005. Oil exporters depended on high oil prices to fund their government spending as well as importing consumers goods – Venezuela is a classic example of an economy that has relied on oil revenue for over 80% of government spending. Most big oil producers in the Middle East need the price of oil to be above $40 a barrel in order to cover their import bill. But a rising price of oil is usually a healthy sign that China is growing as it is the world’s biggest importer of oil.

3. What will be the ‘normal’ price of oil?

The critical change in the oil market from 30 years ago is that there is now an abundance of oil. Back then it was seen as an asset rather than a consumer good – oil in the ground was like money in the bank. But new sources of oil such as shale and tar sands have amounted to the existence of plentiful reserves. It must be added on the demand side the gaining momentum of mass-market for electric cars have reduced the demand for oil. It is being suggested that not all oil will extracted as there will not be enough demand. It makes sense that the five big producers in the Middle East – Saudi Arabia, UAE, Iran, Iraq and Kuwait – which can extract oil for under $10 a barrel, to undercut high-cost producers and capture the market share. So it is better to have money in the bank rather than in the ground. Will oil prices plunge? Unlikely especially when oil exporters are cannot sustain low prices for very long – in order to fund their expenditure they need oil prices of $60 barrel.

Source: The Economist 20th January 2018 – ‘Crude Thinking’

 

Norway sovereign wealth fund takes an ethical stance

Norway’s soveriegn-weatlh fund surpassed US$11trn in assets on September 19th this year. With its significant revenue from North Sea oil and gas getting invested overseas it is likely to get even bigger to the extent that Norway can start to shape ideas abroad. It is increasingly speaking out on ethical behaviour of companies and is an increasingly activist shareholder. The ethics watchdog for the fund recommends that it excludes several firms in oil, cement and steel industries for emitting too much greenhouse gas. This may seem hypocritical in that Norway produces significant amounts of oil but it operates under its own ethical guideline set by parliament.

Source: The Economist – 23-9-17

Missing out on billions of dollars

Norway’s sovereign wealth fund has share in 9,000 companies, 1.3% of the entire world’s listed equity. It has lost out on billions of dollars of revenue by its government prohibiting any investment in tobacco companies and manufactures of certain weapons. The fund is forbidden by law from investing in firms that produce nuclear weapons or landmines, or are involved in serious and systematic human rights violations, among other criteria. These include Boeing, Airbus, Imperial Tobacco, Philip Morris. Last year the council looked into the construction industry in Qatar – host of the 2022 soccer World Cup – and neighboring countries, after reports of abuse by human rights groups. Since then new regulations have been implemented which protect the rights and living and working conditions of labour in the construction industry. This includes the right of immigrant workers to hold onto their passport. There is a broad consensus in Norway that the fund should not make money from companies that take people’s lives.

Norway and coase theorem

Another way Norway is trying to influence global warming is by using its sovereign wealth fund to change behaviors of other countries. Ronald Coase argued that bargaining between parties could produce a mutually beneficial and efficient solution to problems like pollution. An example of this was the a deal between Liberia and Norway. Norway will give $150m in aid in return for Liberia stopping the destruction of its forests.

Stick and Carrot

The stick approach of trying to force Liberia to stop cutting down its trees might give way to a more effective carrot approach by paying Liberia to do so. This makes both sides better off. Liberia still gets the aid and Norway gets to preserve biodiversity and take a small step against climate change.

5 or 6 more China’s

The reality is that the planet can’t stand another 5 or 6 China’s but developing countries still need to grow and, like their developed country counterparts, it will involve greenhouse gas emissions. If we are to curb global emissions developing countries will have to leapfrog to new technologies as the burning of traditional fossil fuels will just exacerbate the problem. However developing countries have neither the resources nor the incentive to reduce dependence on fossil fuels on their own as their main focus is economic growth. Whilst developed countries have a lot to lose from developing-world emissions it is in their interest to pay the latter to curb emissions e.g. Norway paying Liberia not to chop down its trees. Although this looks a simple enough policy politicians will not be so enthused by it as money that is paid overseas to cut climate change is not very popular with the electorate and therefore the government.

China stops subsidising farmers

In 2000 the Chinese government introduced price supports for farmers with the floors raised annually to stimulate production even when global prices fell. There were three reasons for price supports:

  1. ensure production of key commodities
  2. provide a degree of food security
  3. improve the well-being of farmers

China starts to abolish minimum prices

The last three years has seen the Chinese authorities start to abolish minimum prices for the following commodities – cotton, soybeans, corn and sugar. Without the minimum price the supply on the domestic market has dropped – grain production fell for the first time in 13 years. Remember with the minimum price being above the equilibrium it encourages producers to supply more but the demand will drop at the higher price.

When the minimum price was in operation the Chinese authorities had been stockpiling significant amounts of food and have been able to compensate for the reduction in supply from the farming community. However once these stockpiles have been diminished the only other alternative will be to import food which will be a positive for farmers from Brazil, US and Thailand. This might be sooner than later as the Chinese government is facing capacity challenges as warehouses and silos are overflowing but still China is not able to meet its domestic needs. According to the US Department of Agriculture, China is sitting on 54% of the world’s cotton stocks, 45% of the world’s corn and 22% of the world’s sugar reserves, but many analysts think that a lot of this stock is starting to perish.

Self-sufficiency in feeding the Chinese population still remains a priority for Beijing but after 2014 authorities have stated that they need to make rational use of the global agricultural market and import various food products. However China still spends a lot on supporting its agricultural sector:

2016 – $246.9 billion = 2.2% of GDP. Four times the average of OECD countries.

Although money is still spent on price supports a growing share is going into ways to improve productivity with R&D etc. China is in a position that they could revert back to the price supports if they feel the pain of reform is too great, but analysts think that they will be more accepting of global supply.

Source: China Cut Agricultural Subsidies and American Farmers Have a Lot to Gain


EU example

This policy of subsidising farmers is not unlike that of the European Union – see previous blog post ‘CAP reforms unlikely to benefit New Zealand farmers.’ – with the introduction of the Common Agricultural Policy (CAP). At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:

1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide fluctuations that often occur in the price of agricultural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.

CAP Intervention Price

An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:

CAP Int Price1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.