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Energy price volatility is the new normal for market

As water shortages, greater competition for resources and climate change tighten commodity markets, the old pricing certainties no longer apply

The world is undergoing a period of intensified resource stress because of soaring demand from emerging economies and tightening commodity markets, according to a new report by Chatham House, a London-based think tank.

Chatham House's Resources Futures report , which examines the supply and demand outlook for 19 key resources including crops, water and fossil fuels, says the world must get used to energy-price volatility. Climate change, water scarcity and a shift in historical trading patterns, driven by new demand from developing nations, will also continue to bolster prices, the study says.

Annual price volatility is now higher than at any time in the past 100 years (though for energy prices, specifically, the 1970s were an exception), Chatham House says. While brief periods of price volatility are fairly common, the report says, sustained high levels of volatility across commodity markets since the early 2000s "marks a new trend".

Sudden spikes like that seen last August when Brent crude jumped by around $11 a barrel in just a couple of weeks after storms in the Gulf of Mexico forced operators there to shut in 95% of their oil and over 70% of natural gas production are growing more common.

The International Energy Agency (IEA) said last year that crude-oil prices have undergone an "almost violent structural change" because of increasing demand from Asia and falling consumption in Europe. In the third quarter of 2012 year-on-year European oil demand fell more steeply than in any year since the 2008 financial crisis. At the same time, Asian demand "remained remarkably robust".

With increasing oil-price volatility will come more instability in food prices. Rob Bailey, one of the authors of Chatham House's report, said the world is "just one or two bad harvests" away from a global food crisis, as climate change and failed crops have placed increasing pressure on global food stocks.

The World Bank's Food Price Watch  says global maize and soybean prices reached all-time peaks in July 2012, following a drought in both the US and Eastern Europe. Wheat prices rose by 30% between April and July 2012 the World Bank said, because of rises in crude prices, droughts and weather disruptions.

The dry summer in Russia, Ukraine and Kazakhstan lead to wheat production losses of more than 6 million tonnes, the World Bank says, around 10% of yearly production. Countries in the Middle East and parts of Africa are most vulnerable to such shocks because of their heavy reliance on food imports.

The availability and price of one resource has a knock-on effect on supply of others, Chatham House says. The energy sector, for example, will have to compete for water with the mining, transport and agricultural industries. In Europe alone around 37% of all water used is for cooling in energy production, according to the European Environment Agency. This is followed by agriculture, which uses around 33% of water extracted, water for use by the public (20 %) and industrial use (10 %).

New political economy

Chatham House's report describes a "new political economy of resources" forming as governments fashion their policies to secure resources “a strategic shift that will overshadow environmental concerns. Increased price-volatility within commodities markets will only intensify this competition.

Above all, the rise of consumption in Asia-Pacific, which now consumes the majority of all commodities, is putting stress on markets and shifting global trading patterns. China and India are leading this new world order. Chinese oil and gas demand alone is likely to rise by 60% between now and 2035, according to the IEA. Consumption from India and the Middle East will also soar. China will increasingly depend on the Middle East, forcing it to become more involved in the region's politics, says Glada Lahn, a co-author of the Chatham House report.

A wave of other developing economies, such as Iran, Vietnam, Turkey and Thailand, are also emerging as major resource consumers, helping to boost non-OECD countries' share of global energy demand from 55% in 2010 to 65% by 2035.

But the rise of these new producers in not a certainty, Chatham House says, as many of these prospective resource suppliers have weak infrastructure, a low-skilled workforce, little water and political instability. All these create a less-than-favourable investment climate, Chatham House says, which will translate to higher capital costs.

Trade is also becoming a frontline for conflicts over resources at a time when the global economy is more dependent than ever on cross-border commerce. The most recent example comes from Iran, on which Western countries have imposed sanctions to stifle oil exports. Iranian MP Gholam Reza Kateb said in early January that his country's oil revenues had fallen by 45% in the past nine months because of the embargo. The Iranian rial has lost 40% of its value since August 2012 and food prices in the country have skyrocketed.

Competition heats up

The future availability of resources depends on a range of factors including their accessibility, the development of new technology and environmental concerns. More supply will involve production from more technically difficult operating environments.

A wealth of new oil resources has been discovered over the past decade, including vast reserves of unconventional gas; Brazil's pre-salt oil resources; and large deposits of conventional natural gas in East and West Africa, and in the offshore Eastern Mediterranean. But while competition for these resources grows, Chatham House says water scarcity could limit production. In Africa alone between 75 million and 250 million people will be exposed to increased water stress by 2020 because of climate change, the think tank says. Subsidies for consumption of fossil fuels are part of this problem, offering few incentives for alternative energy sources, exacerbating climate change.

The IEA says fossil-fuel subsidies increased last year by almost 30% to $523bn. Such subsidies were one of the main obstacles to increasing energy efficiency and reducing carbon emissions worldwide, the agency said in November.

But even under the IEA's more benign outlook for energy consumption over the next two decades which would see greenhouse gas emissions in the atmosphere stabilise at 450 parts per million, allowing for a 2°C rise in temperature the implications of global warming are profound, said Chatham House's Lahn. "It's just not good enough in terms of maintaining a stable climate because that is our energy security in the long term," Lahn said. "The melting [of the] Arctic ice cap has been momentous over the past decade and that shrinkage has been quite severe in telling us how much carbon we're putting into the atmosphere."

The potential impacts of global warming-related flooding will affect energy infrastructure as well as global geopolitics if mass migration becomes necessary, Lahn added. "If that happens, energy security will be out the window. We'll have water and human security issues."

Key energy points from the report:

  • Over the past decade the global share of fossil-fuel trade to China and India has more than doubled from 4.4% to 10.8%;
  • Over the next 20 years, this increase will reinforce geostrategic interests between Asian consumers and energy exporters in the Persian Gulf and sub-Saharan Africa;
  • Some energy exporters, such as Saudi Arabia, are fast-growing energy consumers, which may limit their ability to maintain trade volumes;
  • The emergence of unconventional gas has redrawn global energy projections with China targeting production of 30 billion cm of from coal-bed methane and shale-gas deposits by 2015;
  • The resurgence of coal is being driven imports from China and India;
  • Global energy production and transportation systems will be disrupted by increased energy demand, climate change, extreme weather and increased competition for water. Infrastructure will be at risk from storm damage, rising sea levels and the effects of melting permafrost;
  • Water and energy supplies will become increasingly interdependent and greater competition for resources could lead to conflict and instability;
  • Existing mechanisms are inadequate to deal with oil-supply shocks, particularly with the rise of new consumers; and
  • Increased competition for fossil fuels could lead to conflict in the East and South China Seas, the South Atlantic, the Arctic Ocean and East Africa.
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