Tuesday, January 3, 2012

McKinsey on Commodity Prices: "The next agro-industrial revolution"

The CRB index broke out of its descending wedge formation with a dramatic gap up today so I thought this might be appropriate.

Over the years I've poked fun* at the McKinsey brand but in the end they are worth listening to.
To make up, I thought I'd run an ad for some of their output.
From McKinsey & Co.:

Resource prices are rising and becoming more volatile. Without a resource revolution, we all face the prospect of damage to global growth, welfare, and the environment.

The English thinker Thomas Malthus argued in his famous essay1 on the principle of population that there was no longer sufficient land to feed the world’s rapidly growing population, threatening poverty and famine. But an agro-industrial revolution soon transformed the economies of Europe and North America, and his fears proved unfounded.
More recently, conventional wisdom held that market forces would always come to the rescue. Until ten years ago, this hope was largely fulfilled. During most of the 20th century, resource prices—of food, water, energy, steel, for example—declined, despite strong growth in the world’s population and even stronger growth in GDP. Prices fell because of a combination of new low-cost sources of supply and technological innovation.

But in the past ten years, demand from emerging markets, particularly in Asia, has erased all the price declines of the previous century. A number of factors create a risk that the world might enter a new era of high and volatile prices over the next two decades. Up to three billion people could join the middle class, boosting demand at a time when obtaining new resources could become more difficult and costly. The stress on resources will probably be compounded by increasing links among them—links which mean that price shocks in one can swiftly be transmitted to others. In addition, environmental deterioration, driven by higher consumption, is making the supply of resources, particularly food, more vulnerable.

The new McKinsey report Resource Revolution: Meeting the world’s energy, materials, food, and water needs shows that the resource challenge can be met through a combination of expanding the supply of resources and a step change in the way they are extracted, converted, and used. Such resource productivity improvements, using existing technology, could satisfy nearly 30 percent of demand in 2030. Just 15 areas, from more energy-efficient buildings to improved irrigation, could deliver 75 percent of the potential for higher resource productivity.

Meeting the resource-supply and productivity challenges will be far from easy—only 20 percent of the potential is readily achievable and 40 percent will be hard to capture. There are many barriers, including the fact that the capital needed each year to create a resource revolution will rise from roughly $2 trillion today to more than $3 trillion, with additional capital requirements to pursue climate change and universal-energy-access agendas. The benefits could be as high as $3.7 trillion a year, however, if carbon had a price of $30 per metric ton and if governments removed substantial resource subsidies and taxes.

Policy makers should consider action on three fronts: unwinding subsidies that keep prices artificially low and encourage inefficiency; ensuring that enough capital is available and that market failures associated with, for instance, property rights and incentives are corrected; and bolstering society’s resilience by creating safety nets to help very poor people deal with change and educating consumers and businesses to heed the reality of future resource constraints.

In the 20th century, governments and businesses didn’t have to worry about resource productivity; they could focus on capital and labor. Over the next 20 years, resources must be at the heart of public policy and business strategy.
1 Thomas Malthus, An essay on the principle of population, New York: Penguin, 1970 (originally published in 1798).
Over decadal timeframes McKinsey is in agreement with a lot of Jeremy Grantham's thinking, links below.

"Is McKinsey & Co. the Root of All Evil ?"
"McKinsey at Enron".
As far back as 2002 BusinessWeek was taking a look "Inside McKinsey":
Enron isn't its only client to melt down. Suddenly, times are trying for the world's most prestigious... 

Yves Smith Says Nice Things About McKinsey & Co. (they're in the business of propping up diseased managements)

The Grantham on commodities series:

April 26, 2011

The End of Cheap Commodities (or not)
April 26, 2011 
Commodities Have Reached a Permanantly High Plateau* (or not)

April 29:
Commodity Prices tend to be Mean-Reverting (cotton)
May 3
Commodities: "The Case for Human Ingenuity"
May 5, 2011
Commodities: Did Jeremy Grantham's 'Paradigm Shift' Letter Call the Intermediate-term Top

May 9, 2011
"What Grantham Got Wrong About Commodities"
May 11, 2011 
More on Grantham's 'Paradigm Shift' in Commodities: "So Who's Right and Who's Wrong? Henderson or Grantham?"
June 2, 2011
Job Creation Disappears and Lord Rothschild Suggests You Panic, Sells Gold (and the Jeremy Grantham Commodity Call that Didn't Make the Headlines)
July 1, 2011 

A Tip of the Cap to Jeremy Grantham on his Commodities Call

And for comparison/contrast:
September 2010 
Société Générale's Dylan Grice: "Higher crop prices 'permanent'" (ADM; SYT)
Dec. 2010 
Société Générale's Dylan Grice-"Commodities: ‘Their Expected Long-Run Real Return is 0%’"