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The swing factor in commodity markets

By V Shunmugam and Ritambhara Singh, Commodity Online
July 23, 2007 13:14 IST
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Every one knows that International politics plays a key role in deciding the 'power centers' among nations and a few know that there exists a relationship between international politics and commodity markets that had existed from time immemorial.

The range of goods traded among continents since the voyages of discovery from Megallan to Columbus has steadily been increasing over the centuries with the development of markets, commerce, and technology. Among them, technology not only helped in development of individual markets but also led to a substantial integration among the global markets, making efficient the flow of information and goods and services.

This trend towards greater market integration, however, has not been monotonic; it has been periodically interrupted by shocks such as political wars and global economic depression, or by endogenous political responses to the distributional effects of globalization itself. While we look back at the international commodity markets, during some period politics had reinforced the effects of technology by strengthening the bond between them, while in others it has offset them.

In several cases, severe shocks have had long-run effects on the international integration of commodity markets as a result of several politically induced hysterics. Some major global issues that had an impact on the commodity markets were Iran's nuclear progress and Iraq's military ambitions creating furore in the US' and its allies' political circle, European Union's subsidies on sugar, Nigerian oil crisis, Japan dumping automobiles into the US, and the WTO issues over the Chinese textile sector.

Iran, the N-conundrum

Iran has the world's second largest proven oil reserves after Saudi Arabia and the second biggest natural gas reserves after Russia. Iran's geo-strategic position and its already developed network of pipelines make it a key factor in the energy markets. However, both international and domestic factors have hampered their optimal exploitation since the 1979 revolution that toppled the Shah. Revenues from oil exports - projected to reach at least $45 billion (5 percent of global supplies) in the year to March 2007, according to Iranian press reports - fund about 50 percent of its annual budget.

Iran's nuclear energy program had remained controversial during the recent years, forcing IAEA sanctions on it. While Iran had its economic rationale behind it, the country's past record made nations to question its intentions. The fact that the US led sanctions on Iran's international financial transactions, serviced by US and European Banks, gave birth to expectations and speculation that Iran might indirectly retaliate by blocking the portion of the Strait of Hormuz (the pathway for 40 percent of the world crude oil supplies) falling in Iranian waters.

This fueled a rise in crude oil prices and had a cascading effect on all commodities as energy plays a role in their production. Further, the US continues to dissuade India too from entering into the proposed gas pipeline project that would transport gas to India from Iran via Pakistan. The fate of the project still hangs in the balance. Besides, the Iranian oil and gas sector suffers from under-investment as a result of boycott mainly by US and EU companies for the last two decades.

Nigeria - the oil tangle

Nigeria, the largest oil-producing country in Africa, witnessed countrywide protests and labor strikes in crude oil fields after the government increased fuel prices and privatized two state-owned oil refineries. As it coincided with the summer driving season of the US, crude oil prices rose after the general strike called by the unions.

Crude prices retracted back with the calling off of the strike by the employees. Persistent militant attacks on commercial and state-owned oil refineries and pipelines in Nigeria, apart from frequent kidnapping of oil workers and officials of companies like Shell operating in the oil rich Niger Delta region also affect the global crude prices.

EU's sugar subsidy & its impact

On the agricultural front, World Trade Organization (WTO) ruled that the EU subsidies to domestic sugar producers violated global trade rules and hence harmed the producers of the developing countries. According to Brazilian Agriculture Minister Roberto Rodriguez, the decision meant that the opportunities for EU to export two million tons of sugar from next year cease and Brazil would be allowed to export an additional 10 percent. This caused a slump in global sugar prices as EU producers were in a hurry to offload excess sugar into world markets (which were already reeling under a glut), before the ban/deadline came into effect.

China's cotton stand: US' loss is India's gain

It is worthy to note that the US government on concerns of rising trade deficit ($58.50 billion in April '07) filed a complaint with the WTO in early February, 05, alleging that China was using export subsidies to help its companies, especially textiles, helping them dump manufactured goods in the US. It led to imposition of quotas on Chinese textile products but cleared a major obstacle to bilateral trade following a bilateral agreement. But China, a leading consumer of US cotton, gradually reduced US cotton imports turning towards India. The shift dampened US cotton prices and fueled Indian cotton prices, leading to a 20-fold increase in Indian cotton exports to China during 2005-06. Adding fuel to the fire of US cotton producers, Brazil too won a case against the US cotton subsidies in the WTO.

Globalization - the change agent

Globalization remained a powerful force that had accelerated changes in the world economy over the past half a century. It has affected the fate of companies as much as that of countries. And perhaps, nowhere has the change been more dramatic than in the US car industry. General Motors, under pressure from its foreign competitors, has seen its profitability dwindle in the US car market leading to a shut down of most of its plants in the US. The company does plan to build more car plants in the future, but all in emerging markets like China and India. On the contrary, Toyota emerged as the fastest growing car company in the US, building a factory a year to meet the demand for its fuel-efficient mid-sized cars and hybrids.

It was the oil crisis in the 1970s that first brought to the fore the problems of US automakers who concentrated more on oil guzzlers compared with fuel-efficient small cars. Imports of Japanese cars soared in the 1980s, to the annoyance of US companies and unions alike, capturing nearly one-quarter of the US automobile market share. And when the companies pressured the US government into limiting imports from Japan, Japanese companies like Toyota and Nissan started building car plants in the US.

These units, which were located in low-wage, non-union areas, ushered in new, flexible production methods, and as a result, reaped higher profits from the smaller car segment. They started modifying models more frequently based on consumer preferences. The US car companies tried but failed to design a competitive small car. They also went on to experiment with Japanese production methods but nothing seemed to be doing the trick for them, which could close the quality gap. In 2006, both Ford and GM finally accepted that they would never be able to dominate the US car market like in the past. The Japanese dominance and hence the demand from US auto manufactures for parts from US manufacturing reduced and, thus, weighed on domestic raw material prices.

While the political and trade conflicts affect the international commodity markets it also affects the producers, the manufacturers, and the economies as well. It is evident that Iran and Nigeria play a crucial role in global crude oil prices. Further, any adverse and unfair measure of trade by any country affects not only bilateral but also multilateral trade relations be it the issue of EU's sugar subsidy or China's stand on cotton.

Even changes in interest rates by major world economies, sometimes on the back of political motives cause a slow down in the world economy. After all, globalization has not only integrated the markets of nations, but has also made some nations vulnerable to political moves of other nations. This seeks for a new global order whereby peace and development is promoted thereby minimizing the impact of political and trade wars on nations and their economy.

Authors are Chief Economist and Senior Analyst with the Multi Commodity Exchange of India Limited.

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V Shunmugam and Ritambhara Singh, Commodity Online

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