KARACHI – Over the last decade the world economy has experienced an unprecedented boom-bust cycle with extreme fluctuations in commodity prices. The dynamics of commodity price cycles are of lasting interest to policymakers and market participants, given their significant impact on economic and financial developments.
Commodity prices have long exhibited boom-and-bust patterns with high and varying volatility in nominal and real terms. Over the past ten years, commodity prices went through a prolonged, broad upsurge and then a deep slump in the aftermath of the global financial crisis.
A working paper of the International Monetary Fund (IMF) explores, empirically, the causes of extreme fluctuations in commodity prices over January 1990 to June 2010 and seeks to identify the relative contribution of advanced and emerging market economies to the changes in commodity prices through a model that incorporates both supply- and demand-side variables on a global scale.
The spot price of crude oil surged from $20 per barrel in January 2002 to $134 in July 2008, surpassing its 1980 record high in constant prices. Similarly, the price of fine wine also rose by 243 percent over the same period. Triggered by the credit market turbulence, the sudden downturn in global economic activity lowered crude oil and fine wine prices by 70 percent and 42 percent, respectively, in the second half of 2008.
The correlation in the prices of oil and wine has been minutely studied in a working paper entitled “A barrel of oil or a bottle of wine”.
The post-crisis recovery, however, brought about a renewed surge in crude oil and fine wine prices, which increased by 86 percent and 62 percent between January 2009 and June 2010. The statistical behavior of crude oil and fine wine prices has shown remarkable similarity with a correlation of over 90 percent during the sample period.
This correlation carries important implications with regard to the underlying determinants of two very different commodities, with implications for other industrial and agricultural commodity prices. This paper makes three contributions to literature on the behavior of agricultural and industrial commodity prices. Firstly, the IMF working paper explicitly divides global demand into two separate components-emanating from advanced and emerging market economies. This is the first attempt to separate the underlying determinants of the shifts in the composition of crude oil and fine wine demand.
Secondly, unlike most studies, we use GDP-weighted monthly data, which contain more information than quarterly and annual series given the swift adjustment of commodity prices to shocks. Supply constraints have the expected, but limited influence on the pricing process. On the other hand, we find that aggregate demand growth, especially in emerging market economies, is the key determinant of the changes in both crude oil and fine wine prices.
Econometric results also show that the structural shift in the composition of aggregate commodity demand is a recent phenomenon. We also demonstrate that global liquidity conditions influence the dynamics of crude oil and fine wine prices. Even though this impact does not necessarily imply financial speculation in price formation, global excess liquidity-associated with low real interest rates-is likely to have magnified the price pressures stemming from supply demand imbalances.
A review of the international oil market shows that the pace of growth in world oil demand, crude oil supply expanded at a steady, but slower rate over 1990-2008. Global crude oil supply increased at an average annual rate of about 1.5 percent from 66 million barrels per day (MBPD) in 1990 to 85 MBPD in 2008.
The Organisation of Petroleum Exporting Countries (OPEC) maintained a faster rate of growth in crude oil extraction-2.3 percent a year, compared to an annual increase of 0.6 percent in non-OPEC supply. Similarly, average global crude oil consumption grew from 67 MBPD in 1990 to 77 MBPD in 2000 and 86 MBPD in 2008. Furthermore, the composition of crude oil consumption has shifted from advanced to emerging market economies, as crude oil demand of non-OECD countries surged 52 percent between 1990 and 2008, compared with an increase of 14 percent in OECD countries.
In other words, emerging market economies made the greatest contribution to the upsurge in global crude oil demand, accounting for 69 percent of the increase in world oil consumption between 1990 and 2008 and more than 100 percent of the change in global crude oil demand since 2000 with oil consumption in OECD countries declining during the period.
