Resource Consumption -- the Ultimate Bubble?
When he was a young man in the late 1960s, world-renowned investor Jeremy Grantham nearly lost everything. Swept away “in a wonderful speculative bubble of teeny tiny stocks,” his net worth climbed at one point to $80,000 (bearing in mind, that a good yearly salary was $12,000) before crashing. “By June of ‘69, before anyone else realized there was a bear market, I was utterly wiped out.”
Speaking last Monday at an Earth Institute event, Grantham described how this early experience led him to become the world’s leading investment expert in understanding, identifying and avoiding the negative impacts of speculative bubbles — and how that understanding in turn led him to identify one of the biggest and most frightening macro trends of the 21st century, looming resource scarcity.
In 1977, Grantham cofounded GMO, a global investment firm that currently has $108 billion in assets under management. Under his leadership, the firm made a name for itself by correctly identifying and profiting from the dynamics of asset bubbles. “The only thing thing that really matters in investing is the forming and breaking of great bubbles,” Grantham explained. “We now have 330 in our database, important and insignificant. And we know a lot about them.”
In the late 1990s, Grantham predicted the bursting of the tech bubble; in the mid-2000s he foresaw the housing bubble. In both cases he remained confident that the bubbles would eventually end, because out of the dozens major speculative bubbles in the modern era, every single one eventually “reverted to mean,” with price returning to the trend that existed before the bubble formed. In no case, he said, was there a “paradigm shift” in which a bubble did not eventually fall back to the old trend.
At some point, however, Grantham noticed something strange about the price behavior of oil — the most important commodity for running the world economy. For about 100 years, from the 1870s to the 1970s, the price of oil traded at $16 dollars a barrel, “plus or minus a lot,” dropping at times to $8 and rising as high as $32, but always returning to around $16. “This is actually how a commodity in a supply and demand situation trades. It’s fairly typical.”
But then, in the 1970s, the consolidation of OPEC’s power caused the mean price to jump to $35 a barrel. “It was a paradigm jump. OPEC caused a $16 leap up to $35, which is not an insignificant jump; it’s a double.” Around that new mean, the price “scooted up to $100,” and then down to $16 “for a microsecond, fooling me into believing that it was closing an old bubble. It wasn’t. It was just a normal, downside event of a much higher trendline.”
This new trend persisted for more than 20 years, “and then it did it again,” said Grantham. Over the first decade of the 21st century, the average price of oil jumped to an average of $75 a barrel. The difference this time is that the average price soared not because of artificial price controls, but because the world has finally reached fundamental supply constraints.
“When OPEC ramped up the price, it didn’t change the lifting cost. They could still lift oil for $2 a barrel, and there was still plenty of oil around. They just chose to rig the price. This is different,” Grantham said. Today, “it costs $75 to $80 dollars a barrel to find reasonable quantities of new, traditional oil. This is a cost-driven event. The price will not go down to $16 ever again. It may get down to $35 for a minute or two, but it cannot stay there. The cost of producing oil is simply too high on a marginal cost basis. Fracking oil is irrelevant to this issue. Tar sands is irrelevant. These are high-cost, high energy input, high capital cost input places to get oil out of the ground.”
Grantham pointed out that 10 percent of the world’s current oil supply comes from one field in Saudi Arabia. By contrast, the production rate of a typical hydrofracked well drops 80 percent within three years. “From now on we’re scraping more and more costly, tough to find, tough to produce oil.”
Once he realized that average oil prices were not coming down, Grantham and his team decided to analyze 33 other key commodities. They found that on average, commodity prices had dropped 1.2 percent per year for a century, until 2000. And then, between 2002 and 2008, commodity prices suddenly spiked, rising more than they had during the Second World War.
“No one fussed, no wrote about it much, it didn’t get into the public awareness, or even into the awareness of most investors,” he said. In 2008 “it dropped during the financial crisis, which froze the global economy for a few months, and then, as if to prove it was serious, it bounced back in 2011. There is no bubble in history, that when crushed, bounces back quickly like that. This is not a psychological bubble.”
So why did commodity prices shoot up so fast? To be sure, the spike in oil prices was a major factor, as oil is an input into all the rest. But oil alone, said Grantham, can’t account for the entire rise. A more logical explanation is that after more than a hundred years of exploding global population, coupled with the rapid industrialization of countries like China in the last 10 years, the world is finally reaching the limits of growth in consumption.
Grantham sees food as a particular concern, pointing out that after many years of rapid increases, growth in crop yield productivity has slowed, raising the specter of famine for the world’s poor, especially as population continues to rise and a growing middle class in China adopts a more resource-intensive, meat-heavy diet.
Climate disturbances and water shortages only add to these risks. A 2011 study by Columbia University’s Wolfram Schlenker and David Lobell of Stanford suggested that climate change has already added 5 percent to global food prices since 1980. An earlier study by Schlenker and Michael J. Roberts of the University of Hawaii suggested that increased temperatures from climate change could reduce yields of American corn and soybeans by 30 to 80 percent.
And as Upmanu Lall, Director of the Columbia Water Center has pointed out, because water is used both to produce energy and food, the potential for water scarcity in hotspots around the world affects the production of other commodities. “Water scarcity limits energy production and food production, so it is fundamental in the same sense as other resources,” Lall says. “What’s different about it is that as a renewable resource, it is subject to wild climate fluctuations and hence is harder to manage.”
Hitting water, energy and food limits is likely to have highly destabilizing consequences for the world. Grantham pointed to Egypt as an example. From 1950 to the present, Egypt’s population went from around 20 million to 84 million, and is still rising fast. “They can only provide grain to about half their population today. They import from the world market, so when the world market price triples, like it did, they have to pay three times the price.”
At the same time, Egypt’s oil production has peaked, and the nation has gone from being an oil exporter to an oil importer. “When you’re importing oil and your main grain, then you’re running a trade deficit and you have to ask: Who’s going to pay?”
Instability in Egypt and other North African countries in turn has potential impacts on the one resource Grantham thinks poses the greatest risk of catastrophic shortages: phosphorus.
Along with nitrogen and potassium, phosphorus is one of the three major fertilizers used in agriculture. But while nitrogen can be captured from the atmosphere and potassium mined from relatively large global deposits, phosphorous is much scarcer and is heavily concentrated in particular regions, such as an ancient seabed in Morocco. If instability in North Africa spreads, the entire world’s ability to feed itself could be affected. At current rates of consumption, Grantham said, the entire global supply of phosphorus could be depleted in 50 to 80 years.
While the threat of imminent phosphorus shortages is controversial, most experts agree with Grantham that agriculture rapidly needs to become much more efficient in its use of phosphorus.
The confluence of these challenges, combined with climate change, paints a sobering portrait for the human race. There are two trends, however, that give Grantham hope.
The first is the rapid decline in fertility around the world — even in unexpected places like Iran and Bangladesh. “This is something Malthus never dreamed of,” he said.
The second, he said, was “the unexpected, explosive improvements in solar and wind power,” which have in recent years increasingly become cost competitive with traditional fossil fuel generation. Coupled with rapid improvements with energy storage technology, the advance of renewable energy could offer real hope for a transition to a more sustainable future.
“Basically, the instinct of civilizations in the past has been to run off a cliff,” Grantham concluded. “This time it’s different. We have one global civilization, so we have to be very careful not to run off a cliff.”