It takes a bubble to make us change

Matthew Lynn, Business Times 3 Jun 08;

ANYONE filling up the tank of their car right now will be cursing oil speculators. Likewise, anyone loading up a shopping cart with food for a family may feel angry with hedge fund managers pushing the cost of wheat, rice and other basics through the roof.

Prices of oil, commodities and food have exploded in recent months. Although there are some solid foundations to that, the boom has now turned into a bubble. Prices are starting to race far ahead of anything that can be justified by the fundamentals of supply and demand. Predictably, that is creating a backlash against the financial markets that are pushing prices up.

We should all leave the speculators alone. The world needs a massive change in the way it uses raw materials. Politicians are too timid to bring that about. The markets are doing the job for them, and if it takes a bubble to change people's energy consumption, then so be it.

Oil now costs more than US$130 a barrel. Nobody expects the price to come down fast anytime soon. Instead, it may go higher. Goldman Sachs Group Inc analyst Arjun Murti has said that the price may reach US$200. So has Svein Rennemo, the chairman of Norway's StatoilHydro ASA, according to the Finansavisen newspaper. After the increase over the last three years, it would be a brave investor who bets against US$200 oil.

What is true of oil is true of many other basic commodities. Copper and iron have soared in the past few years. Wheat, corn, rice and soya beans all peaked this year: At one point, rice was a record US$25.07 for 100 pounds. That has sparked riots from Haiti to Egypt. Some people may go hungry.

Not surprisingly, that has triggered action against speculators. This month, India expanded its ban on trading of food futures, including soya bean oil, potatoes and chick peas, in an attempt to curb price increases. In the US, Joseph Lieberman, chairman of the Senate Homeland Security and Government Affairs Committee, has said that legislation may have to be passed to limit big investors taking positions in commodities.

Plenty of Germans would like to do something similar. 'The biggest cause of the soaring food prices is the financial speculators, and in this case they truly are locusts,' Gerd Sonnleitner, the president of the German farmers association, said last month. 'The locusts don't care about rice or milk or people. They only care about the fluctuations in the market.' In one sense they are right. The 'locusts' - shorthand for hedge funds - have been at work. As Organisation of Petroleum Exporting Countries (Opec) Secretary-General Abdalla el-Badri pointed out last month, speculators are playing an 'important role' in surging oil prices. The same is true of commodities and food.

Yet, they are wrong in thinking it's a bad thing. Here's why. First, oil production needs to expand. The International Energy Agency (IEA) estimates that global oil consumption will rise to 98.5 million barrels a day by 2015 from 84.6 million in 2006. By 2030, it will be up to 116.3 million. To get that out of the ground and into the pumps is going to involve more exploration, production, refining and distribution. There is only one way that scale of investment will be mobilised: by causing a price increase that starts a buying frenzy in oil assets.

Next, the developed world has to start making itself more fuel efficient. If China and India begin using as much oil as Europe and the US, we won't just need more supply - we'll need lower consumption in rich countries. And if we are to combat climate change, we'll need to cut down on pollution as well.

To make that happen, behaviour must change. That means that petrol-guzzling sport-utility vehicles (SUVs) will have to be replaced with hybrids. High-speed trains should take over from planes as the standard way of covering distances of as much as 1,500 km. Our houses have to be redesigned to use less energy, and more of it should come from solar and wind power.

All of that is expensive and hard work. Politicians are too nervous to impose the taxes to bring that about. With oil at US$50 or US$100 a barrel, it wouldn't happen. At US$200 a barrel, the only place we'll be driving an SUV is to the scrap-metal merchant.

Lastly, agricultural policies need to change. Again, if India and China are to become as wealthy as Europe and the US, the world will need a lot more food. That means modifying the way we run agriculture, which, in Europe at least, has been more about preserving farming jobs, and caring for the landscape, than maximising output. Countries such as Germany with lots of fertile land and falling populations should be turning themselves into major food exporters. But, again, it's not going to happen unless a massive price increase forces it.

It always takes a big shock to the system to change behaviour. That is just what the speculative bubble in commodity prices is delivering. It may not be pretty, or comfortable, but it is the market doing the job - which is why we should celebrate the bubble, and not condemn it. -- Bloomberg

Matthew Lynn is a Bloomberg News columnist. The opinions expressed are his own