Falling Commodity Prices: Bane or Boon?

Jan. 12, 2009
Despite the Economic Slowdown, Investment in Production Capacity Has Not Kept Pace with Global Demand
By Keith Larson, VP Content, Putman Media

I just got home from gassing up the car. And with gas at less that $2 USD per gallon, I found the experience a welcome reprieve from the C-note fill-ups of only a few weeks ago. Indeed, the recent drop in fuel prices is especially welcome as the Christmas holiday approaches and will help me do my small part as the American Consumer to help speed a global economic recovery. (Although truth be told, the Larson household will see fewer and more modest gifts under the tree this year. And we’ll forgo flying to see the in-laws. We’ll drive instead. In our well-used car, I might add. No help for Detroit here.)

But I digress. The recent dramatic reversals in crude oil and then gasoline prices did set me to thinking about the abrupt reversals in many commodity prices over the past several months—from energy to metals to cement—and their complex entwinement with the global business of process automation. In some ways, lower commodity prices would seem a potential boon to process manufacturers, while in other ways they’re a serious impediment.

Resource companies, such as those involved in the extraction of metals and energy, are at the front lines of the commodities slump. For example, global aluminum-maker Rio Tinto, which took on substantial debt after merging with Alcan, indicated it would eliminate 14,000 jobs worldwide and slash capital expenditures by 50%. Global mining company Anglo American also recently announced that it would halve its capital spending to $4.5 billion USD next year, primarily by rescheduling development projects. And while the “unprecedented period of rapid declines in commodity prices” presents difficulties in the short term, Anglo said in a press release, it retains its confidence in the medium to long-term fundamentals of its core commodities.

Ay, there’s the rub, the Bard might have said. Many commodity prices have likely plunged too far, analysts indicate. The longer view suggests that despite the global economic slowdown, investment in the production capacity of commodities such as energy and metals has not kept pace with growing global demand over the past several years, and that a capital investment retrenchment now could lead to commodity prices surging again—and potentially restraining an overall economic recovery.

Commodity prices are unlikely to remain at their current lows for long, says a recent report from consultancy Oxford Analytica. “The long-term upward trend in demand from key emerging markets, along with a market- and policy-driven recovery in those markets’ commodity demand over the next year, suggests that commodities may mount a substantial recovery even before mature markets recover from the current downturn.”

Part of the problem is the extended timeline for such projects. They’re expensive, and it’s typically years from the time a new project is conceived and to when it begins to generate cash flow. That’s an ugly combination in today’s screwed up credit markets.

For process manufacturers a step or two downstream from commodities, lower energy and raw material costs should at least help cushion the negative effects of slumping demand.

And for operating companies already committed to expanding production capacity, lower steel and cement prices would seem beneficial, resulting in lower total project costs. But even on this front I’ve heard word of project delays as companies seek to renegotiate contract terms in recognition of today’s lower material costs.

For commodities producers, a longer term view might indicate continued investment in production capacity, despite slumping prices. Non-commodity process manufacturers, too, might capitalize on the current slowdown to build capacity at reduced costs. But where are they to get the money when the credit markets remain so sluggish?

Long-term thinking might be just what’s needed. But given the current economic climate that’s a tougher-than-ever sell as well.