The Growth Map

I also wrote a paper in 2004 showing that China’s role in driving demand would be critical.² As by far the biggest of the BRICs, China’s need for resources would continue to drive up the price of oil and many other commodities unless it fell significantly short of expectations in terms of economic growth, or found some way around using traditional energy supplies, whether through new technology, increased efficiency or alternative sources. At the time of this research, there was no hint that Chinese policymakers were looking for such alternatives. By 2010, their view had changed and with it my own view of the future for commodity prices. I am not sure that the long-term bull market in commodity prices is as powerful as I thought it was in 2005. In fact, I side more than ever with the optimists, who argue that the reason Malthus’s worst fears never came to pass and will not in the foreseeable future is technology.

At key moments in human history, man has found solutions to his most acute problems. An oft-quoted example of this was the great horse manure crisis that afflicted America’s cities in the late nineteenth century. In New York in 1900 the population of 100,000 horses reportedly produced 2.5 million pounds of manure every day. Streets were apparently covered with the stuff and the air thick with flies. The Times speculated that, by the middle of the twentieth century, London would be buried under nine feet of horse droppings. The future of cities was at stake. What saved them was the arrival of motorized transport. The entire manure problem vanished at a stroke, courtesy of men like Henry Ford.

I’m not suggesting that feeding the BRICs’ appetite for resources will be easy. Nor do I wish to trivialize the challenge it presents. But I do have faith that scientific innovation, wise government policy and the markets can provide solutions that will help us avoid the doomsayers’ scenarios. When nations become richer and individuals prosper, this stimulates business to search for new ideas and creative technologies that will drive the future.

Economists, however, make a mistake when they focus on the supply and demand issues of today without looking either back at historical patterns or out into the future. In 2001, when I dreamed up the BRIC acronym, the popular view was that commodities were a poor business and that prices only ever went down. Most energy- or commodity-industry executives I spoke to were very cautious about making new investments. The CEOs made constant reference to the 1970s and early 1980s and worked on the assumption that underlying crude oil prices would be around $35 per barrel. This was the basis for all their investments. Yet between the end of 2001 and the beginning of 2011, the IMF’s global commodity index rose fourfold.

In January 2005 I participated in the annual meeting of the top executives of a leading European-based energy company. After making my presentation about the BRICs dream and the world economy, I was invited, with two other guests, to debate our views with the company’s CEO. The price per barrel of oil at the time was around $42, and the CEO asked me how confident I was this would not drop to $28 within a year. His anxiety was typical among energy and commodity executives. They worried that by responding to rising prices by increasing investment, they would be caught out when supplies increased and prices fell. Most would much rather be conservative, pay higher dividends and buy back shares rather than invest in the long-term and expensive expansion of their capacity. This logical response to the volatility of commodity prices might, ironically, have been partly what kept them so high.

In my judgment, it is important to distinguish between real trends and noise. While it is always difficult, the ability to do so is what ultimately marks out good analysts from bad. The lazy consensus back in the early 1980s among many economists was that the future would exactly resemble the immediate past and present. They misunderstood the way supply and demand responds to oil prices. In the short term, not much changes. OPEC can increase or decrease production at short notice, but developing new fields and building the infrastructure to ship and refine large supplies of oil takes time. Over longer periods, however, countries, companies and individuals can dramatically affect the supply and demand of energy, by developing new sources and changing consumption habits. Oil prices are affected, of course, by supply and demand, but they also themselves affect supply and demand. The more oil costs, the fewer people want to heat their houses with it or use it to get to work. It takes time for such changes to work through a society, but if high prices persist, they do. Or, in economic terms, the long-term elasticity of supply and demand is higher than the short-term elasticity, and possibly higher than many economists believe. I have no reason to doubt that this experience will play out again. When I look at China in 2011, its supply-and-demand response to higher energy prices reminds me of some things that happened with global energy supply and demand back in the early 1980s, just after I’d finished my PhD on the topic.

Taking this view involved reexamining the forecasts my colleagues made in 2004. Given rising demand in China and India, and to a lesser extent Russia and Brazil, they envisaged a scenario between 2005 and 2020 in which world oil demand would grow on average by 2 percent a year, a significant rise from 1.4 percent a year over the previous two decades. Similar projections could doubtless have been made for other commodities. Beyond 2020, however, they forecast demand flattening out. Their reasoning was based on economic theory and empirical evidence from South Korea and Japan suggesting that as a nation’s GDP per capita rises from very low levels, its energy usage intensifies, hitting its peak when GDP per capita reaches around $6,000 (at 2003 values). As per capita wealth increases, incremental increase in energy use then tapers off, eventually converging with the rates we see in more advanced societies.

Economists explain this by saying that the intensity of energy usage follows an S curve, starting slow, speeding up and then flattening out during a more mature stage when energy efficiency improves. Economists also utilize a concept known as purchasing power parity, or PPP. The idea of PPP is that identical goods should cost the same in different markets, and the exchange rate should reflect that. The $6,000 figure given by my colleagues was based on the purchasing power of the U.S. dollar in 2003, for example. Today it would be around $7,500. In layman’s terms, under PPP the price of a cup of coffee in New York converted into euros should buy you a cup of coffee in Paris. Chinese GDP per capita in 2011 in PPP terms is now around $7,500 while India’s is still somewhat behind, at around $3,300.

One interpretation of why this S curve exists is that as people first “discover” wealth, they spend freely to acquire new and exciting luxuries. In developing countries one of the very first things people buy as they move up the economic ladder is a car, immediately intensifying their energy demands. I have already described the contrasting journeys from Beijing airport to the city center in 2011 and twenty years ago. In the early 1990s, the biggest obstacle was the hundreds of cyclists and their carts piled high with vegetables and fruit coming into town from the countryside. Today, the journey comes with the same frustrations experienced in most major cities in the West: car traffic and congestion. The same pattern is emerging in many other Chinese cities and is set to occur in many urban areas of India. Only as people become richer and more used to their wealth do they start to prize energy efficiency over consumption.

We clearly have some way to go before the BRICs reach the top of the S curve and moderate their energy use according to this model. China is getting close but India remains a long way off. Until then, the energy and commodity markets will face severe difficulties in matching supply to demand. There will be times when it feels as if the world has insufficient resources, just as it might seem that rising commodity prices are about to unleash a period of high inflation and economic volatility, as they did in the 1970s. We are already seeing new alliances emerging between the commodity-hungry BRICs and commodity producers all over the world. These alliances are bringing commodity-rich Brazil and Russia closer to China and India. Commodity producers across Africa are being courted by China. This may explain why South Africa has been welcomed so readily into the BRIC political club. A significant commodity producer itself, it may also be seen by China and India as a beachhead into Africa.

But I also believe that there will be other factors that could significantly alter the upward trend of resource and commodity prices and consumption. For example, China and India might not grow as quickly as I predict. A stronger world growth trend over the next twenty years is highly dependent on China and India. If either or both, especially China, fail to grow close to projected rates or find much more efficient forms of energy consumption earlier than is typical for countries at their stage of development, then the projections for global energy demand during the period 2005–2020 might need to be revised downward. I have heard it argued that the pressure on resource prices and availability will persist regardless of what happens in China and India. I find this difficult to believe. What happens with regard to their demand for both energy and resources overall is going to be dominant for the commodity supply industry, at least on the demand side of the equation. The future of the world economy in the coming decades hinges on growth in the BRIC countries and the United States. Growth may ease in Japan and Europe, even China and Russia as their populations age. But along with Brazil, India and the United States, which are likely to see ever growing populations, they will have a decisive impact on the growth of the world economy—and this will be critical for the demand for world energy. All of this seems to have extremely powerful implications for world energy prices and raises fears about the availability of resources, but it might not be quite so straightforward. A lot will depend on the decisions of producing companies as well as energy users as prices adjust.

Remember those energy company executives in 2005 who thought that the equilibrium oil price was around $35, and worried that prices might not be sustained much above that level. As a result, many were highly reluctant to invest. By 2011, with $35 a distant memory, and prices far above that for years, many had changed their minds. They now think we have reached a new, higher equilibrium, and they could be right, but just as I found when I was studying for my PhD all those years ago, that equally might not be true—at least not for long. With oil prices as high as they are today, energy companies may be encouraged to invest in additional production, and consumers may seek alternatives to expensive oil. If this happens, any strong perception that today’s prices represent a new equilibrium might quickly be proved illusory.

Another significant change since 2004, and one that has latterly increased in momentum, is the attitude in China and India toward developing alternative sources of energy. The industrialization and urbanization of China are undoubtedly the main drivers of the current supercycle in commodity prices and production. But no one enjoys paying high prices for energy and commodities, so in addition to developing its supplies of traditional fossil fuels, China has also launched a vigorous program of investment and support for renewable energy. Western critics may point at China’s polluted cities and rivers and call the country’s growth unsustainable, but China’s leaders see exactly the same problems, feel them even more acutely than these distant critics and are busily seeking solutions.

By 2020, China plans to have reduced its carbon intensity by between 40 and 45 percent compared with 2005 levels.³ Writing in the Financial Times in November 2009,⁴ Sir Gordon Conway, cochair of the China Council for International Cooperation on Environment and Development (CCICED), described China’s plan for a low-carbon economy. “The Chinese leaders are moved by a sense of urgency,” he wrote. “Following the traditional economic model is not an option: resource, social and environmental constraints make it impossible. They are also aware of the danger that rapid growth will lock China into industrial and urban structures that will become a liability in a low-carbon world.” As a result, the Chinese leadership had asked the CCICED to draw up three scenarios. Under the first, China continues down its current path of energy consumption, and produces nearly 13 billion tons of carbon dioxide by 2050, nearly twice what it produces today (already more than the United States and Canada combined). The second scenario would limit emissions to 9 billion tons by 2050. The third would let emissions peak in 2025 and then fall to 5 billion by 2050, equivalent to what the United States emits today.

The key to cutting emissions, wrote Conway, is “decoupling growth from greenhouse gas emissions.” This would mean reducing energy consumption per unit of GDP by 75 to 85 percent by 2050, through a comprehensive efficiency scheme, involving everything from low-carbon cities and transport systems to revamped factories. Fossil fuels would be used more efficiently, use of renewables and nuclear energy would expand and carbon-heavy emissions would be captured before they polluted the environment. Not only do the Chinese see this plan as a means to cleaner air and water, and less dependence on fluctuating fossil fuel prices, but they also see it as a way for China to develop a competitive advantage in a low-carbon world. The ambition and detail of this policy far outstrip anything we have seen from the United States.

Applying the impact of China’s low-carbon measures to predictions for China’s oil consumption in 2050 is fascinating. If China were to succeed in supplying 50 percent of its new energy needs with renewable resources by 2030, and 100 percent by 2050, as the CCICED reports it hopes to, then this would have a dramatic effect on our projections for global oil demand. In 2004 we predicted that the world would be using 75.2 million barrels of oil per day by 2050. Assuming the Chinese do what they intend, then that estimate is 20 percent too high. The world in 2050 will be using just 60 million barrels of oil per day. If India were to commit to similar targets, that would slash a further 20 million barrels per day from our 2004 projection for oil consumption by 2050.

This Chinese initiative strikes me as extremely exciting and should prove quite a stimulant for the supply of energy from sustainable sources. It surprises me that professional commodity market participants are not more focused on China’s plans. I certainly keep an eye on them, and try to track the government’s progress. In May 2011, the China Daily, which now publishes a weekly European edition, devoted five full pages, including the front page, to the topic of electric cars. The newspaper discussed the likely future demand for automobiles in China, citing the Ministry of Industry and Information Technology’s intention that there should be more than 200 million registered vehicles by 2020, up from 70 million in 2011. The government has announced its commitment to spending approximately $15 billion over the next decade to boost electric car development. This follows a 2010 commitment to boosting the number of electric-powered vehicles by 20 million by 2020. China’s influential National Development and Reform Commission has said that it is looking to subsidize the cost of at least 4 million electric-powered vehicles and that the government is already trialing their use in the country’s main cities, including Beijing and Shanghai.

The two main problems with electric cars are the high cost of batteries and their limited range. The Chinese recognize this and are doing all they can to support the growing battery industry. As most driving in China is done in cities, with distances of less than sixty kilometers per day, they see electric cars as being potentially as viable and easy to use as iPhones. The whole world stands to benefit from China’s concerted investment and focus in this field. (My personal investment portfolio includes shares in a small Swedish solar power company, and the stories I hear about Chinese interest in it are remarkable.)

It will not be straightforward for China to achieve its ambitious goals for energy conservation and improved efficiency. Announcing plans to boost the use of alternative energies, electric cars and the like is easy. Actually achieving them in a country in which about 50 percent of its population still lives in rural communities—of whom at least a third will move into cities in the next twenty years—is difficult. That being said, with strong central leadership, China is better placed to implement such tough goals than others.

So we have a complex world evolving in the commodity markets, with strong price pressures influencing many aspects of the world economy. But just as in the 1980s there was a response to the rising prices, it seems likely that the same will occur this time. Much will depend on how countries can coordinate and cooperate to respond to these immense challenges.