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According to recommendations in a recent McKinsey & Co. report, lifting both resource productivity and supply are critical to reduce future volatility in the years ahead.
By James Wellstead – Exclusive to Resource Investing News
While similar price spikes have occurred over the past century, innovations in exploration, extraction and consumption were able to lower commodity prices by half while increasing consumption of critical commodities by 600 to 1,200 percent. Despite this track record, McKinsey argues that the next 20 years offer a new challenge in achieving similar innovations.
“Our analysis suggests that [commodity prices] will remain high and volatile for at least the next 20 years if current trends hold — barring a major macroeconomic shock — as global resource markets oscillate in response to surging global demand and inelastic supplies.” With more than 3 billion people entering ‘middle-class consumer’ status by 2030, commodities are in for an unprecedented and fast-paced spike in demand.
Rising commodity prices akin to those experienced in the past year will continue to offer producers and businesses ample incentive to meet the rising demand. However, McKinsey believes that a significant component of the solution to volatile commodity prices and shortages goes beyond achieving a large expansion in gross supply. We also require a “step change in the productivity of how resources are extracted, converted, and used… to head off potential resource constraints over the next 20 years.”
“Better resource productivity could single-handedly meet more than 20 percent of forecast 2030 demand for energy, steel, water and land,” the report stated.
These productivity gains also offer significant value to those who can achieve them. “We estimate the total value to society associated with these productivity improvement opportunities—including the market value of resources saved—to be $2.9 trillion in 2030*.” 70 percent of the productivity improvement opportunities suggested have an internal rate-of-return of more than 10 percent at current prices.
Productivity innovation is critical
In the 2009 book, Factor Five, co-authored by the Co-chair of the U.N. International Panel for Sustainable Resource Management Ernst von Weizsäcker, the authors claim new technologies and integrative design can quintuple the amount of work produced from energy, water and other resources.
The implications of such a shift in resource productivity could create a new Kondratiev wave—a long-term growth cycle typically lasting 30 to 50 years that can be attributed to major technological innovations such as the invention of steam power, railroads, and software information technology.
McKinsey’s research suggests that these 75 percent of productivity enhancing opportunities stem from 15 different options, including greater energy efficiency in power plants, the iron and steel industry and increasing transport fuel efficiency.
Innovation in mining
The mining industry has the potential to achieve efficiency and productivity gains in a number of areas. Michael Beare, SRK Consulting‘s principal mining engineer, said recently that “the mining industry is very poor at passing on productivity improvements compared to other industries, like building cars, where business improvement practices are really established. It’s only relatively recently that we’re starting to see that approach come in with mining.”
These productivity improvements are coming in the form of technology, as well as systems integration and planning. Remotely operated equipment and mine planning software are two technologies that Beare identified as leading the pack at the moment. But it’s also the simple things like controlling and monitoring mine operations more closely that can make a difference.
“For example, it’s measuring things like engine hours on equipment and looking at the tons per hour off each piece of equipment from the bucket count. Simple things that the best mines do routinely, but the average mines don’t do at all.”
Innovations in extraction and exploration techniques are also crucial in growing the supply as well. Natural gas fracturing (“fracking”) is the most recent significant innovation to impact the supply side response and McKinsey believes that duplicating this effort in the recovery of oil and coal could also go a long way to reduce resource volatility.
But at the moment, a shortage of capital for explorers and developers continues to keep markets supplies tight. “That’s really where it hits,” Beare commented, “because it stalls projects. The irony is that demand for commodities still seems to be fairly high, but new operations aren’t coming in, so potentially the bubble is getting bigger.”
The stakes of supplying global commodity markets could not be higher. With rising food prices playing a role in regime changes in the Middle East and fuel subsidy removals leading to a potential indefinite nationwide strike by Nigerian labour unions, global political stability requires immediate action.
*At current prices before accounting for environmental benefits and subsidies.
Securities Disclosure: I, James Wellstead, hold no direct investment interest in any company mentioned in this article.