Tuesday, November 23, 2004

Commodities bull a bear
for the environment

There has been a stealth bull market in commodities for some time. I say stealth because few people have noticed it until perhaps now as gold has gotten some headlines after reaching 16-year highs and oil has touched $55 a barrel recently. First, this post is categorically not meant to be investment advice. The old saying, "Fools rush in where angels fear to tread," certainly applies to investing in this area. (So as they say in every investment circular, "Past results are not indicative of future returns. Consult with a competent investment professional before investing.")

Now, let me get to what I want to talk about. It's worth it to understand what's going on in the commodities markets because they give us signals about what's going on in the environment with respect to resources, at least in the eyes of people who buy and sell the stuff. Naturally, higher prices indicate scarcity either due to supply problems or increased demand. Of course, depending on which commodity you cite, higher prices could be due to either problem or both. But, prices also imply two other things: 1) what the definition of a resource is and 2) what people are willing to do to get it. Both have big environmental implications.

The simplest way to illustrate point 1 is with an example from mining. Mining companies classify something as ore if the metal contained in it can be economically extracted at today's prices with today's technology. (I'll discuss those technologies in a minute.) If the price goes up, rock that was previously uneconomical to mine can suddenly become ore since the higher price will offset the higher cost of getting the metal from the rock. Usually, something is classified as rock instead of ore for two reasons: 1) the metal is in a form that is harder to get out or 2) there's less of the metal per unit of rock than is economical to mine.

The simplest way to illustrate point 2 is to fly over the Gulf of Mexico or any offshore oil field. The platforms that you see may cost up to $1 billion. That's a lot of money to drill a hole. But, if the expected finds of oil or gas are big enough or the price is high enough, it's worth it.

With high prices people naturally want to drill for more oil and dig for more ore. On the farm where commodities are grown, farmers want to plant more crops.

Now, with high prices comes public concern. The public wants cheaper goods, and it turns to politicians with their complaints. The politicians are essentially powerless in the face of a long-term bull market in commodities to do much of anything in the short run. (I'll come back to this in a future post.) But, they can look like they are doing something by opening up public lands to mining and oil exploration. And, sure enough, when they do, companies find minerals and oil there.

So, it should be no mystery why, for example, drilling in the Arctic National Wildlife Refuge is high on the list of concerns for this administration. (I won't repeat here all the reasons why such drilling will make little or no difference in prices or supply which has been well-covered by the media). Opening ANWR would give the appearance of doing something and reward an important group of the administration's supporters, but it won't actually solve any problems.

That's public land. On private land there will be no vote. Mineral rights will be purchased if available and practical. Large swaths of land deemed dirt just a few years ago will suddenly become "ore." The machines will move in and start tearing at the earth and the mills will start milling the ore. In the oil fields it will be the same thing. Rigs will begin to appear in the farm fields and the yacht basins everywhere--at least, everywhere drillers think there's oil or gas. At the peak of the last oil boom there were 5,000 drilling rigs active in the United States. That number dwindled to a few hundred in the mid-'90s. Look for a return to the high before it's all over.

Farmers will start planting fencepost to fencepost. Those who haven't ripped out trees and windbreaks already in order to plant more crops will do so. These measures were, of course, designed to conserve soil from wind erosion. But who cares about that when soybeans are $10 a bushel as they were earlier this year before Chinese buying stopped and prices collapsed to around $5.50 today? Naturally, more planting means more use of pesticides and herbicides, more contaminated runoff both from manure and from chemicals. It also can mean more use of water from irrigation. For farmers in poor countries high prices provide incentive to tear down more trees such as those in the Amazon rainforest to make way for crops. In short, higher prices mean more of everything including the bad stuff.

Speaking of chemicals, technology has now made it possible to mine ore with very small concentrations of metals in them. Gold ores that have less than one-fifth of an ounce of gold per ton of ore are worth processing. (I really did mean "ton." It's not a typo!) For copper a much less profitable metal, it could mean less than 2 percent of the rock need be copper. The ore is crushed and then mixed with a liquid containing chemicals (usually cyanide) that combine with the small amounts of metals in the crushed ore. The liquid then flows into a processor that extracts the metal from the solution. It's hard to get across just how many tons of earth have to be mined in this way in order to get the metals we need.

Of course, there's also the problem of keeping the cyanide and other chemicals from leaking out, a problem Montanans recently voted to do without.

The problems with oil and gas drilling include the leakage of brine (saltwater) into freshwater acquifers which have been punctured by the drill, the disposal of toxic chemicals associated with drilling, the disturbance of the land and the effect on wildlife or the surrounding community, and the myriad problems associated with the transport, refining and use of petroleum and its derivatives. There's also the danger of well blowouts which I've seen firsthand and which devastate the surrounding terrain as brine gushes out onto farmland or natural areas and hot flames that can melt metal sear anything nearby.

There are two good effects of a commodities bull market: 1) people tend to become more efficient in their use of resources that cost more and 2) they tend to look for substitutes, either for reasons of cost or because they do not want to be subject to the vagaries of the market. If the substitute is biking instead of driving or wind power instead of coal-fired electricity, that can be a positive. If the substitute is another resource that is merely cheaper like aluminum for tin, then there isn't much of gain as far as the environment is concerned.

Commodity price cycles come in long waves of both the "up" and "down" variety. The last wave peaked in either 1974 or 1980 depending on who you talk to, which commodity you're looking at, and how you measure. But everyone who was alive in the '70s remembers what a highly inflationary time it was. Prices were rising at a 12 percent per year clip at the end, and gold topped $850 an ounce, a level it has not seen since. Oil hit $35 a barrel which when adjusted for inflation comes out to between $70 and $80.

One prominent and, by all accounts, very wealthy commodity investor believes the current commodity bull began in 1998. He expects it to run for another 5 to 10 years, something the environmental community should largely dread unless they can turn it into an opportunity to discuss renewable energy and better stewardship.


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