December 31, 2015

The Top Ten IMF Blogs of 2015

Three of my co-authored blog posts made it to the top 10 most read IMF blogs for the year 2015. Below is the list.

Number 1: Seven Questions About The Recent Oil Price Slump with Olivier Blanchard

Number 6: Sovereign Wealth Funds in the New Era of Oil with Adnan Mazarei, and Ananthakrishnan Prasad

Number 8: Metals and Oil: A Tale of Two Commodities with Akito Matsumoto

In addition, my blog with Maury Obstfeld on: The Price of Oil and the Price of Carbon, released in December got an honorable mention.

December 9, 2015

Seven Questions About Climate Change

Climate change is at the top of the agenda of policymakers as they gather inParis for the United Nations Climate Change Conference, COP21. Climate change is a threat to the very survival of humanity. Notwithstanding the severity of the threat, actions to halt climate change have been scant and uneven across countries. This Q&A article provides brief answers to seven questions about climate change, its consequences, and the coordination for developing mitigation strategies.[1]

Question 1: What is climate change?

Climate change refers to changes in the patterns of the overall climate of the earth. It can refer to changes in the Earth’s average temperature and precipitation patterns. Among them, the gradual increase in the average temperature of the Earth’s atmosphere and its oceans is often referred to as global warming (see Figure 1), and the potential causes and consequences from global warming have been the main focus of many discussions.

Some causes of climate change are natural. These include changes in the Earth’s orbit and in the amount of energy coming from the sun. Volcanic eruptions are also natural causes of climate change. There is however a consensus among scientists that recent global warming cannot be explained by nature alone.

Human activity is another source of climate change. Most scientists argue that global warming since the mid nineteenth century is mostly due to the combustion of fossil fuels (coal, oil, and natural gas) that constitute today’s major sources of energy for the global economy. The burning of these fossil fuels releases greenhouse gases, such as carbon dioxide, into the air.[2]

Question 2: Is there evidence of global warming?

The average temperature of the Earth has risen by a little more than one degree Fahrenheit over the past 100 years or so. It may not seem like much, but small changes in the Earth’s average temperature can lead to big consequences. The Intergovernmental Panel on Climate Change’s (IPCC) Fifth Assessment Report concludes, that “the human influence on the climate system is clear and is evident from the increasing greenhouse gas concentrations in the atmosphere, positive radiative forcing, observed warming, and understanding of the climate system.

There is a strong scientific consensus that the global climate is changing and that human activity contributes significantly to this trend. According to Cook and others (2013), 97 percent or more of climate scientists agree that this is due to human activity—notably, emissions of carbon dioxide.

Considering that carbon emissions are chiefly caused by the burning of fossil fuels following the industrial revolution, human activity is seen as playing a key role in global warming. Scientists find that around 1950, carbon dioxide levels in the atmosphere reached its highest point in 650,000 years and has been increasing with dramatic speed since then (see Figure 2). The carbon lifecycle and deforestation have made it harder to resorb carbon dioxide. Oceans absorb carbon dioxide and this in turn leads to acidification. Changes in the ocean’s ecology then destroys coral reef habitats.

Question 3: What are the economic and social consequences of global warming?

Global warming can cause climatic catastrophes. Global warming leads to rising sea levels, melting of glaciers, and ice sheets; and these changes, in turn, affect precipitation patterns. The severity and frequency of hurricanes and storms also increase as a result. These catastrophes include irreversible events. For example, permafrost melting allows previously frozen organic matter to release potentially large amounts of methane.

The social consequences of global warming can be dramatic. While air pollution associated with use of coal and oil has consequences on the immediate health and wellbeing of individuals, the resulting global warming can affect human and animal livelihoods by endangering and even destroying their habitat.[3] Global warming can thus trigger famines, mass movement of populations, and endanger animal species directly; and it can also alter the balance of ecosystems indirectly.

Global warming disproportionately affects vulnerable groups and certain territories. For example, islands and coastal areas are the most threatened loci because of rising sea-levels. Individuals living in rural areas in poor countries are also disproportionately affected by climate change because they are more reliant on natural resources and the environment for their subsistence (see e.g., World Bank, 2011).

Climate change and global warming reduces economic growth and slows economic activity in different ways.[4] For example, global warming can affect agriculture in two ways. First, it can destroy agricultural harvests. Second, it can also affect agricultural productivity permanently. Beyond agriculture, global warming can damage infrastructure, raise health costs and insurance premia, and cause financial stress. The disorder caused by socioeconomic tensions, including mass migration and conflicts, resulting from global warming can also deter foreign investment, and, hence, reduce growth.

Continue reading here.

December 3, 2015

The Price of Oil and the Price of Carbon

“The human influence on the climate system is clear and is evident from the increasing greenhouse gas concentrations in the atmosphere, positive radiative forcing, observed warming, and understanding of the climate system.” —Intergovernmental Panel on Climate Change, Fifth Assessment Report

Fossil fuel prices are likely to stay “low for long.” Notwithstanding important recent progress in developing renewable fuel sources, low fossil fuel prices could discourage further innovation in and adoption of cleaner energy technologies. The result would be higher emissions of carbon dioxide and other greenhouse gases.

Policymakers should not allow low energy prices to derail the clean energy transition. Action to restore appropriate price incentives, notably through corrective carbon pricing, is urgently needed to lower the risk of irreversible and potentially devastating effects of climate change. That approach also offers fiscal benefits.

Low for long

Oil prices have dropped by over 60 percent since June 2014 (see Chart 1). A commonly held view in the oil industry is that “the best cure for low oil prices is low oil prices.” The reasoning behind this adage is that low oil prices discourage investment in new production capacity, eventually shifting the oil supply curve backward and bringing prices back up as existing oil fields—which can be tapped at relatively low marginal cost— are depleted. In fact, in line with past experience, capital expenditure in the oil sector has dropped sharply in many producing countries, including the United States. The dynamic adjustment to low oil prices may, however, be different this time around.

Oil prices are expected to remain lower for longer. The advent of shale oil production, made possible by hydraulic fracturing (“fracking”) and horizontal drilling technologies, has added about 4.2 million barrels per day to the crude oil market, contributing to a global supply glut. Shale oil will lead to shorter and more limited oil-price cycles. Indeed, shale requires a lower level of sunk costs than conventional oil, and the lag between first investment and production is much shorter. Furthermore, shale is still at a relatively early stage of its industry life cycle, where the scope for learning is substantial, as shown by production levels that have proven resilient thanks to phenomenal efficiency gains forced by the big drop in oil prices.

In addition, other factors are putting downward pressure on oil prices: change in the strategic behavior of the Organization of Petroleum Exporting Countries, the projected increase in Iranian exports, the scaling down of global demand (especially from emerging markets), the secular drop in petroleum consumption in the United States, and some displacement of oil by substitutes. These likely persistent forces, like the growth of shale, point to a “low for long” scenario, even after the supply legacy left by the high-price era of the 2000s has dissipated. Futures markets, which show only a modest recovery of prices to around $60 a barrel by 2019, support this view.

Natural gas and coal—also fossil fuels—have similarly seen price declines that look to be long-lived. Coal and natural gas are mainly inputs to electricity generation, whereas oil is used mostly to power transportation, yet the prices of all these energy sources are linked, including through oil-indexed contract prices. The North American shale gas boom has resulted in record low prices there. The recent discovery of the giant Zohr gas field off the Egyptian coast will eventually have repercussions on pricing in the Mediterranean region and Europe, and there is significant development potential in many other locales, notably Argentina. Coal prices also are low, owing to oversupply and the scaling down of demand, especially from China, which burns half of the world’s coal.

Continue reading here.

November 21, 2015

From Global Savings Glut to Financing Infrastructure: The Advent of Investment Platforms

A new paper that I co-authored investigates the emerging global landscape for public-private co- investments in infrastructure. The creation of the Asian Infrastructure Investment Bank and other so-called “infrastructure investment platforms” are an attempt to tap into the pool of both public and private long-term savings in order to channel the latter into much needed infrastructure projects. This paper puts these new initiatives into perspective by critically reviewing the literature and experience with public private partnerships in infrastructure. It concludes by identifying the main challenges policy makers and other actors will need to confront going forward and to turn infrastructure into an asset class of its own.

October 26, 2015

Sovereign Wealth Funds in the New Era of Oil

As a result of the oil price plunge, the major oil-exporting countries are facing budget deficits for the first time in years. The growth in the assets of their sovereign wealth funds, which were rising at a rapid rate until recently, is now slowing; some have started drawing on their buffers.

In the short run, this phenomenon is not cause for alarm. Most oil exporters have enough buffers to withstand a temporary drop in oil prices. But what will happen if low oil prices persist, and how will policymakers react?

We explore here the fallout from low oil prices on sovereign wealth funds in oil-exporting countries and find that that they have important domestic implications. The impact on global asset prices will depend on the extent to which the unwinding of oil exporters’ sovereign wealth funds is not compensated by portfolio adjustment in other parts of the world.

The rise of sovereign wealth funds

In the early 2000s, high oil prices brought about a massive redistribution of income to oil exporters, resulting in current account surpluses and a rapid buildup of foreign assets. Governments established new sovereign wealth funds or increased the size of existing ones to help manage the larger pool of financial assets.

Continue reading here. Also see the coverage of the story in the Wall Street Journal

October 6, 2015

Metal Prices Outlook: Low for Long

The IMF's new Commodity Special Feature focuses on metals in the world economy and in particular the West to East (China) shift on the demand side and the North to South shift on the supply side that is the shifting frontiers of resource extraction. The latter has led to the expansion of the known global subsoil reserves through the opening up and institutional reforms in Latin America first and then Africa. The balance between demand and supply points to a "low for long" scenario in metal prices.

September 14, 2015

Metals and Oil: A Tale of Two Commodities

“It was the best of times, it was the worst of times.” With these words Charles Dickens opens his novel “A Tale of Two Cities”. Winners and losers in a “tale of two commodities” may one day look back with similar reflections, as prices of metals and oil have seen some seismic shifts in recent weeks, months and years.

This blog seeks to explain how demand — but also supply and financial market conditions — are affecting metals prices. We will show some contrast with oil, where supply is the major factor. Stay tuned for a deeper analysis of the trends in a special commodities feature, which will be included in next month’s World Economic Outlook.

Metals matter

Base metals — such as iron ore, copper, aluminum and nickel — are the lifeblood of global industrial production and construction. Shaped by shifts in supply and demand, they are a valuable weathervane of change in the world economy.

There is no doubt about the direction of the prevailing wind for metals in recent years. Prices have been gradually declining since 2011 (chart 1). While oil prices have also dropped, the decline is more recent (prices peaked in 2014), and more abrupt. That said, in both cases the downward pressure on prices result broadly from abundant production from the era of high prices. This is now coming to roost with lower demand from both emerging markets and advanced economies. There are importance nuances however in the relative strength and nature of those forces.

July 14, 2015

Global Implications of Lower Oil Prices

The sharp drop in oil prices is one of the most important global economic developments over the past year. In a new report that I co-authored, we find that (i) supply factors have played a somewhat larger role than demand factors in driving the oil price drop, (ii) a substantial part of the price decline is expected to persist into the medium term, although there is large uncertainty, (iii) lower oil prices will support global growth, (iv) the sharp oil price drop could still trigger financial strains, and (v) policy responses should depend on the terms-of-trade impact, fiscal and external vulnerabilities, and domestic cyclical position.

March 18, 2015

News Shocks in Open Economies: Evidence from Giant Oil Discoveries

From the The Grumpy Economist:

I attended the NBER EFG (economic fluctuations and growth) meeting a few weeks ago, and saw a very nice paper by Rabah Arezki, Valerie Ramey, and Liugang Sheng, "News Shocks in Open Economies: Evidence from Giant Oil Discoveries" (There were a lot of nice papers, but this one is more bloggable.)

They look at what happens to economies that discover they have a lot of oil.

An oil discovery is a well identified "news shock."

Standard productivity shocks are a bit nebulous, and alter two things at once: they give greater productivity and hence incentive to work today and also news about more income in the future.

An oil discovery is well publicized. It incentivizes a small investment in oil drilling, but mostly is pure news of an income flow in the future. It does not affect overall labor productivity or other changes to preferences or technology.

Rabah,Valerie, and Liugang then construct a straightforward macro model of such an event.

Utility comes from consumption and work. The production function has an oil sector and non-oil sector. There are adjustment costs to investment and to reallocation of capital between oil and non-oil sectors. The consumption good is tradeable, and the economy sells oil internationally to get it as well as to produce it.

Continue reading here.

March 15, 2015

An Exploration in the Deep Corners of the Oil Market

Oil prices have dropped dramatically focusing the attention on the short run. This article takes a longer view. It argues that the oil market is shaped by forces pertaining to demand and supply. A simple model integrating these forces is presented as a useful tool to explore likely scenarios. Notwithstanding the level of uncertainty surrounding the evolution of both demand and supply forces, simulations point to the emergence of supply shortages suggesting that available forecasts predicting persistently low oil prices may be too optimistic. 

Oil prices have fallen by over 50 percent since June 2014. Much has been writ- ten about what triggered this slump, and the relative role of supply and demand factors. Considering that price elasticities are extremely low in the short run, disturbances, such as the shift in strategy by OPEC, can result in sharp fluctuations in prices. Simple extrapolations of recent trends would give a very misleading picture of future oil prices over the longer term. The long-run price elasticities are considerably higher, as both consumers and producers change their behavior, and adopt new technologies, and underlying developments in demand and supply come to the fore. While there is uncertainty about the evolution of these developments, there are known elements such as geology on the supply side and demographics on the demand side. Technological innovation, responding to economic incentives (e.g., the advent of shale exploitation), and to policies aimed at reducing greenhouse gas emissions (e.g., the emergence of alternative energy sources) also will play a key role in shaping the oil market.

Continue reading here