EEP 101/ECON 125 Lecture 14: Natural Resources (NR)

David Zilberman UC Berkeley

The 2003-08 food commodity price boom

The food commodity price boom substantially impacted global economic activity.

It affected developing nations by impacting real output, the balance of payments, government budgetary positions and most importantly the well being of the very poor. It also affected developed countries, by transmitting business cycle disturbances and creating inflationary pressures.

Can we identify the main cause of this price spike?

World Bank, March 2010

Commodity price trends: The big picture

During the 21st century, commodity prices spiked to new highs

World Bank, March 2010 Source: Trostle (2008)

Crop price trends

This report focuses on crop prices from 2002 to 2007

Data source: IMF primary commodity price database World Bank, March 2010

Crop price trends

Cumulative increase in world price (in 2005 US$) with respect to 2001
2002 corn soybean rapeseed rice wheat 11% 16% 13% 15% 38% 24% 11% 11% 2003 17% 34% 2004 25% 60% 2005 10% 32% -15% 64% 22% 2006 35% 30% 3% 75% 54% 2007 82% 81% 40% 89% 103% 2008 149% 163% 99% 293% 166%

Data source: IMF primary commodity price database World Bank, March 2010

Is biofuel the culprit?*

*Wiebe, 2009, in The Biofuel Situation and Policies in Developing Countries
Source World Bank (April 2008) IFPRI (May 2008) OECD-FAO (May 2008) Estimate 75 % 39 % 21-22 % 42 % 34 % 24 % Commodity global food index corn rice & wheat coarse grains vegetable oils wheat Time period January 2002 February 2008 2000 2007 2000 2007 2008 2017 2008 2017 2008 2017

Collins (June 2008)

Glauber (June 2008)

25-60 % 19-26 %
23-31 % 10 % 4-5 % 35 % 3%

corn US retail food

commodities global food index US retail food corn global food index

2006 2008 2006 2008

April 2007 April 2008 April 2007 April 2008 January April 2008 March 2007 March 2008 March 2007 March 2008 2007

CEA (May 2008) Rajagopal et al. (2009)

15-28% Corn Bank, March 2010 10-20%Worldsoybean

Review of Renewable Vs. Non Renewable

Nonrenewable resources (mineral, fossil water, remnants of ancient civilizations, old growth forest, dead things). Renewable resources (fisheries, forests, grasslands, water systems, living things). Many renewable resources and most nonrenewable ones are exhaustible.

Analysis of dynamic systems

Natural resource management is control and direction of dynamic systems. Policies affect the evolution of populations and/or resource inventories The indicators of the situation of dynamic systems are state variables Number of fish in a lake at a moment of time Volume of water in an aquifer Policy makers affect control variables Size of harvest Price of water Systems are affected by random shocks Weather Pest infestations

Quantification of NR systems

Measurement of dynamics systems is challenging

counting fish is not easy

NR resource systems may be heterogeneous

trees and fish of different sizes, of different ages, and at different locations minerals of different qualities at varying locations

The art of modeling identifies crucial features of the system and integrates simplicity with realism Models are approximations that are subject to error

Equations of motion

Depict the evolution of state variables over time

How the stock of oil or number of fish change

Stock size today is

the resource stock of tomorrow is EQUAL TO todays stock MINUS todays harvest (or mining) PLUS resource stock growth (for renewable resource) PLUS new discoveries PLUS

Applying Our Knowledge of Interest Rates

Higher interest rates lead to increased mining or harvesting Resource owners that have to pay high interest for funds are more likely to mine resources & sell them than resource owners who face low interest rates

Poor individuals with heavy credit constraints are more likely to mine their resources
Income & credit support for the poor reduce NR mining

Net discounted present value (NPV)

Discounting to time 0 is used for comparing income of different periods The objective of resource management programs are to maximize the sum of discounted values of all net benefits over time (Net Benefits of period 1, plus 2, plus 3, etc.)

Example: Computing NPV

If we have earned

55 dollars at first period 60.5 dollars at period two

If the discount rate is 10% The NPV is 100 Dollars (55/1.1=50, 60.5/(1.1*1.1)) If interest rate is 20%the NPV is

45.83 which is equal to 55/1.2 + 42.03 Which is equal to 60.55/(1.2*1.2) = 87.86

Higher interest rates reduce value of future earning

Non renewable resources

The actual stock of non renewable resources is declining over time, but known reserves may increase because of discoveries

Perceived shortages and improved discovery technologies trigger searches and lead to discoveries Known oil reserves are estimated to last 40-80 years, the same estimate was given in the 1940s
Still oil and natural gas reserves may run out Non renewable resources are rarely depleted, but may become too expensive to mine

Factor determining extraction: demand

Demand is reflecting marginal value of resource in applications (value of oil in transportation and heating)

Higher incomes and lower prices increase demand

Demand increases with increased population It may be reduced by introduction and adoption of resource conserving technologies (fuel efficient cars) It is reduced by back stop technologies (solar energy)

Demand can be reduced by Taxes Population policies R&D

Other factors determining extraction

Extraction cost- reduced mining or harvesting cost or improved infrastructure (roads) increase extraction

Recycling- alternative supply sources reduce extraction

Known Reserves (more reserves increase extraction) Market structure Cartels extract less than competitive producers Open access result in excessive mining Regulation and policies Technology control (restriction on use of explosives) Zoning ( do not drill in Alaska)

Generic Model

Marginal Mining cost. MNC(x) . Marginal future cost (User costs). MFC(x). The future cost represents loss of future opportunities by present extraction. Externality cost. MEC C =Optimal allocation C B A A=Allocation under open access

B=Allocation without considering externality costs

Alternative Allocations

Open access and no regulation will result in excessive resource use (A- Pollution & future ignored) Competitive supply by firms with well defined resources, ownership rights without pollution control still result in excessive mining (B) Competitive supply when ownership is well defined and pollution is taxed results in optimum (C) Cartel may under provide resources (if price under monopoly is greater than at C) or under provide if pollution cost great than the cartels price increase.

Elements of a Resource Policy

(1) Establishing private prosperity for the resource. This prevents the open access problem and moves from point A to point B in Figure 1. (2) Externality control. Including tax on the resource (leading to a transition from B to C). Gasoline tax in U.S. can affect Climate change dynamics reduce air pollution Resource taxes also lead to adoption of resource efficient technologies emergence of backstop technologies (recycling when appropriate) (3) Support to Backstop research (4) Subsidy for adoption of resource efficient technologies( fuel efficient cars,public transport)

Renewable resources

Growth provides a base for harvest without ultimate depletion. Change of stock = Growth minus harvest At a Steady state (sustainable solution) Growth = Harvest There are many sustainable solutions, the one that maximizes discounted net benefits is optimal

Growth as function of stock

We have steady state (harvest =growth) at B,M,C,X

B= low stock sustainable outcome C = High stock sustainable outcome M=Maximum Sustainable yield X=maximum Sustainable Stock M G g r o w t h O

Resource Stock

Alternative Sustainable Outcomes

Extinction- no stock on growth X=maximum Sustainable Stock (All food goes for consumption not growth) M=Maximum Sustainable yield (Between O and X)

B= low stock sustainable outcome (Between O & M)

C = High stock sustainable outcome (Between M &X)

Maximum Sustainable yield is not necessarily optimal

Higher stocks reduce harvesting costs

Lower stocks allow more extraction

Alternative extraction strategies

Extract first sustain later Extr The story U.S &Europe acti
on
Time

Conserve first sustain later Extrac Occurs in fisheries which are near extinction tion Or in restoration efforts

Time

Major Contributors to extraction:

Demand, Open access,Extraction technology Resulting elements of Extraction control policy Reduction of demand

taxes, subsidies to resource use reducing technologies

Control of access

establishing property rights requiring licenses to extract limiting harvesting season

restricting size of equipment restricting total harvesting capacity regulating externality caused by harvesting (By catch)

Regulation of Extraction technology

Multiple benefits of resources

Resources (forests, wetlands, etc.) provide multiple services (recreation, bio-diversity, etc.) Harvesting reduces alternative environmental benefits

One solution: taxation of harvested resources

Alternatives: subsidies for conservation (not harvesting), debt for nature, payment for environmental services Marketing of environmental amenities (Ecotourism, bioprospecting, tropical nuts )

Intensification and conservation

Agricultural intensifications (fertilizers,chemicals)increases yield per acre and reduces utilized land and deforestation Aquaculture provides substitutes for fishing, but has its own environmental side effects (to be controlled) Forest plantation reduces pressure on natural forest Husbandry of animals (rhinos) would reduce pressure for tasks and other features of wild animals

Fishery Issues

International water. There are international agreements and evolving laws of the sea, yet, open access problems continue

Monitoring problems. Countries establish transferable fishing permits. Monitoring and enforcement may limit their effectiveness
Regulation of timing. The size, number of boats and duration of fishing may be regulated. Limitations: (i) It leads to overinvestment in equipment. (ii) Frozen fish are inferior to fresh ones. with fine mesh nets) have future and externality costs

Technology controls. Some techniques (use of explosive, fishing

Aquaculture and marine culture. Provide alternative sources of
fish, but have externality costs

P0

Non renewable resource prices

Prices are indicators of scarcity

Prices of non renewable resources decline when known resources grow faster than use
Prices of most non renewable resources has decline Higher interest rates lead to lower prices at present and higher future prices (they increase present mining)

Higher mining cost increases prices but reduces price changes over time

Optimal price of resource over time with zero extraction cost

Pt r2 > r 1 r1

Higher interest rate reduces initial price

BUT

Pt Pt

Increased rate of price changes when stock is constant

t* t Figure 3

More mining under higher interest rates in earlier periods and less mining beyond t=t*

Mining

xt xt

t*

Figure 4

Price Dynamics of Renewable Resources

The rate of the price change is affected by:

The discount rate tends to increase price over time. Rate of resource population growth tends to reduce price over time (as supply increases) Extraction cost factor dampens the other two

Demand growth increases prices

New resource sources tend to reduce prices

Prices of most renewable resources have decline over time