The discussions in Chapter 2 demonstrated how, in the course of the twentieth century, Japan, the USA, and Western Europe, the world's industrial centers, have become increasingly dependent on imported commodity supply. Expanded needs due to industrialization and income growth, the relative depletion of the domestic resource base, and the secular decline in transport costs, explain why it had become increasingly economical for the advanced nations to replace the domestic production of a multitude of raw materials by imported supply. Primarily on account of differences in resource endowments, the dependence on imported primary commodities is most pronounced in Japan and least in the USA, with Western Europe in between.
The apparent indispensability of many commodities, and the threat of international supply disruptions through wars and other disorders, has long caused concern to the importing nations. Influenced by the autarkic tendencies that evolved during the Great Depression, even Keynes (Reference Keynes1933) deviated from the gospel of comparative advantage. He expressed the view that the leading economies’ reliance on faraway sources of raw materials supply had become excessive, so a greater self-sufficiency might be warranted on both political and economic grounds, even when local production cost more than imports. In more recent times, the major industrialized countries have launched a variety of actions to overcome the perceived problems of commodity imports insecurity.
We consciously employ the perceived concept because the greater risks of relying on imported supply, as distinct from domestic supply, are not uniformly borne out by historical evidence. In fact, one can claim that the emergence of global markets, offering a wider potential diversity of import sources, may well make imports more secure than domestic supply. The breakdown of coal availability in the UK during the extended coal strike in 1984 would have been less accentuated had a greater role been played by imports. Famines due to a crop failure are easier to avoid when consumption depends on geographically diversified imports.
The purpose of the present chapter is to explore the ramifications of the issue of imported supply security, and to scrutinize the alternative measures that have been used for overcoming the difficulties that an unreliable import supply of raw materials could cause. Domestic supply is conventionally subsumed to remain secure and stable.
Even though the analyses should be of relevance to any country heavily dependent on commodity imports, the subject will be treated mainly with reference to the major industrialized nations. The focus is on supply disruptions that are unanticipated, occur suddenly, and prevail only in the short-to-medium term. Monopolistic producer action, embargoes, wars, strikes, and natural disasters are cases in point. No attention is given to the gradual supply changes that stretch over time periods long enough to permit full economic and technical adjustments. The disruptions under consideration involve sizable cuts in the quantity supplied, resulting in violently rising prices, or physical shortages if the price is controlled.
The emphasis is on alleviating programs initiated or supported by the governments of the importing nations, although actions can of course also be taken by the commodity-using industries. Quite often government actions are implemented in conjunction with the major importing firms.
In Section 9.1, we consider the circumstances under which supply disruptions become especially serious. Section 9.2 explores the nature of the difficulties likely to emerge. The menu of policies to overcome the problems is discussed in Section 9.3, while Section 9.4 summarizes the main findings.
9.1 When Will Supply Disruptions be Particularly Serious to the Importing Economy?
The severity of a commodity supply crisis for an importing economy will depend on a number of factors. Some of these will be due to conditions in the importing country, while others will have to do with circumstances in the producing/exporting areas. We review these factors, starting out with those that originate in the importing country.
Import dependence. Everything else being equal, the severity of the supply crisis in a given commodity will vary with the share of imports in total use in the importing country. An interruption of imported supply is unlikely to be serious if imports constitute a limited share of consumption, since in such a case the impact on total availability will be small, and only the less important marginal uses of the commodity will be affected.
Value of the commodity import in relation to the size of the importing country's economy. Between two equally indispensable materials, a reduction in supply and an ensuing increase in price will be more painful if it involves the one representing the greater import value.
Substitutability of the commodity. A supply crisis will have more severe consequences for materials with no close substitutes. Apart from the ease with which the functions of one material can be performed by another, substitutability has an economic and a time dimension. Easy substitution implies that the substitute material is available at a cost not much higher than the material in crisis. In this sense, palm oil is a good substitute for groundnut oil, since both have comparable costs and prices. In contrast, silver is not a good substitute for copper, for although silver has many of copper's desirable attributes, its cost per unit weight is about 70 times that of copper. If there is a supply crisis in copper, copper prices can rise a lot before it becomes economical to substitute it with silver on a large scale. Easy substitution also implies that the replacement can be introduced promptly. This may not be possible if there is capital equipment that is specific to the use of the original material, for then the need to rebuild that equipment will delay replacement.
Indispensability of the final product in which the commodity is used. A supply crisis will have more severe repercussions if the commodity is employed to make products vital to key functions in the importing nation. An import disturbance in nickel will raise greater complications than one involving imports of cocoa, because stainless steel, the finished product involving nickel use, is harder to forgo than chocolate.
The severity of a supply disruption will also be related to the circumstances characterizing the export sources.
Concentration of export supply. With geographically concentrated supply, the impact of natural or artificial disruptions (e.g., droughts, earthquakes, strikes, and political upheavals) will tend to be greater. Geographic proximity will also tend to facilitate the launch of supply-cutting cartels, especially when this proximity strengthens the political and economic affinity among the producers.
Difficulty in substituting new sources of international supply for current ones. Disruption of supply from established import sources will be most severe when capacity utilization is high worldwide, leaving little prospect for switching to alternative sources. The severity of the disruption will also vary with the length of time it takes to develop new capacity and the differential between the cost levels of this new capacity and that of the established suppliers.
Circumstances on the supply side also permit some judgment about the risk that a supply disruption will occur. Indications of political instability are taken as a sign of an increased likelihood for a supply disruption to occur. The history of earthquakes, violent weather, or strikes in major supply centers can also help in assessing the risk.
This list of factors is helpful in singling out the commodities which may warrant special action to assure stable import flows. The degree of risk aversion among policymakers will determine how many commodities will be included in this group and how much will be done about them. Risk aversion appears to be greater in the USA than in Europe and Japan. Despite its much lower import dependence for most commodities, the USA has been by far the most energetic among the three in launching efforts to assure its imported commodity supply.
A group of “strategic” metals with exceedingly concentrated sources of global productionFootnote 1 probably come highest on the list of candidates for action to secure import supply. In 2014, 90% niobium (columbium in the USA) was produced in Brazil; 86% of rare earths and 83% of tungsten originated in China; South Africa accounted for 68% of world platinum output and the share rises to 84% if Russia is included; the same two countries accounted for 74% of global output of palladium; while South Africa, Russia, and China together generated 99% of global vanadium supply. There is very little production of these “strategic” metals in Japan, the USA, or the EU, so the import dependence is almost complete. These materials are very hard to substitute in the short to medium term, and they all satisfy vital needs in the production of indispensable alloys and catalysts.
After the two oil crises of the 1970s, petroleum too has entered the list of products that warrant action to assure supply. In distinction from the strategic metals, whose trade values are quite small, petroleum trade weighs heavily in the importing countries’ economies.
Other metals (e.g., copper, nickel, tin, and uranium) have sometimes prompted action aimed at averting the risks of uncertain foreign availability. Iron ore and lead, in contrast, have attracted less attention in this respect, mainly because of greater diversification of their sources of supply.
Among agricultural raw materials, natural rubber has been seen as a risk on account of its importance for transport and other key industries, and the heavy concentration of its supply to south-east Asia. However, the availability of synthetic rubber, a good substitute for many purposes, has reduced the fear of supply cuts. Wool and cotton have prompted fewer disruption worries. Import dependence and supply concentration are very high in the case of tropical beverages, but supply disruptions have not been seen as a serious threat, probably because these products are not regarded as indispensable.
Base foods like cereals, pulses, and meats have not been prominent among the materials causing worries about supply security, despite their nature as essential goods. The reason is a low degree of import dependence: In the USA this is the result of strong comparative advantage, while in Western Europe and Japan it is due to long-lasting and far-reaching agricultural protection (see Chapter 3).
9.2 The Nature and Severity of the Problems Caused by Disrupted Commodity Supply
A price rise is the first consequence of disrupted commodity supply. Given the low price elasticity of demand for indispensable raw materials, the price reaction can be quite violent. For strategic metals, this elasticity is (absolute) 0.1 or less in the short run, so the price could easily double as a consequence of a 10% supply shortfall.
The price rise will impact immediately on the importing country's macroeconomy. The current account will deteriorate and inflationary pressures will be accentuated. For these effects to be perceptible, however, the imports and consumption of the commodity must represent a high value in relation to the importing nation's economy. This may be true of fossil fuels and possibly base metals, but hardly for any of the strategic metals.
The reduced supply will limit usage. Rationing of what is available can be done by price or by regulation. Price rationing is more efficient, since it will favor discontinuation of the least economic uses. In both cases, some former users will have to do without the commodity, and may be forced to close down their businesses. Unemployment could rise as a consequence. Closures will also have dislocating effects further down the production chain. Such effects can be severe if the output of the commodity-using industry is essential to important sectors of the economy.
The commodity users who stay in business will make efforts to substitute in favor of other raw materials, or to invest in capital that saves on the disrupted commodity use. The cost of these adjustments will impact negatively on productivity, causing some slowdown in economic growth. These microeconomic dislocations will have a further negative effect on macroeconomic performance.
The consequence of a supply disruption to an importing country will be more severe if that country is hit in isolation, such as through a selective embargo, while other importers can obtain their needs without problem, for then that country's international competitiveness will suffer. Political regulation is a prerequisite for embargos to have such effects, for without regulation market forces will assure a reallocation of supplies in favor of the embargoed nations.
The negative consequences will be strongest in the short run, but will subside over time, even if the disruption continues. Economic forces will bring relief through substitution and savings in usage.
Attempts have been made to measure the economic costs of commodity supply disruptions on the basis of specific scenarios. The outcomes depend entirely on the assumptions underlying the scenario: how large and lasting will be the supply shortfall; how fast can alternative supply be mobilized; and how, and at what speed, will the importing economy affected by the shortfall react?
The arbitrariness of the results emerges starkly from two old studies on chromium (US Bureau of Mines, 1986). In the 1970s, analyses relating to (West) Germany concluded that the country's GDP would fall by about a third as a result of a complete unavailability of chromium supply. This drastic result must be due to an extreme assumption about supply and equally extreme suppositions about inflexibilities in the German economic system. A study from the 1980s concerning the USA assumed a complete three-year loss of South Africa's chromium supply and a 90% loss of Zimbabwe's, concluding that these shortfalls would reduce US GDP by 0.2% in the first year, 0.1% in the second, and about 0.05% in the third year.
Significant efforts have been devoted ever since the mid-1970s to determine the macroeconomic impacts of disrupted oil supply. IEA (2004) notes the wide array of quantitative results reached by earlier analyses, mainly due to the differences in the models employed for the task. In retrospect, its own results are less than entirely persuasive. The IEA study asserts that a sustained oil price rise of $10/bl (from $25 to $35) will reduce the OECD's GDP growth by 0.4% in the same and the following year, and raise the rate of inflation by 0.5% in the same and the following five years. Given the dramatic and sustained oil price increase since early 2004, when the study was published, one would expect to be able to notice its impact simply by a visual inspection of macroeconomic performance, even when other concurrent factors influencing GDP and inflation change. However, no such relationship can be detected from the numbers of Table 9.1. Catching the wider macroeconomic impact of commodity market disruptions is apparently a complicated task.
Table 9.1 Oil prices and the macroeconomy
| Year | 2002 | 2004 | 2006 | 2008 | 2010 | 2012 | 2014 |
|---|---|---|---|---|---|---|---|
| Crude oil price ($/bl) | 25.0 | 38.3 | 65.1 | 97.3 | 79.5 | 111.7 | 99.0 |
| Change from previous year ($/bl) | 0.6 | 9.5 | 10.6 | 24.9 | 17.8 | 0.4 | −9.7 |
| GDP growth (%) | |||||||
| OECD | 1.7 | 3.3 | 3.1 | 0.3 | 3.0 | 1.3 | 1.8a |
| China | 9.1 | 10.1 | 12.7 | 9.6 | 10.6 | 7.7 | 7.3 |
| India | 4.6 | 8.1 | 9.7 | 3.9 | 10.3 | 5.1 | 7.3 |
| Consumer prices (% change) | |||||||
| OECD | 2.7 | 2.4 | 2.6 | 3.7 | 1.9 | 2.3 | 1.7 |
| China | −0.8 | 3.9 | 1.5 | 5.9 | 3.3 | 2.6 | 2.0 |
| India | 4.3 | 3.8 | 6.2 | 9.2 | 9.5 | 10.2 | 5.9 |
a Estimated value.
There are also important noneconomic aspects of commodity supply disruptions. For example, defense concerns underlie many of the efforts to assure strategic metal imports. When a military threat is serious, the needs of the armaments industry will be satisfied on a high-priority basis, irrespective of the costs that are involved.
9.3 Measures to Alleviate the Consequences of Supply Disruption
Damaging disruptions of physical commodity supply in the international market are rare. Prices can vary a lot due to, e.g., shifts in desired inventory levels, expectations about future events, or outright speculation, but quantities are much more stable. Inspection of global agricultural production data reveals no sharp human-caused disruptions. Relatively rare crop failures of up to 15% of global output from one year to the next have occurred in coffee and cocoa, whose production is geographically concentrated, while downward fluctuations have been much smaller for essential food products like cereals and sugar, or for cotton.
From the minerals world we know of only three artificial disruptions of significant magnitude over the past 40 years.
The first relates to cobalt, an “indispensable alloy of strategic importance.” In 1976, world production fell by almost 20%, as a consequence of political upheavals in Zaire (now Congo-Kinshasa or Democratic Republic of the Congo), where more than half of world output was produced. The producer price reacted with a lag, from $5.40/lb at the time the crisis broke out to $25 later in the decade, and remained elevated for a four-year period. The substitution process triggered by the price change was painful and costly, but its force and speed proved that the metal was indeed dispensable. Demand in the USA fell by 53% between 1978 and 1982, and developments in other countries ran in parallel. By 1983, production had fully recovered and the price had returned to its precrisis level (USGS, annual, 2002).
The second disruption occurred in the oil market in 1979–80, initially as a consequence of the Iranian religious revolution when the Shah was deposed, followed very soon after by the Iran–Iraq war. Global oil output fell from 64.6 million barrels per day in 1979 to 58.2 in 1981 (BP, annual), a 10% decline. The price more than doubled from December 1978 to May 1979, when it attained $32 per barrel, and rose even further in the following two years (UNCTAD, 2000).
The third is the more recent disruption of rare earth metals from China. Rare earth metals are used in devices that in recent years have become virtually indispensable in everyday life, such as mobile phones, computer memories, florescent light bulbs, wind turbines, hybrid vehicles, rechargeable batteries, and many more. The high concentration of rare earth metals production and traded supply from China, in combination with a strong increase in demand for these materials since 2000, erupted in 2010 into a highly contentious political issue. In 2010–11, prices of rare earth metals exploded because of repeated export quotas imposed by China. Between 2009 and 2010 rare earth exports from the country declined from about 50,000 tons to some 30,000 tons, a cut of 40% (Kingsnorth, Reference Kingsnorth2010; Lynas Corporation, 2011). This obviously caused serious concerns in importing countries, which had become increasingly dependent on China's supply of these crucial materials. Additionally, in September 2010, due to a dispute over maritime boundaries, China completely stopped its export of rare earth metals to Japan (Areddy et al., Reference Areddy, Fickling and Shirouzu2010; Bradsher, Reference Bradsher2010). In response, the USA, EU, and Japan launched a joint effort to put a halt to China's trade restrictions, widely considered as unfair and politically motivated. In 2014, the World Trade Organization (WTO) in fact ruled in favor of the major importers, against China's claims that the restrictions were due to environmental and resource conservation concerns (USGS, annual, 2015).
The fact that disruptions in the supply of essential commodities are rare does not necessarily alleviate fears of their occurrence, nor does it discourage action to overcome their undesirable consequences. But it is interesting to note that the intensity of such action tends to come in waves, with peaks after disturbing developments in commodity markets. One such peak occurred in the early 1970s and was related to the widespread belief in commodity power and the many cartel attempts launched at the time (see Chapter 10). After a long period of calm in the commodity markets, new concerns about supply disturbance and the need for measures to assure supply emerged in the 2000s decade, with a focus on oil and gas, and in the 2010s decade, focused on rare earth metals. The USA dominated the efforts in the 1970s, but in the 2000s the action had a more international character.
Two general remarks are appropriate before we discuss the security of supply arsenal in detail. First, when markets are truly global a supply disruption is bound to be a global phenomenon too, warranting international action to come to grips with the problems. Actions by individual nations in isolation may be ineffectual and politically destabilizing, and the benefits, if any, may be appropriated by free riders (Griffin, Reference Griffin2009). Second, with the proliferation of commodity exchanges, supply disruptions have lost some of their sting, since commodity users can insure themselves against price increases by hedging in futures markets. Of course, the users’ gain must be juxtaposed against the losses incurred by the speculators who issue the insurance.
Many different measures can be employed to reduce the risks and consequences of disruptions in essential commodity imports. The menu can usefully be divided into (a) measures intended to secure an uninterrupted import flow and (b) those aimed at assuring a greater domestic availability that can be relied on in the event of an import breakdown. Our discussion follows this order.
Most of the measures to assure stable commodity imports relate to the choice of suppliers and the development of special relationships with them. There would be no need to be concerned about supplier choice if commodities were homogenous and markets operated under perfect competition, for then a supply disturbance would merely result in higher prices that rationed what was available among interested buyers. The realities of most commodity markets deviate significantly from this ideal. Problems could arise because some suppliers may be unable to offer the precise grades required. Furthermore, physical trade is typically conducted on the basis of standing relationships that take time to develop. Quite often, the price at which transactions are conducted reacts to shifts in supply with a lag. After a sudden reduction in supply, the buyers whose source had been knocked out would need time to establish new trading relations. In the meantime, some of their demand would be unsatisfied while the price remained below the market clearing equilibrium. In such circumstances it becomes important to avoid the disadvantage suffered by the commodity user who is left out in the cold. There is a benefit in stable relations with reliable suppliers, even though, in the end, the supply disruption will result in higher prices for all buyers.
Choice of Suppliers
An obvious and straightforward measure in this regard is to diversify the importing country's sources of supply on both geographical and political criteria. The consequence of a breakdown of one source will seldom be critical if none of the suppliers accounts for a dominant share of the total.
The choice of suppliers should also favor those deemed to be stable and secure. Three instances from the early 1970s point to the criteria of unreliability that continue to be valid in the new century, though they do not in all cases apply to the same countries: The embargo of 1974, imposed by the members of the Organization of Arab Petroleum Exporting Countries on oil sales to the USA and Netherlands, made the members of the group appear unreliable. The short-lived embargo on soybean exports instituted by the US government in 1973 aimed at assuring domestic availability at a low price, but it reduced confidence in the USA as a reliable supplier, and strengthened Brazil's position in the international soybean market. Canada's refusal to honor its uranium supply commitments to some European countries in the 1970s also motivated by the priority of domestic needs, encouraged the development and expansion of alternative supply. Admittedly, the cases involving the USA and Canada are examples of government activism in primary resources that have long since been replaced by policies favoring international collaboration and that favor market solutions.
Efforts to assure stable imports through careful choice of suppliers do carry a cost. Diversification of import sources may reduce economies of scale. Geographical diversification can add to transport costs, especially for high-volume products like oil, iron ore, bauxite, and coal. A premium price can be commanded by suppliers with an established record of reliability. For this reason, the Netherlands and Norway have been able to charge a somewhat higher price than Algeria and Russia over extended periods of time for their sales of natural gas to Europe. Suppliers with an uncertainty element, in contrast, have to accept a discount. This was long true with coal and strategic metals from South Africa. Until apartheid was disbanded, there was a risk that importing governments might embargo South African exports.
Tighter Relations with Suppliers
In the 1950s and 1960s, direct foreign ownership was commonly regarded by the multinational resource enterprises and their governments in the Anglo-Saxon world as the most effective means to assure steady raw materials import flows. The profit motive was obviously another reason for direct investments to exploit foreign natural resources. Nevertheless, backward integration was seen as an important tool to assure not only against disruption of physical availability, but also against destabilizing fluctuations of market prices. Irrespective of what happened to prices, the owner could always count on the output at the cost of production.
As events turned out, the backward integration proved to be of doubtful value to the multinationals. Many of their direct foreign investments were nationalized in the 1960s and 1970s by the newly independent administrations in developing countries, at a substantial cost to the investors, since compensation was meagre – when it was paid at all (Chapter 11). More important, however, the nationalizations disintegrated the very foundations on which the policies of supply security had been based. Even in cases where foreign ownership remained, its role in supply security was diluted by government activism in the host countries that characterized the primary sector of these times.
In contrast to Anglo-Saxon practices, Japanese and to some extent German supply security arrangements emphasized the establishment of long-term supply contracts with independent raw materials producers. Quite often these contracts involved the provision of long-term finance with some concessional element as an inducement to establish raw material production (Radetzki and Zorn, Reference Radetzki and Zorn1979), along with technical assistance in a variety of fields, e.g., exploration for minerals, but they seldom comprised managerial control.
The long-term contractual supply arrangements entered into in the 1960s could stretch over anything from a year to more than a decade. When long-term investment finance was provided, the supply obligations regularly lasted at least until the loans had been repaid. The standard contracts of the period specified both quantities and prices, the latter often with escalation clauses. Prices have come to play a reduced role in concurrent long-term contracts. Such contracts, where they still exist, are basically agreements about quantities, while the prices are determined by commodity exchanges.
Long-term contracts do provide a shield against supply disruptions so long as they last. The problem is that when they involve corporate parties in different countries, their enforcement is not easy. Hence, if changing circumstances create dissatisfaction with one of the parties, a renegotiation will be necessary for the contract to survive. Supply assurance at predetermined conditions, therefore, becomes quite limited.
The irony is that supply was forthcoming and disruptions had been rare irrespective of the mode chosen to assure supply. The Anglo-Saxon model was less successful, however, given the cost to the investors as their assets were nationalized. The Japanese–German mode, too, involved an added cost of supply, but it was not exposed to the detriment of state takeover, since there was nothing to nationalize.
A further irony is that the lessons about the outcome of the alternative modes to assure supply security seem to have been solidly forgotten, or maybe never learnt, by the new actors (often state-owned) from China, India, Brazil, Malaysia, and other developing countries. In the 2000s, these actors have gone on a somewhat indiscriminate buying spree to obtain foreign ownership positions, predominantly but not exclusively in the fossil fuels field, in their efforts to assure their imports. The deals have comprised very substantial investments in countries presenting quite high political risk (IEA, 2006).
Tighter relationships with commodity suppliers also include treaties with political and/or economic content between the governments of the countries that trade. The importing government can offer political and military support, a foreign aid package, a generous bilateral trade deal, or a long-term price guarantee against a promise of first option on the raw material produced by the exporting country. The relationship between Saudi Arabia and the USA in the 1990s and 2000s has contained many of the elements listed here.
Other Measures to Assure Imported Supplies
Military power has long antecedents in its role as a guarantor of international commodity supplies. Both the Allied and the German and Japanese fleets provided protection to commodity flows from overseas to Europe and Japan during the Second World War. Naval protection of petroleum shipping from the Persian Gulf has also come into use intermittently during later decades in times of political and military tension in the region.
Joint sharing arrangements among importers constitute yet another measure to alleviate the impact of supply shortfalls, especially when the buyers risk being unevenly hit. The petroleum emergency policies under the auspices of the International Energy Agency (IEA, 2001), involving saving and sharing, put in place in response to the oil crisis of 1973–74, are a case in point.
Barter trading arrangements have sometimes been used to help in cementing bonds with foreign raw material suppliers. The commodity-importing country can become a priority buyer by offering the exporter some especially valuable goods (food; specialized manufactures) in return. Mutual priority barter arrangements prevailed during decades between Finland and the USSR, the former supplying high-tech manufactures in return for oil. The arrangements broke down with the collapse of communism in 1990.
Promotion of Domestic Output
With greater domestic output, the impact of an international supply disruption will be less severe. The measures to promote production within the country can be dealt with very briefly, since they were discussed in some detail in Chapter 3. Agriculture was the focus of that discussion, but the arguments and measures used have applicability to all commodity categories. As is apparent from that discussion, promotion of domestic output often has other, even stronger, motivations, i.e., to maintain employment or to prevent capital destruction in the supported activities, irrespective of whether there is a threat to domestic supply.
Import restrictions commonly constitute a key element in the promotion of domestic output. These permit higher prices to be charged domestically than would be possible if there were a free import flow. Subsidies to domestic production are often an element of protection. Public procurement is another tool to encourage domestic production. This measure, too, would ordinarily involve the payment of prices above the world market level to the domestic producers.
A grotesque example of maintenance of domestic output using supply security as motivation is the production of hard coal in Germany and Spain with the help of huge subsidies. Stockpiling could accomplish the supply security objective at a fraction of the subsidy cost (Radetzki, Reference Radetzki1995).
Stockpiling of Strategic Metals in the USA and Other Countries
Maintenance of commodity stocks is a classical measure to come to grips with issues of supply security. Government efforts to establish and maintain stockpiles of strategically important imported commodities have been launched at different times in virtually all major industrialized countries that depended on imports (Vernon, Reference Vernon1983).
The efforts of the USA have been, without comparison, the largest and most persistent. Inventories of some 80 commodities (mainly, but not exclusively, metals) of importance for the country's defense efforts were built after the Second World War and expanded further in the early 1950s, in response to fears of shortage aroused by the Korean war. The US strategic stockpiles continued to grow until 1973, when their total value was assessed at some $6.7 billion (around $23 billion in 2014 money when using the MUV index). The stocks of many commodities represented very sizable proportions of total annual consumption in the USA. The situation was most extreme in tin, where the stock corresponded to a full year of global consumption (Cooper and Lawrence, Reference Cooper and Lawrence1975). By 1973/74, however, stockpiling had gone out of fashion. New directives were issued on the strategic needs, according to which some 90% of the stockpile was declared surplus and available for disposal (Mikesell, Reference Mikesell1986). In 1992, the US Congress made a further downward adjustment of the strategic needs, and in 2010 the USA stored 28 commodities with a market value of $1.4 billion.Footnote 2 Although the sales were gradual, they have at times had a depressing effect on international markets. The disposal program continues (USGS, annual, 2015). Fashions moved in parallel outside the USA. The governments of other countries also reduced or discontinued their strategic metals stock programs.
The stockpiling programs of the USA reveal some of the problems surrounding this kind of policy. The USA's endeavors have had a strategic military objective. The determination of stockholding size then required a delineation of possible war scenarios, of the ensuing import shortfalls and their durations, and of the shares of these shortfalls that it was strategically important to satisfy from the government inventories. This proved fiendishly complicated, as the policy shifts described above demonstrate. When inventories are sizable, procurements and disposals due to a change in the perception of needs will destabilize markets and prices. Releases have been envisaged only in the event of scarcities caused by wars involving the USA itself. Shortages and ensuing price increases caused by other circumstances normally did not warrant stockpile action, but sometimes nevertheless triggered a perverse political decision to increase inventory levels, so accentuating the upward price move. Complaints have been repeatedly voiced about the great inflexibility in the procedure for inventory releases. Much of the potential benefit would have been erased if these had prevailed upon a sudden and acute war-related need.
The stockpile policies have involved a significant net cost. Apart from the storage cost and the interest on the capital tied up, one must reckon with a deterioration in quality due both to the passage of time and to technological change, which may have altered the needed specifications and made old stocks unsuitable for the most critical needs. Given that procurements would have tended to take place in tense situations when prices were high, and disposals would occur in relaxed market conditions with low prices, one would expect the transactions to yield losses on average. No assessment of the net cost to society from the stockholding programs has been undertaken.
The functioning of the US strategic minerals and metals stockpile has fortunately never had to be put to a fully fledged test during war or war-like emergencies. It is possible that its benefits would have proven well worth the cost incurred during peace.
The IEA Emergency Stockpile of Oil
In the 2000s, there has been a strong revival of supply security concerns, this time, however, with a heavy focus on oil. The revival has been triggered by greater OPEC activism, which, along with the demand shock of 2004, driven mainly by China, led to an oil price explosion. Superimposed on these events have been political supply problems in Venezuela, along with actions by Russia to control oil and gas supplies, purportedly for political ends.
The antecedents to an internationally managed emergency stock for oil stretch back to the first oil crisis of the early 1970s, when the IEA was established. The current membership of this organization overlaps, in the main, that of the OECD. Supply security measures have been one of the IEA's major mandates. According to current rules (IEA, 2007), members that are net importers of oil have a legal obligation to hold emergency oil reserves equivalent to at least 90 days of net oil imports of the preceding year. At the end of March 2014 stocks controlled by IEA members amounted to some 4.1 billion barrels, the equivalent of 575 million tons. The adequacy of this inventory can be gauged by comparing it with the largest supply disruption since 1973, that of the Iranian Revolution, which cut global supply by 5.6 million barrels per day for six months, creating a shortfall of 1 billion barrels or 140 million tons.
Taking a clue from the criticism of the inflexibility of the US strategic stocks of metals, the IEA maintains an emergency response team to facilitate rapid and flexible action to emerging disruptions. For example, when Hurricane Katrina affected crude oil production in the US Gulf coast in August 2005, the collective decision to initiate the use of emergency stocks was taken within 10 hours. The exact method of emergency stock releases does however differ between IEA member countries. To make the stock last longer, the maximum drawdowns are typically reduced during the subsequent months of crisis, while at the same time other measures, e.g., surge production, redirection of imports, and demand restraints, are introduced.
According to a new study made by the IEA, the global benefits of the member countries’ ability to react to significant oil supply disruptions (based on the stockpiles) over 30 years was valued at an astounding $3.5 trillion dollars (IEA, 2014c). The study used an economic model to assess the effects from hypothetical oil supply disruptions on member countries’ GDP, oil prices, and net import costs with and without the emergency stockpiles. It is found that the main benefit of holding stocks is its limiting effect on supply losses, which implies avoidance of increased import costs and impact on the world economy.
No action by the strategic inventory managed by the IEA has been reported in response to the Iranian revolution and the Iran–Iraq war of 1979–80. But the inventory has played a role on three occasions since the creation of IEA. The first was during the Gulf War in January 1991, when 2.1 million barrels per day were released. It was used again in September 2005, involving roughly the same quantities, to reduce the impact of Hurricane Katrina. The last time was in 2011, as a response to the prolonged supply disruptions due to the Libyan civil war. On each occasion the stockpile interventions were far below the maximum potential, yet the added supply helped to calm the market in some measure.
9.4 A Summary of Findings
While supply security is an issue that has emerged in response to an increasing dependence on imports of critically important commodities, it is important to remember that crises in supply are not limited to imported supply. In fact, a diversified network of imports may provide a better shield against disruption than a concentrated domestic supply subject to the vagaries of weather or strikes.
The rich industrialized world has long practiced deep agricultural protection, assuring high levels of self-sufficiency of indispensable food. For this reason, food is seldom in focus when measures to avert imported raw material supply crises are under consideration. Instead, the issue of supply security typically relates to metals, minerals, and fuels, deemed to be essential and hard to replace.
A global supply crisis of significance is characterized not only by a substantial price increase; it must also involve a significant cut in supply. Such crises have been quite rare, and we have been able to identify only three (cobalt in 1978, oil in 1980, and rare earth metals in 2010) since the Second World War.
The implications for the importing economy will be felt in many dimensions. At the microeconomic level, the industries using the commodity will suffer a cost increase, and rationing will have to be employed if price is regulated. Some firms will have to do without, and may face a survival threat in consequence. At the macroeconomic level, the current account will deteriorate, inflation will gather pace, and the growth rate may decline, but commodity consumption and imports have to be very sizable for these effects to be perceptible.
Various measures have been tried to assure the stability of imports in the event of a supply crisis. Careful choice and diversification of supply sources, tighter relationships with suppliers, bilateral treaties, and direct ownership positions in foreign production have been tried with varied success. Encouragement of domestic output or of domestic availability through strategic stockholding has also been common in the arsenal used to overcome supply crises. All these measures carry a cost, and to be worthwhile, these costs must be lower than the detriment of the crisis.
Supply disruptions occurring in truly global markets are best countered by internationally coordinated measures. The emergency stockpile of oil under the direction of the IEA provides an illustrative example. The proliferation of commodity exchanges and futures markets has provided a means of price insurance to commodity users, thus reducing their pain and diminishing the need for public action.
Looked at in retrospect, the concerns and the costs incurred to overcome the vagaries of supply security may appear to be somewhat exaggerated. The incidents of crisis have been rare, and the ability of the advanced economies to substitute out of the supply crises suggest that the cost of the measures used to assure stable supply must be quite small to make the efforts worthwhile. But then, history offers no firm insights about future events. If a supply crisis of huge dimensions and deep severity were to occur in the coming years, then even the more costly among the measures considered in the present chapter might emerge as highly worthwhile.
