Resource revolution needed, by Jeremy Oppenheim & Richard Dobbs

The agreement in Durban to launch a new negotiating process to develop a legally binding agreement to limit GHG emissions (to come into force in 2020), was an important landmark. But governments need to focus, too, on what could prove to be a resource crunch of unprecedented severity. A resource revolution is vital as part of global efforts to underpin economic growth and meet environmental concerns.

During most of the 20th century, the price of the key resources (e.g. energy, food, and materials) fell, supporting global economic growth. But that benign era has come to an end. In the past ten years alone, all the price declines of the 20th century have been wiped out and, with the exception of energy in the 1970s, volatility is at an all-time high. Now, a number of factors could come together to threaten even higher and more volatile resource prices.

Up to three billion people are set to join the global middle classes over the next 20 years, many of them in the burgeoning cities of India and China. Incomes, particularly in Asia, are rising on a scale and at a pace that are also unprecedented. China’s economy is growing ten times as fast as the United Kingdom’s economy grew during the Industrial Revolution and with 100 times as many people. These new middle classes will have enormous spending power, boosting demand for resources to new highs. This could be a trend break in the history of resources.

Surging demand will coincide with a period in which finding and extracting new sources of supply is becoming more difficult and expensive. The average real cost per oil well has doubled over the past ten years. New mining discoveries have been flat despite the fact that spending on exploration has quadrupled. Increasing demand for water could mean that some countries will face significantly higher marginal costs for adding new supply from sources such as gravity transfers or even desalination. The world’s new and expanding cities, many of them in Asia, could displace up to 30 million hectares of the highest-quality agricultural land by 2030 — more than 2 percent of land currently under cultivation.

Moreover, resources are now more tightly linked to each other than at any point over the past 100 years, so that price shocks in one resource ripple rapidly to others. The energy intensity of water has risen as the groundwater table has fallen and due to the increasing use of desalination. Unconventional energy sources will require more inputs of resources such as steel, as well as water and land. Industry data show that unconventional methods such as horizontal drilling use more than four times as much steel as traditional vertical drilling.

Adding even more strain to this picture is the fact that climate change may already be compromising the supply of resources. Increased soil erosion, the excessive extraction of groundwater reserves, ocean acidification, deforestation, declining fish stocks, the unpredictable risk-multiplying effects of climate change, and other environmental effects are all constraining the production of resources—and economic growth. The Economics of Climate Adaptation Working Group recently found that some regions are at risk of losing up to 12 per cent of their GDP annually as a result of existing climate patterns.

Asian governments and businesses now need to put their collective minds to what can be done to meet the resource challenge. They need to act simultaneously to increase the supply of resources and engineer a step change in the productivity of how they extract, convert, and use resources.

On the supply side, water and land are likely to pose the biggest challenges, assuming no major improvement on resource productivity. Over the next 20 years, we estimate that the amount of supply added every year would need to increase by 140 per cent and up to 350 per cent for water and land, respectively, compared with the rate at which their supply increased over the past two decades. Assuming these rates of increase, water consumption would be 1,850 cubic kilometres higher by 2030, 30 per cent higher than today’s levels. There would be 140 million to 175 million hectares of added deforestation; and carbon dioxide emissions of 66 gigatonnes in 2030 that could, according to some estimates, lead to a rise in global average temperatures of more than five degrees Celsius by the end of the century.

The economics of a supply-led approach to ensure meeting demand are uncertain given sector inflation and increasingly high extraction costs, and the environmental impact is unambiguously negative. Those are strong arguments for acting on resource productivity in tandem. McKinsey Global Institute research finds that there are opportunities available to boost productivity that would meet up to 30 per cent of demand for resources in 2030. Just 15 types of opportunity, from improving the energy efficiency of buildings to moving to more efficient irrigation could deliver about three-quarters of the prize.

Acting both on supply and productivity could lead to a decline in carbon emissions to 48 gigatonnes per annum in 2030, getting halfway to a 450 parts per million (ppm) carbon dioxide equivalent pathway that the Intergovernmental Panel on Climate Change says is consistent with limiting global warming to no more than two degrees Celsius in a median case. (To reach a 450-ppm pathway would require an even greater shift to low-carbon power, delivered through renewables, the increased use of biofuels in road transportation, reforestation of degraded land resources, the improved management of timberland, and measures to increase the productivity of pastureland.) Higher yields on smallholder farms and large-scale farms would mean a net reduction of roughly 250 million hectares in the land needed for cultivation of crops, with benefits to biodiversity and significantly lower water consumption. Reduced demand for food and energy due to higher productivity in their conversion and end-use could lower prices.

Capturing this productivity potential would require additional capital investment of around $1 trillion a year on top of the investment needed for supply expansion. But the long-run benefits are very significant indeed, at around $2.9 trillion each and every year by 2030. The value of the opportunity would increase to $3.7 trillion if we were to assume a $30 per tonne price for carbon as well as the removal of energy, agriculture, and water subsidies, and energy taxes. Today, governments rarely price water at its true cost, there are large energy and agriculture subsidies, and there is no global carbon price.

Only about one-third of the opportunities are readily accessible; many others face barriers including large capital requirements, principal-agent issues, and information failures. The key question is whether policy makers and businesses can implement measures fast enough to achieve a “soft landing” with stable or gradually declining resource prices and reduced environmental risk. The best chance of success lies in taking an integrated view of resources and the increasing links between them, and prioritizing the potential likely to achieve most impact.

If, on the contrary, they are slow to act, the world could experience a hard landing characterized by a period of very high and volatile resource prices, putting increased strain on the global economy, on the world’s poorest, on the environment, and on political relationships between nations.

Jeremy Oppenheim is a director at McKinsey & Company and leader of its Sustainability & Resource productivity practice. Richard Dobbs is a director at McKinsey Global Institute.

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