The last few years have taught economists and commodity producers much about what people are willing to pay for grains and metals. For economists, this is useful additional data about the demand functions for soybeans or corn or copper or zinc. For producers, recent high prices pose a thornier question: Should they make long-term investments to expand their operations? Or are current price levels going to disappear nearly as quickly as they emerged, leaving new farming or mining investments high and dry?
Beginning economics students learn that the demand curve shows all the different quantities of something for which people are willing to pay at each of a wide series of prices. The range goes from whatever high price it would take to reduce purchases to zero and what quantities people would take if the product were free.
Students also learn that in the real world, we typically face only a small segment of that demand curve. We could figure out how many gallons of gas people would buy if the price were $15 and how much they would buy at 15 cents. But in the last three decades, the price has stayed in the $1 to $3.25 range in most areas.
We know now that large quantities of corn will sell even if the price is more than $5 a bushel. The same is true for copper, even when prices exceed $3.50 per pound. And the last few weeks have shown that at least a few people are willing to pay almost $20 a bushel for spring wheat.
The expanded information about the range of prices buyers are willing to pay poses a knotty question for producers: Should they bet their business fortune on such high prices persisting for a long time? That’s “long” as in 30 years or more.
There still is a lot of ore for copper, nickel, zinc, lead and other metals in the United States. The question is how much it costs to get such ore out of the ground and separate the metal. Even large ore deposits are uneconomical to mine if the cost exceeds the price of the metal from other sources.
Opening a major new mine can cost hundreds of millions of dollars. Unlike a locomotive, combine harvester or drill press, this investment has virtually no salvage value. It is a true “sunk cost.” If operating profits don’t stay high enough long enough to amortize development costs, the investment will have been a bad one.
For years, many existing U.S. copper operations deemed 85 cents a pound the shutdown point. Below that, revenue no longer would pay even day-to-day operating costs, much less recoup any fixed ones. At least $1.25 per pound was necessary to justify starting a new mine, and that price would have to persist for years.
In recent years, world prices, driven by demand from China and other industrializing nations, have exceeded $3 per pound. This is well above the level required to re-open dormant mines and justify new ones, like some considered for Minnesota’s Iron Range. But will these price levels last?
PolyMet Mining Corp. apparently believes profitable prices will last, even if not at current record levels. The Canadian company is proceeding with a copper-nickel mine near Hoyt Lakes, Minn., although the permit process is not yet complete, and said this month it was relocating its headquarters there.
The decision a farmer faces — whether to buy existing farmland — is somewhat different. The problem is that high grain prices drive up the price of farmland, both for rent or purchase. After paying the higher land price, profit levels are no longer so rosy. That is what happened in the 1970s, as U.S. grain exports boomed after the dollar was devalued in 1972.
The danger for land-buying farmers is that if grain prices decline, so will land prices. That’s what happened in the 1980s, when tens of thousands of farms went into foreclosure or bankruptcy.
Grain prices are driven in part by the same global growth that is boosting metals. But subsidies and mandates to increase biofuel production also play a big part. The danger here is political. Right now, government subsidies, taxes on lower-cost imports and various states’ mandates to use ethanol all encourage ethanol production and thus corn use. Will public sentiment change and take away these incentives?
Higher corn prices motivate farmers to shift acres into corn and away from alternate crops like soybeans and wheat or, increasingly, cotton and rice. Thus prices for those farm products also rise, even though they play little direct role in ethanol production.
All commodities go through price cycles, with prices shifting from low to high and then back down again over a period of years. Each time there is a boom, young enthusiasts argue we have reached a new era and that old limits no longer apply. Old-timers recall past disappointments and warn that good times cannot last forever. We will see who is right this time.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.