How primary commodity producers — farming, mining and energy companies — remember 2008 will be a bit like how different people remember an amusement-park visit.
For those who like scary rollercoasters, it was great. For others, the sooner forgotten, the better.
But it is all part of doing business in sectors where both supply and demand tend to be inelastic. “Inelastic” means that the quantities producers offer or users are willing to buy don’t vary a great deal with price changes, especially in the short run.
Buyers are relatively insensitive to price changes when the articles in question are necessities — think of food or gasoline. Consumers may reduce their gasoline usage by a small percentage or buy cheaper food, but the overall levels of consumption don’t change that much, even if prices double. On the same score, manufacturing and milling industries will keep buying key raw materials like iron ore or copper.
Supply can be inelastic when there are high fixed costs — large investments in factories or other facilities — relative to variable costs like labor.
Because both sides of this equation are true for most primary products, relatively small perturbations in other factors like weather or income or political unrest can cause extreme fluctuations in price.
Many consumers are well aware of how crude oil began the year at about $90 per barrel, ran up to nearly $150 by July and dropped to under $40 in late December. Gasoline prices locally paralleled this from about $3 a gallon a year ago to about $4 in mid-summer and now back to under $2.
But petroleum was not the only example. The mining industry saw a similar pattern. Copper stood at $3.11 per pound in the last week of December 2007, touched $4.07 in early July and fell to $1.39 this week. Iron-ore prices are not closely tabulated, but the year began with reports of major mining companies instituting unilateral price boosts and ended with collapsing prices and Asian mills refusing shipments.
Corn prices began 2008 at $4.25 a bushel, broke through $7 in late June and fell to around $3.50 in late December. Wheat, soybeans and other major crops followed similar patterns.
The effects of such fluctuations spread beyond producing firms. Prospects for Minnesota’s Iron Range and for nonferrous mining areas further west seemed rosy a year ago. Now they are increasingly bleak. Countries like Brazil or Argentina for which commodity exports remain important see their foreign exchange earnings shrink, along with prices and volumes of key products.
How much producers ramp up output in response to higher prices has long-term effects. Mining companies knew that $4 copper would not last. Farmers knew the same about $7 corn. Experienced operators in each sector know how dangerous it is to make long-term investments based on short-term price spikes.
But some made plans for major new facilities. Now the future seems much more somber, and new investment in mining and agriculture is shrinking. Tight credit conditions are as much to blame as lower price expectations.
Forest products are one natural resource sector that did not ride a price rollercoaster this year. That is because a moribund building industry kept everything but paper mills in a deep slump. As a fading economy bites into even that one bright spot, it will only get worse in 2009.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.