Post by jeffolie on Apr 29, 2008 17:25:16 GMT -6
Why we're stuck with insane prices
Forget supply and demand. We're now seeing scarcity economics at work -- what happens when buyers fear they won't get what they need at any price.
April 29, 2008 -- 16:25 ET
For example, why should oil sell for $119 a barrel, a whopping $55 a barrel, or 86%, higher than it did last April? But this kind of price insanity is exactly how a scarcity economy works.
If you think prices have become insane, you're right. But insanity rules markets for everything from oil to rice right now. In fact, insanity is the new "normal." Scarcity markets exist because buyers believe the normal rules of supply and demand have broken down. Buyers in a scarcity market don't believe higher prices will depress demand or increase supply enough to allow supply to meet demand. In such a market, prices are driven by fear that there will not be enough supply at any price. Potential buyers need to be bloodied by repeated experience on both the supply and demand side. In the oil industry, major suppliers that were being counted on to increase production have announced production declines.
And it helps establish scarcity economics as the rule of the markets if potential buyers become convinced that higher prices won't dampen demand. That happens fastest in markets for goods that buyers especially need. Most Asian consumers of rice, for example, can't choose to eat less without running a real risk of hunger or starvation. And there isn't a ready substitute for high-priced rice. What are they supposed to do, eat even-more-expensive wheat or corn?
A sense of inevitability
But the most profound effect of scarcity economics on prices comes in markets where buyers who were convinced that higher prices would cut demand come to believe that higher prices have little effect on demand.
Once a scarcity market is established, it produces behavior by buyers that can lead to the very scarcity they fear. Hoarding, for example, can empty shelves. Of course, the emptying shelves themselves create panic buying that just empties the shelves faster.
Security at any price
And by taking supply off the market, hoarding produces shortages. In a scarcity market, the high-cost producer sets prices because buyers who fear they won't be able to get the goods they need will pay almost any price to ensure themselves of a supply. You can see scarcity economics at work in today's fertilizer market, for example. Potash of Saskatchewan (POT, news, msgs) produces potash and nitrogen fertilizers. But with the world short 1.2 million metric tons of potash in 2008 and desperate for nitrogen fertilizer, Potash is seeing its already high margins soar to astounding heights. In announcing its first-quarter earnings, the company projected that margins in 2008 will be roughly 3.5 times as high as in 2007. The Chinese didn't get all the potash they wanted. The country is now looking at a shortfall that some experts peg as high as 40%, just when China is trying to increase food production to cut inflation in domestic food prices. From 1989 through 2006, potash delivered in Asia sold for $200 a metric ton. According to the company, potash prices could reach $1,000 a ton by the end of this year. That has left Wall Street analysts who recently increased their projections to a range of $700 a metric ton struggling to catch up.
articles.moneycentral.msn.com/Investing/JubaksJournal/WhyWereStuckWithInsanePrices.aspx
insane prices-We're now seeing scarcity economics
Forget supply and demand. We're now seeing scarcity economics at work -- what happens when buyers fear they won't get what they need at any price.
April 29, 2008 -- 16:25 ET
For example, why should oil sell for $119 a barrel, a whopping $55 a barrel, or 86%, higher than it did last April? But this kind of price insanity is exactly how a scarcity economy works.
If you think prices have become insane, you're right. But insanity rules markets for everything from oil to rice right now. In fact, insanity is the new "normal." Scarcity markets exist because buyers believe the normal rules of supply and demand have broken down. Buyers in a scarcity market don't believe higher prices will depress demand or increase supply enough to allow supply to meet demand. In such a market, prices are driven by fear that there will not be enough supply at any price. Potential buyers need to be bloodied by repeated experience on both the supply and demand side. In the oil industry, major suppliers that were being counted on to increase production have announced production declines.
And it helps establish scarcity economics as the rule of the markets if potential buyers become convinced that higher prices won't dampen demand. That happens fastest in markets for goods that buyers especially need. Most Asian consumers of rice, for example, can't choose to eat less without running a real risk of hunger or starvation. And there isn't a ready substitute for high-priced rice. What are they supposed to do, eat even-more-expensive wheat or corn?
A sense of inevitability
But the most profound effect of scarcity economics on prices comes in markets where buyers who were convinced that higher prices would cut demand come to believe that higher prices have little effect on demand.
Once a scarcity market is established, it produces behavior by buyers that can lead to the very scarcity they fear. Hoarding, for example, can empty shelves. Of course, the emptying shelves themselves create panic buying that just empties the shelves faster.
Security at any price
And by taking supply off the market, hoarding produces shortages. In a scarcity market, the high-cost producer sets prices because buyers who fear they won't be able to get the goods they need will pay almost any price to ensure themselves of a supply. You can see scarcity economics at work in today's fertilizer market, for example. Potash of Saskatchewan (POT, news, msgs) produces potash and nitrogen fertilizers. But with the world short 1.2 million metric tons of potash in 2008 and desperate for nitrogen fertilizer, Potash is seeing its already high margins soar to astounding heights. In announcing its first-quarter earnings, the company projected that margins in 2008 will be roughly 3.5 times as high as in 2007. The Chinese didn't get all the potash they wanted. The country is now looking at a shortfall that some experts peg as high as 40%, just when China is trying to increase food production to cut inflation in domestic food prices. From 1989 through 2006, potash delivered in Asia sold for $200 a metric ton. According to the company, potash prices could reach $1,000 a ton by the end of this year. That has left Wall Street analysts who recently increased their projections to a range of $700 a metric ton struggling to catch up.
articles.moneycentral.msn.com/Investing/JubaksJournal/WhyWereStuckWithInsanePrices.aspx
insane prices-We're now seeing scarcity economics