Milling & Baking News - March 29, 2016 - 36

Washington Update X

The cure for high/low prices
BY ROBBIN JOHNSON

In the world of commodities, there is
a well-known aphorism: "The cure for
high prices is high prices, and the cure
for low prices is low prices." The record-high prices for many commodities three or four years ago are a major
cause of today's much lower prices.
An important question for agriculture
- both for inputs and outputs - is
whether this cycle will soon repeat.
Food prices are largely market-driven, but oil and gas prices are not. Ever
since 1973, the Organization of Petroleum Exporting Countries (OPEC)
has tried to override this lesson, and
they are expected to want to try again.
What is likely to happen?
High price cures
When prices rise to high levels, several things change in response. New
production emerges, both through

expansion of the resources devoted to
output and through intensification of
inputs. At the same time, consumption drops, and consumers search
out substitutes; such changes in consumption patterns may persist even
after prices come back down, turning
a cyclical instability in demand into a
chronic change in usage. And, where
possible, consumers put off buying
high-priced goods. More supply and
less demand leads inevitably back toward lower prices.
Because food demand is relatively
inelastic, the option of deferring consumption is not very successful. But
output growth and substitution effects
may be quite pronounced. Moreover,
once additional production is put in
place, it often remains even after prices come down. Likewise, when substitutions occur, it may be costly - or
impossible - to attract users back, as
36 / March 29, 2016 XMilling & Baking News

they become accustomed to their new
consumption patterns. For example,
some of America's reduced beef consumption per capita in recent years of
high prices may prove permanent, reinforced by other societal and dietary
trends.
Low price cures
When prices fall, high-cost producers may scale back or shut down.
Low prices also induce additional
usage, and they may encourage
stockpiling. Food, again, is constrained in its responses because
marginal production costs usually
are low compared to fixed costs, enabling output to continue even at the
new, lower prices. Stomach size, social trends and health concerns may
limit usage growth, dampening the
demand response. Many foods also
are subject to spoilage, limiting the

effect of stockpiling in response to
low prices. As a result, while periods
of high food commodity prices tend
to be brief, periods of low prices may
persist much longer.
Energy markets
The attempts by Saudi Arabia to
rally a sufficient number of large oil
producers to cut output, as OPEC has
done in the past, seem not to be gaining the same degree of traction. If not
enough other major oil producers are
willing to cut back production, Saudi
Arabia's oil minister has pledged to
keep its own production running at a
high level. Will this situation end up
keeping oil and gas prices low for a
more prolonged period? There are a
number of reasons for thinking that
low energy prices will persist for
some time.
First, energy consumption is being

pushed toward rising levels of efficiency by forces beyond price. For
example, Corporate Average Fuel Efficiency standards for U.S. automobile
and truck fleets are rising. Even as
consumers shift back toward larger
vehicles, the effect on increased energy usage is blunted.
Second, a key driver of high oil and
commodity prices earlier in this century was the seemingly insatiable appetite of China. China's slowing growth
and its past tendency to overbuild
infrastructure have certainly slowed
that engine of demand.
Third, stockpiling energy is much
more feasible than for food. Storage
tanks may be pumped full, new facilities may be built for anticipated future
returns, and fossil fuel supplies may
be left in the ground but ready to flow
at the first signs of rising prices.
Particularly interesting is the effect
of production costs on price response.
There already is substantial evidence
that producers using "fracking" techniques have found ways to lower
their operating costs. Moreover, many
of the less well-financed companies
in this industry are likely to end up
in stronger, better-capitalized hands
after their sale or bankruptcy. In the
natural gas world, large investments
have been made in the infrastructure
for shipping liquefied natural gas.
Low prices are unlikely to drive this
sector out of business.
Finally, many of the producers of
fossil fuels are state-owned corporations, for whom normal economic
forces may not fully apply. And many
major producing countries depend on
oil and gas revenues for much of their
national budgets. They can ill afford
to cut back in the face of low prices,
making them less willing to cooperate
to reduce production. The entrance of
post-sanctions Iran into global energy
markets adds yet another strong supplier with reasons to keep pumping.
There seem to be many reasons to
believe that $100+ per barrel oil prices
may have been more of an aberration
than a future certainty. If so, agriculture can, on the one hand, look forward to more attractive input costs
and, on the other hand, a less promising biofuels prospect. MBN

Robbin S. Johnson, a fellow
with the Hubert H. Humphrey
Institute of Public Affairs,
is a contributing editor at
Sosland Publishing Co.
bakingbusiness.com / world-grain.com

http://www.bakingbusiness.com http://www.world-grain.com

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