Ore and More

Bloomberg.com: Australia coal-mine floods raise costs of cars, planes, washers

Many people have this supply and demand curve that keeps on moving: They believe that while pricing of resources is being driven up by China’s purchases, at some point supply is going to exceed demand and we are going to have a price decrease. This flood in Australia shows the problem with that curve. Historically a flooded coal mine would not matter. Production would shift and there would be enough excess capacity in the production of coal that prices would not more than double. But with China buying so many resources today, that’s all changed.

The end result is neat: one mine goes down, profits double. What is going to stop the big three iron ore producers or coal producers from just cutting production 20% to keep prices high? Volume is not the business here. No one has huge leverage. Everyone has nice margins. When the next slowdown occurs, a simple dam failure would cause prices to stay high. Just a few mine closures for a few years for refurbishment would have the same effect.

Oligopoly theory throws classic supply and demand economics out the window. People forget to write in the classic floor that price setters can set. This flood shows that floor very nicely.