Low prices, heal thyself Low prices usually bring an end to low prices, just as high prices cure high prices. The extreme low prices experienced at the end of 1998 will force resources out of production in one way or another, and production will drop sooner or later. Prices will then rise. In January 1999, futures contract prices indicated market expectations of substantial price increases by July of this year. That may well occur, although futures markets did not give six months' warning of the low prices received in late 1998.
Futures markets are one way producers can reduce price risk in marketing their output.
But hedging production through use of futures contracts is only a useful risk-management tool as long as the basis is consistent or predictable. That simply has not been true in the chaotic market conditions that prevailed in many recent weeks. On the other hand, now that these new facilities exist, their construction costs are sunk costs. Even if the initial owners go bankrupt, someone may be able to buy the facilities at enough of a discount to earn cash-flow. The current price trough may put the industry to a wrenching, but information-producing, test of these hypotheses.