Market structure and high commodity prices - The continual pull to scale

There is the adage that the solution to low (high) commodity prices is low (high) prices. Prices change demand and supply, so low (high) prices will cut (raise) supply and raise (cut) demand. Prices will adjust. Market prices cycle between extremes with demand and supply lead to equilibrium adjustments. 

This commodity story is playing out today. Higher prices in oil and natural gas will lead to increased supply and a demand response. The adjustment may not be immediate, but there is clear mean reversion as producers and consumers change their behavior. 

Unfortunately, the story is more than a onetime adjustment in price. There are industry organization effects and restructuring of competitors. Price changes lead to a continual movement to economies of scale. Economies of scale are always lurking in the background when there are consistent price swings. Few industries become more fragmented as a response to market volatility. No firm becomes smaller by design. It is either increasing scale or elimination. 

With high price comes credit constraints that support large firms and hurts small firms. The same cargo that has to be financed for trade because more expensive. Lines of credit have to be increased even with higher value of collateral. Smaller trading firms are often unable to get this added financing at attractive terms. When prices are low, credit again may become scarce as the threat of bankruptcy increases for producers.  Of course, financing issues impact large firms, but the ability to weather these issues is easier when scale is already present. 

Logistical problems are also problems of scale. Failure for delivery, loading delays, and higher transportation cost all hurt the small firm that may not be as diversified as larger firms. Concentration of business makes the cost of logistical failure greater. 

Dispersion in price and logistical issues also lead to greater vertical integration by firms in order to control prices along the supply chain. Again, there is a movement to scale.

The movement to scale means more concentrated trading and less price transparency. This is never good for the investors involved in commodity trading.