Slippery ground

The theory behind cycles goes something like this: starting with low prices (say, in the oil sector), which is a commodity, you reach a point where many players in the industry are not able to service debt. As a result fresh debt is not available. Given low stock prices, neither is equity. So overall supply is stagnant to falling, as marginal players who have eroded equity are forced out of business. We saw this recently in oil (with high-cost shale and deep-sea players), steel (the recent high-cost greenfield projects) and sugar (where capacity below 10,000 tonnes of cane per day became unviable). The same thing is happening in paper and shipping but in slow motion. As the old saying goes, if money stops coming in through the balance sheet (in the form of debt or equity), it will come through the P&L account (in the form of higher prices and operating margins). That is, if there is a capacity shrinkage/stagnation in the industry, incremental demand will push up prices. Hence, the popular saying, lower prices cure lower prices - the principle behind commodity cycles. This is being used to explain the current uptick in oil prices, presenting it as a cyclical upturn rather than a correction in a structural downturn. Lower oil prices result in higher consumption demand, especially price sensitive latent demand. And oil exploration has been largely suspended, except in the shale sub sector, leading to a paucity of new oil finds. But is that the end of the story or just a chapter in a longer story? The first structural down

This article was originally published on February 09, 2018.