Why does it matter?
Commodities are different from manufactured products. It’s important for us to understand the differences. We need to know why commodity prices are falling. We also need to understand why producers still aren’t ready to cut production.
Product differentiation is the key difference between commodities and manufactured products. Commodities are homogeneous in nature. Simply put, met coal produced by Walter Energy (WLT) isn’t much different than met coal that’s produced by other producers (KOL)—like Alpha Natural Resources (ANR), BHP Billiton (BHP), Arch Coal (ACI), and Peabody Energy (BTU).
In contrast, a Ford (F) car is different from a car that’s manufactured by General Motors (GM). The cars are different in regards to design, comfort, fuel efficiency, and power. For manufactured products, people may like one brand and dislike another brand.
For commodities, people are almost indifferent. As a result, if the demand for a particular brand of car is falling, the manufacturer will cut production and focus on innovation. If met coal demand is falling, producers wait for other others to cut the production.
While price competition is everywhere, it’s greater in commodities. It’s the only way that producers can differentiate themselves. In the case of a car, the manufacturer can advertise the car’s features. The manufacturers can try to prove how their car is better than other cars.
However, met coal is met coal. Producers can’t differentiate met coal between various mines. Although there are some differences in chemical and physical properties, the differences are reflected in the prices. In an oversupply situation, producers try to attract customers by cutting prices. As a result, commodity prices are more volatile. In contrast, manufactured goods’ prices don’t vary as much.
In the next part of this series, we’ll discuss the structure of the global met coal market.