Falling commodity prices and the prisoner’s dilemma

The title of the series must have made you wonder. Well, that’s exactly what we wanted. Now that you’re reading this series, let’s unfold the theme.

A Beautiful Mind was directed by Ron Howard. It won four Academy Awards in 2001. The movie is about an American mathematician named Dr. John Nash. His research on game theory provided insights into strategic decision making. A particular problem in game theory, known as the prisoner’s dilemma, is particularly interesting to us.

Suppose a pair of criminals, A and B, were involved in a crime. They’re locked in a prison in different cells. They can’t communicate with each other. They haven’t confessed to the crime. There isn’t enough evidence to convict them for the crime. The police officer gives each of them three scenarios:

1. If A confesses and B doesn’t, A will be set free and B will spend 20 years in prison
2. If neither of them confess, they will each spend one year in prison
3. If both of them confess and betray each other, they will each spend five years in prison

What should the prisoners do?

Dr. Nash’s research shows that the prisoners will betray each other—even though the best outcome would be to cooperate with each other. Mutual mistrust will make the prisoners confess and betray each other. Each prisoner fears that if he is silent and the other confesses, he could serve a greater punishment.

This is happening in the global commodity markets. From crude oil to met coal and iron ore, producers haven’t cut production. They did this for the greater good. They’re waiting for others to do it first.

In this series, our main focus will be on coal producers (KOL)—including Walter Energy (WLT), Peabody Energy (BTU), Alpha Natural Resources (ANR), and Arch Coal (ACI).

In the next part of this series, we’ll see how commodities are different from manufactured products.