Subzero Commodity Prices : Why Commodity Prices Fall Through the Zero Bound and Where and How it Could Happen in 2011

One of the more remarkable properties of commodity markets is the capability of their nominal prices to be negative numbers. This flexibility to violate the zero bound can appear in outright flat prices, spreads, and net unit costs. The principal driver is typically overwhelming supply relative to storage capacity, resulting in a prohibitive cost (in fact, a negative price) for trying to claim storage rights. Given that storage is usually the driving factor, negative commodity prices are almost never observed in easy-to-store markets (such as metals) even though they are routine in electricity, a market whose product cannot be stored in that form. The opposite phenomenon occurs in a stock-out situation that forces cash market prices toward infinity, rationing consumer demand so that inventory is never actually exhausted. That physical commodities can and do transit between these extreme economic states helps explain their inherent and unavoidable price volatility. We think of subzero commodity prices in four fundamental dimensions: (a) outright zero or negative nominal prices due to unavailability of incremental storage capacity (e.g., flared natural gas), (b) net zero or negative production cost due to a co-production credit from an associated commodity (e.g., gold found in a copper deposit), (c) public goods, such as light and water, and their pass-through effect into cost structures and quality (e.g., apples and fine wine), and (d) negative margin due to the nature of an industrial process, such as the yield constraints in petroleum cracking. In 2011, to make the diesel demanded by the market, refiners cannot avoid overproducing LPG