Matching Demand and Supply

Recent events related to the COVID-19 lockdown have brought into very clear focus the economic laws of supply and demand that usually operate more in the background.

Essentially, these laws state that, in a competitive market, the unit price for a particular item will vary, until the quantity demanded is equal to the quantity supplied.

If market demand is higher than supply, the price will rise, to attract new supply. But if supply exceeds demand, the price will drop, until some suppliers no longer think the market is attractive and drop out.

During the coronavirus pandemic, the commodity that attracted the headlines and influenced stock markets was crude oil — the blood that flows through the global economy’s veins. The market price for oil collapsed, creating havoc in oil-producing regions around the world, including Alberta, Saskatchewan, and Newfoundland and Labrador here in Canada. And the price collapsed because supply was much higher than the market could absorb.

COVID-19 led to a shut-down of much of the world’s economy and forced large numbers of people to stay in their homes. Airlines grounded airplanes and cruise ships stayed in port — if they could find a port that would accept them. Use of cargo ships, trucks and cars decreased substantially.

Because of that, market demand for petroleum products fell about 30 per cent, causing the price to drop. The Organization of Petroleum Exporting Countries (OPEC) and its allies announced a plan to cut production by about 10 per cent, starting in May. But because the cut was less than the decrease in demand, production was still much more than consumption.

Surplus oil filled all the storage capacity, including tankers that stored oil at sea. When it became clear all the available storage would soon be full, the price dropped again. For a few producers, it dropped below zero, because they had to pay others to take it.

These events caused ripple effects all along the supply chain for petroleum products. But it was especially painful for those with big investments in drilling for and production of oil. Some producers were forced to stop production, because their revenues were not covering their costs. For them, it was better to leave the oil in the ground than sell it for what buyers were willing to pay.

Others had to continue production at a loss, to generate at least some cash flow to meet their financial obligations.

Budgets for exploration to increase future supply were cut around the world, including here in Canada. People lost jobs and what had been substantial incomes.

Historically, producing oil has been a very profitable business because market demand increased faster than supply for decades, as world population grew, economic activity expanded, people became more affluent, and dependence on petroleum increased. That is no longer the case. And it may never be again, as oil and other fossil fuels are likely to be increasingly replaced with greener alternatives, to slow down the pace of climate change.

For what was a large and prosperous industry, it was a hard lesson about the laws of supply and demand. Producing more of a commodity than the market requires and is willing to pay for ultimately makes that commodity very cheap and increases costs incurred for handling and storage of the products.

It is not a smart thing to do.

Instead, it is a reminder of something once said by Isaac Asimov, the famous science fiction writer, “The saddest aspect of life right now is that science gathers knowledge faster than society gathers wisdom.”

The oil industry is not the only industry to learn that lesson. Prices for other commodities have collapsed at various times over the years, as well, devastating the industries dependent on them.

From June 2014 to February 2015, global commodity prices fell an average of 38 per cent, causing grief for oil producers, miners, farmers and many other commodity producers. The decrease was largely due to decreased demand from China and Europe and increased production of oil and agricultural commodities in the United States.

But that was only part of a much larger pattern of fluctuations in commodity prices, as is illustrated in the graph of the Bloomberg commodity price index in Figure 1, covering the past 25 years. Since the most recent drop, the index has been at its lowest point for that entire period. In other words, on average, producers are now being paid less for their output than they were at any time over the past 25 years.

Figure 1

Price volatility is a fact of life for anyone who sells commodities — products that are essentially the same, regardless of who produces them. When prices go up, there is no guarantee they will continue to go up or even remain at the higher levels. Enjoy the higher prices while you can, because they won’t last.

As a producer, when prices fall, you have essentially four choices:

  1. process your commodity products into more distinctive products, for which there is less competition and that can be sold for more stable prices;
  2. manage your costs, so you can make a profit even when prices are low;
  3. store the excess production and hope for better prices in the future and/or
  4. stop producing, when prices do not cover your costs.

So how does this affect the fishery?

Well, similar to oil or iron ore, the fish products we sell are commodities. What makes them distinctive is the species and the quality, not the product forms we sell. Because of that, we have no advantage over other suppliers of similar products we compete with in other parts of the world.

We have suffered from price collapses at times, as well — notably in 1981–82, when practically the entire fishing industry in Atlantic Canada went bankrupt and had to be restructured with substantial input of public money.

That occurred because we produced more cod blocks than the market wanted and was willing to buy. And it took years and a lot of work before the situation turned around. I know because I was there.

Figure 2 shows the global fish price index from 1990 to 2019, with 100 as the base.

From 1990 to 2006, prices fluctuated from year to year, due to annual fluctuations in supply and demand, but remained within a relatively narrow range around 100. In other words, demand was approximately equal to supply, so prices didn’t change much for 16 years, even allowing for general price inflation during that time.

Figure 2

After 2006, fish prices continued to fluctuate, but the fluctuations were larger and the overall trend was up. That was because market demand was increasing faster than supply.

The increase in demand was largely due to higher consumption in China, as people were becoming more affluent. On the other hand, supply was limited, because global wild fish catches haven’t increased in over 30 years. Aquaculture tried to fill the gap, but it takes years to bring new capacity into production.

The increased prices, combined with favourable currency exchange rates, mean we have enjoyed relatively good prices for our products in recent years, substantially offsetting reductions in quotas for shrimp and crab during the same period. Indeed, the quota reductions were very likely a factor in driving up prices. Overall, the result was that we didn’t suffer like other commodity producers.

That will change this year.

The United States has long been our main export market. In 2019, Canada’s exports of fish products were valued at $7.4 billion and the United States took $4.6 billion, or 61.2 per cent. It is now the country with the world’s highest coronavirus infection rate, with substantial impacts on its economy. And the country’s political leaders seem to be on a path to make the infection rate much worse, before it gets better.

China was our second largest market in 2019, receiving exports worth $1.3 billion, or 17.6 per cent of the total. It was where the coronavirus originated, again with a big impact on its economy that is likely to continue for some time, partly due to reduced demand for its products from other countries and partly due to reductions in its capacity to supply. These effects will reduce employment and incomes.

In other words, our two major markets, representing nearly 80 per cent of our export value, are being severely affected by the coronavirus.

Until people can be vaccinated on a large scale, the threat the virus poses to human health will not go away. And that is likely to take a while — a minimum of a year to two years — so the economies of the U.S., China, Canada and other countries will continue to be affected well into the future.

Our industry is now based mainly on relatively high-priced shellfish species — lobster, crab, scallop and shrimp. Consumer purchases of these products are more in the category of discretionary spending on luxury products than buying everyday staples, like flour, sugar, yeast or coffee.

Furthermore, approximately 70 per cent of spending on fish and seafood products in the U.S. is for meals in restaurants and other foodservice outlets, many of which are now closed and which also represent discretionary spending.

Many people have been laid off or had their working hours and incomes reduced, due to the economic impact of the coronavirus. In this environment, fewer people are able or willing to spend freely on discretionary luxury items. During the financial crisis that began in 2008, we saw how that drove down the prices lobster harvesters received for their catches.

To find markets for all the available supply, we began selling lobsters to McDonalds, Subway and other fast-food outlets, diminishing its image as a luxury product. Increasing demand for our lobsters from China eventually enabled us to sell all our output at good prices.

What will save us this time and how long will it take?

Because of COVID-19, many businesses have been forced to close, including restaurants. Tourism-related businesses, such as cruise ships, hotels and casinos, have seen demand for their services drop off a cliff.  And it may be a while before people feel comfortable traveling or eating in restaurants simply for the pleasure of it, so some of these businesses may not be able to continue operations after the crisis is over.

For the foreseeable future, it will not be business as usual.

The impact of the coronavirus on restaurant and other foodservice sales means market demand for our industry’s products can be expected to decrease, likely dramatically. Maybe it will be possible to make up some of the loss by increasing sales through retail stores, but that probably won’t be easy.

For decades, market research has consistently shown that U.S. consumers prefer to eat fish and seafood in restaurants, because they are not confident in their own abilities to buy fish and turn it into a nice meal. Essentially, they don’t trust industry to provide them with consistent quality and/or tasty products that are easy to prepare. And they don’t trust themselves to know what they should buy or how to prepare it.

According to market analyst John Sackton, only about one per cent of U.S. households buy lobsters for home consumption, compared to 50 per cent who buy shrimp. He estimated that market demand for lobsters this year is likely to be about 200-million pounds, instead of the 300-million pounds in recent years.

The Lobster Council of Canada predicted there would be no buyers for 70-million pounds of lobsters harvested in Maine, Quebec and the Atlantic provinces this year.

Decreased market demand means prices can be expected to drop significantly, as well. And lower prices may be a fact of life for years, as the world economy struggles to rebound from the devastation COVID-19 has created.

As this year’s fishing season was about to ramp up in Atlantic Canada, restrictions on people’s activities due to the coronavirus wasn’t the only problem. Airlines had stopped flying international routes and had reduced capacity on routes within Canada. That meant live lobsters could not be shipped on passenger flights and the capacity of cargo flights was not enough to handle the volume.

The traditional markets for frozen lobster products had largely been shut down. Many of those markets are also important for other species we sell.

Similar to the situation with oil, the decrease in demand for our lobster products means the only way to maintain prices is to reduce supply — i.e. reduce catches — by a third. Getting a large number of harvesters to agree to that is practically impossible. During the financial crisis that began in 2008, some tried to increase their catches, in an effort to offset the lower price.

Any increase in supply is likely to drive prices even lower. You can have either high catches or high prices, but seldom can you have both at the same time and this is not one of those times.

It is inevitable that landings will be much higher than sales. Some of the excess can be put into storage live or frozen, but that means the excess supply will continue into future years, depressing prices in those years, as well. And holding lobsters live carries the risk of loss if they get sick and die.

Lowering the price is likely to be the only way to stimulate enough market demand to take all the supply.

At the start of the spring lobster season, buyers in the Maritimes were offering prices of $3–4/pound for lobsters, a huge decrease from the $10–11/pound harvesters have received recently. If landings are at the level of recent years, even these lower prices may not be sustainable.

Lobsters are the largest and most valuable fishery we have in Canada. This will be a tough year for people involved in that fishery. And fisheries for other species may not fare much better.

Although this year is shaping up to be an extreme example of supply exceeding demand, with devastating effects, it is worth pointing out that we see less-extreme examples in many years.

Figure 3, from a report written by Gardner Pinfold, shows the seasonal pattern of crab landings and export sales.

Figure 3

As it shows, we harvest, process and sell a lot of crab in a very short operating season. Most harvesting and processing are done in two months.

On the other hand, consumption of crab products is spread over 12 months. The peak period of consumption is likely to be during the winter — during the Lunar New Year in China and other Asian countries or Christmas and Lent in North America and Europe — when people eat more fish than they do at other times. These periods are seafood’s equivalent of Christmas for retailers — and they occur long after we catch and process crab.

The pattern in Figure 3 shows that we produce a lot more crab in a two-month period than the market can consume.

We have to freeze it to allow it to be stored until it can be sold. But freezing it immediately lowers the potential market price, because the products must compete with similar products from around the world. In contrast, much of the king and snow crab caught in Norway is sold live, fresh, for higher prices, similar to what we do with lobsters.

After we freeze the crab, we don’t have the financing to hold the inventory, so we need to sell most of it soon after it is processed. That is why there is such a short gap in time between harvesting and sales.

What do you think that means for the prices we get for our products?

Because of the laws of supply and demand, we sell for low prices and lose a lot of the market value we could have gotten. It is not a smart thing to do.

The buyers we sell to hold the inventory and feed it into the market as required, benefiting more from our resources than we do. But we do it, because industry participants are desperate for cash flow when the season opens and have no alternative but to go fishing.

I have heard harvesters claim they are the most important people in the value chain for fish and seafood, because, without them, there would be no sales. This year is a reminder that the most important people in the value chain are the consumers who buy and consume our products — or not. Without them, there is no need for people to harvest the resource or process the catches into products. That is something we should never forget.

In business, if you put your own needs and wants ahead of the needs and wants of the people you expect to buy your product, it usually does not turn out well.

Ultimately, the lesson from all this is that, if you can’t control the flow of products into the market, so supply doesn’t exceed what consumers are willing to buy and pay for, you can expect to get low prices for what you have to sell. It is a lesson our industry needs to learn. We would be much better off if we did.

 

Robert Verge

Managing Director of the Canadian Centre for Fisheries Innovation — Newfoundland

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