The Finance behind the Plastic Problem
The plastic problem has become a major talking point across the entire world. Almost every country in the world is alarmed with how much plastic is being used and the effect it has on the environment. Plastic is an extremely convenient product to use. However, the problem with plastic is that when it is disposed off, it tends to pollute the environment. Plastic is disposed off either by burning it or by dumping it in landfills. However, both these methods are toxic and pollute the entire ecosystem.
The harmful effects of plastic can be minimized by recycling it. This is why governments all over the world try to incentivize the use of recycled plastic over virgin plastic. However, even after all the encouragement, less than 16% of the total plastic used in the world is recycled!
In this article, we will try and understand the financial dynamics which make it economically prudent to use virgin plastic over recycled plastic even though it may be disastrous for the environment.
The Financial Reason behind the Economic Disasters
Before making any policy decisions, it needs to be understood that money is an important motivator and influences the decisions of people. Once this premise is understood, the plastic problem can be seen in financial terms.
The real reason why more plastic is not recycled is because of supply constraints. There just arent enough factories in the world that have the infrastructure to take in used plastic and recycle it. The obvious solution would be to create more factories. However, the more pertinent question is why private individuals arent creating such factories if they know that there is a demand for recycled plastic.
The answer lies in the volatility which is inherent in the plastic market. Recycled plastics are economically viable when the prices of oil are high. This is because plastic is a byproduct of oil. Hence, to produce more plastic more oil is needed. If oil is cheap, producing virgin plastic is cheaper. On the other hand, if oil is expensive, producing recycled plastic is cheaper.
The business of recycling plastic is therefore cyclical. Since there is no stable demand for recycled plastics, private individuals and companies do not want to invest in producing it. Also, since the ones producing it are taking a lot of risks, they tend to inflate the prices to earn a premium for the risk that they have undertaken. These inflated prices make recycled plastics less viable.
The bottom line is that if the volatility in the recycled plastics market is somehow reduced, it will attract more investment. When larger amounts of plastic starts getting recycled, businesses will face economies of scale, and the product will automatically become more competitive vis-à-vis virgin plastics.
How to Reduce Volatility?
The oil market is an international market. It is not possible for any one country or any one body to control the price of oil in the world. Since the market is volatile by nature, it will remain so. However, financial innovation can be used to make the market for recycled plastics less volatile.
Lets have a look at some of the methods that can be used to achieve this objective.
- Price Floor: The real reason why recycled plastic become uncompetitive is that under certain circumstances, virgin plastics tend to become cheaper. To fix this problem, the government can set a price floor for virgin plastics. This means that the government must make it illegal to sell virgin plastics below a certain price. This price should be marginally more than the cost of producing recycled plastics. Once such laws are enacted, investors will be assured that even if the price of oil in the global market falls, producing recycled plastics will still be viable. This will drive more investment into the sector which will lead to an increase in capacity.
- Insurance: Insurance is another possible solution to ensure that the producers of recycled plastic do not face an undue disadvantage. In many places across the world, crop insurance is the norm. This means that if farmers face a loss because of unpredictable reasons such as weather, there are insurance companies which make up the loss. The insurance companies get to keep the premiums in the good years. However, they have to pay the compensation in bad years. Such insurance contracts should be made available for manufacturers of recycled plastics as well. These contracts should only shield them from market uncertainties and not from internal inefficiencies. At first, the government may have to act as the insurance company. However, once a market is created, insurance companies will be more than happy to take over the reins.
- Long Term Contracts: Recycled plastics are not the only business in the world that faces volatility. The dairy business is another business which faced extreme volatility. The prices of raw materials could change by as much as 20% within a single month! To overcome this problem, dairy processors have come up with long-term contracts. In these contracts, the dairy processors pay the dairy farmers their cost price plus a fixed markup. Hence, when the prices go down, the dairy processors make more money. On the contrary, when prices go up, they make less money. In the long run, the profits are averaged out. Such long-term contracts should also be created in the recycled plastic industry as they have proven to be a very effective tool which helps conduct business in an environment of volatility.
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