How CO2 will inflate the price of beer

The New Zealand Herald reported this week:

A lack of CO2 supply nation-wide has brewers fearful of a beer shortage this summer.

The closure of the Marsden Point refinery at the end of March means the only remaining domestic source of liquid and other food-grade CO2 is Todd Energy's Kapuni gas field in Taranaki.

Garage Project co-founder Jos Ruffell said the CO2 shortage was crippling the beverage industry.

The brewery is currently operating at 50 per cent capacity and often goes weeks at a time without being able to package beer.

What happens when there is a shortage of CO2? We'd expect the price of CO2 to rise. This is demonstrated in the diagram below, of the market for food-grade CO2. At the current market price of P0, the quantity of CO2 demanded is QD, while the quantity supplied is QS. Since QD is greater than QS, there is a shortage. When there is a shortage, some buyers are missing out. If you are a buyer in this market, how do you avoid being one of the buyers who misses out? You find yourself a seller, and you make a deal - you pay them a little bit above the market price, and they make sure that you don't miss out. In other words, when there is a shortage, buyers tend to bid the price up. This will continue until the price is bid up to P1, where the quantity demanded and the quantity supplied are both equal to Q1. At that point, the market is in equilibrium.

What does that mean for the beer market? A higher price of food-grade CO2 means that the cost of producing beer will rise. The effect of this is shown in the diagram below. The increasing cost of production decreases the supply of beer from S0 to S1. Now, if the price of beer remained at the original equilibrium price of P0, the quantity of beer demanded would remain at the original equilibrium quantity of Q0, but the quantity of beer supplied would fall to QS, creating a shortage (that is what the quote from the article above suggests). However, it seems to me that it is more likely that the price of beer will rise, to the new equilibrium price of P1.

So, you can probably expect your beer to cost a bit more this summer, thanks to the shortage of food-grade CO2.