No hedging: no protection

Price volatility is increasing on the global agricultural commodity markets.

There are a number of reasons for this: the political deregulation of these markets is just as significant as the volatile interplay of severe crop failures or huge record harvests. As well as climate disasters, political crises and trade policy measures such as export bans and subsidies have a considerable influence. Severe price fluctuations hit developing countries hardest. Images like those from East Africa at the moment make it clear that, as industrial nations, we have a responsibility to the people of those countries. Where emotionally charged issues are concerned, our public media are soon on the trail of “the culprits”. This time the image of evil speculators is being conjured up, blaming them for hunger and poverty; but this scapegoat rhetoric is no help to anyone. In fact, the media are pillorying a market mechanism that helps the traditional players in the agricultural commodity market to hedge their risks.

Take a quick look back: before the Argus eye of public opinion was drawn to speculation on the agricultural markets, it was biofuels which took the blame for high food prices and increasing price volatility. A wave of emotional outrage was unleashed and led to a hasty policy U-turn. Installations that only a short time before had been given political support and funding were abandoned. When respected studies eventually proved that the influence of biofuels on price development and the price spikes of 2007/2008 was in fact minimal, the economic and political damage had already been done. This spiral is threatening to repeat itself. 

The fact that commodity futures markets have an indispensable role is now undisputed; both politicians and NGOs have realised that they create a safety net in the market, precisely in order to prevent reckless dealings with the raw materials for our food. However, at times there is a lack of sound understanding of the way these markets function. Most of those participating in the market use the futures markets and OTC to minimise their risk – for example, of weather-related crop failures – by hedging prices, and not to drive prices up. Financial investors – who are the ones on whom the criticism centres – fulfil an important function on the agricultural commodities markets. After all, they provide the commodity futures markets with the necessary liquidity and trading volumes, so that enough buying and selling opportunities can be available; for traditional producers and processors to be able to hedge their transactions, they always need someone else prepared to take the opposite position! 

Instead of attacking the supposedly damaging speculation, reinforcing the convergence between the commodity futures exchange and the physical market would be a more constructive way of safeguarding the agricultural commodities markets. That is to say that products traded as futures on the commodity futures markets must also actually be obtainable in that form; that applies to trading units and qualities as well as to the aspect of an adequate number of delivery points. The often quoted distortions on the cocoa market caused by the intervention of an investment fund in trading on the relatively small cocoa stock exchange could not have occurred in that way, had there been convergence of the cocoa futures market and the physical cocoa market. 

Frequent but unjustified criticism is also expressed over multiple trading of a crop on the commodity futures market, which is erroneously equated with speculation. The fears underlying this criticism are unfounded. It is not how often a year’s crop is traded on the futures markets that is relevant to the price, but how well the conditions integrate the trading with the physical markets.  If there is convergence between stock exchange trading and the physical market, no distortions can arise if a crop is traded several times on paper. In this respect some futures markets must make some changes to strengthen the convergence between paper and spot markets. The aim must be to create more transparency through regular reporting and thus raise confidence in stock exchange trading. With restrictions, however, businesses are deprived of the opportunity to hedge their transactions. This has the consequence that the agricultural commodities market might become just more and more of a “speculation business” – because a speculator is someone who doesn’t hedge his transactions.

The call for the lowest possible prices is of no help in the fight against poverty and hunger. Instead, higher prices for small-scale farmers in developing countries and emerging economies as well can create an incentive to increase production beyond their own subsistence economy. Low prices, on the other hand, reduce the supply. What is needed is a development policy which rectifies the failings in the development of rural areas and invests in infrastructure.

Wilhelm F. Thywissen
President, OVID – Association of the oil seed crushing and oil refining industry in Germany Berlin, Germany

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