Class 1The economics of commodity markets

and products 

• What are commodities?• Overview of commodity trade and trends• Changing market structures • Following the commodity chain – the example of sugar• Commodity-related risks

What are commodities?

Statistical definition: specific SITC sections:- section 0 (agricultural commodities - largely foods, including processed ones)

- section 1 (agricultural commodities - drings and tobacco)

- section 2 (crude inedible materials - largely oilseeds and raw materials as well as mineral ores)

but groups 233, 244, 266 and 267 exclude (synthetic materials)

- section 3 (fuels - including electricity)

- section 4 (vegetable oils)

- item 522.56 (aluminum - partly also reported in 287.32)

- division 68 (some (semi-)processed minerals and metals)

Problems with the SITC definition

Somewhat artificial: e.g.:

- gemstones excluded

- gold at times reported as a metal and at times as a financial transfer (excluded in commodity statistics)

- textile yarns are largely excluded, even though they are standardized and require much less processing than many metals that are included under “commodities”

- products such as paper and plywood are excluded

- the products do not have a lot in common

Defining the “essence” of commodities?

It is attractive to think of commodities as products that are:- fungible- can easily be described using a few standard parameters- have a more or less uniform price in any single market

When considering the possibilities for sophisticated financial markets, this is a very useful way of thinking of commodities: it allows to identify for which products it is possible to introduce sophisticated instruments. But:

* it would exclude many products normally considered as “commodities” (e.g. fruits, vegetables, flowers)

* and would include many others (e.g., yarns, fertilizers, computer chips, interest rates, pollution rights, crop yields)

Commodity groups

Shares of world exports, 1995

- manufactures: 75%

- food items: 9 %

- fuels: 7 % (1980: 24%)

- ores and metals: 3 %

- agricultural raw materials: 3 %

- non-classified, including non-monetary gold: 3%

Growth rates, 1980-95

8.6 %

4.8 %

-1.7 %

4 %

4.4 %

The main export productsShares of world exports, average 1994-1995 1. Passenger vehicles: 4.9 % 2. Crude petroleum: 4.4 % (194 bn US$) 3. Transistors 3.3 % 4. Data processing eq. 2.5 %5. Motor vehicle parts 2.5 % 7. Petroleum products 2.4 % (109 bn US$)24. Aluminum 0.9 % (41 bn US$)25. Meat 0.9 % (37 bn US$)29. Natural gas 0.9 % (35 bn US$) Note: role of manufactures35. Copper 0.6 % is over-estimated due the46. Shaped wood 0.6 % importance of re-exports47. Alcoholic beverages 0.6 % 49. Fruits and nuts 0.6 % 79. Cosmetics 0.4 %56. Vegetables 0.5 % 93. Wheat 0.3 %66. Animal feeds 0.4 % 96. Coffee 0.3 %68. Fish 0.4 % 103. Sugar 0.3 %74. Coal 0.4 % 111. Cotton 0.3 %

The major developing country exports

Shares of developing country exports, average 1994-1995

1. Crude petroleum: 12.9 % (149 bn US$) 2. Transistors 5.0 % 3. Petroleum products 3.3 % (38 bn US$)18. Natural gas 1.0 % (12 bn US$)22. Shell fish 1.0 % (11 bn US$)23. Coffee 1.0 % Note: role of manufactures24. Copper 0.9 % is over-estimated due the27. Fruits and nuts 0.9 % importance of re-exports31. Precious stones 0.8 %

0% 2% 4% 6% 8% 10% 12% 14%

Wood

Fish

Veg. oils

Meat

Cereals

Fruits

Vegetables

Dairy products

Tobacco

Sugar

Cotton & yarn

Coffee

Cocoa

1970-72

1996-97

Main world agricultural exports, by category (commodity as % of total agricultural exports)

Traditional commodities are losing importance

New dynamic sectors have emerged

Who exports?

(1994) Developedmarket

economies

Developingcountries

Foods 69 % 23 %

Raw materials 74 % 20 %

Ores/metals 67 % 23 %

Fuels 41 % 51 %

Some commodity export data

(non-fuel commodity exports, 1994)

USA: 75.8 billion US$Netherlands: 40.3 billion US$Brazil: 18.7 billion US$Africa: 17.8 billion US$

exports: fuel non-fuel exports

commoditiesAsia 122.9 127.0Latin America 65.6 28.8Africa 17.8 36.7

0

5

10

15

20

25

30

35

40

45

70-72 80-82 90-92 96-97

EU

Other developed economies

AsiaUSAUSA

Latin America

Eastern EuropeAfricaLDCs

0

5

10

15

20

25

30

35

40

45

50

70-72 80-82 90-92 96-97

EU

Eastern Europe

AsiaUSA

USA

Japan

Commodity exports Commodity imports (% of world commodity exports) (% of world commodity imports)

0

5

10

15

20

25

70-72 80-82 90-92 96-97

billi

on U

S$

8%

10%

12%

14%

16%

18%

20%

22%

24%

shar

e of

dev

elop

ing

coun

try

expo

rts

Sub-Saharan Africa

LDCs

Brazil

Brazil

Sub-SaharanAfrica

Comparative development of exports: sub-Saharan Africa, LDCs and Brazil

Agricultural products

0

50

100

150

200

250

70-72 90-92 96-97

US$

billi

on

Exports

Imports

Minerals & metals (incl. steel)

0

50

100

150

200

250

70-72 90-92 96-97

US$

billi

on

Exports

Imports

Fuels

0

50

100

150

200

250

70-72 90-92 96-97

US$

billi

on

Exports

Imports

Developing country trade balancesfor the major commodity groups

30

40

50

60

70

80

90

100

1970-72 1990-92 1996-97

Coffee

Sugar

Tea

Cotton & yarn

Cocoa

Losing market shares in traditional sectors: developing countries’ shares in the world market

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1970-72 1990-92 1996-97

Sh

are

in

va

lue

co

coa

tra

de

Chocolate

Cocoa beans

Cocoa products

Developing country exports

Developed country exports

Losing out in the value-added:the example of the cocoa sector

Regional trade balances (billion of US$, 1994)

Africa Asia LatinAmerica

Foods - 2 + 10 + 24

Raw materials + 2 - 5 + 2

Ores/metals + 3 - 10 + 12

Fuels + 33 + 62 + 14

Commodity dependency - some examples

In many countries, a large part of export earnings comes just from one commodity: (commodity’s share of total exports, average 1993/1994)

Crude oil: Angola 92 %; Cameroon 37 %; Congo 87 %; Ecuador 34 %; Gabon 87%; Iran 83 %; Nigeria 91 %; Papua New Guinea (PNG) 31 %; Saudi Arabia 75 %

Coffee: Burundi 54 %; Colombia 20 %; El Salvador 32 %; Ethiopia 64 %; Guatemala 21 %; Honduras 25 %; Kenya 18 %; Madagascar 20 %; Rwanda 54 %; Uganda 77 %

Cocoa: Cote d’Ivoire 38 %; Ghana 29 %;

Sugar: Barbados 20%; Belize 40%; Cuba 45 %; Fiji 40 %; Guyana 26 %

Cotton: Burkina Faso 59 %; Paraguay 20 %; Sudan 28 %; Togo 18 %

Gold: Burkina Faso 17%; Burundi 26 %; Fiji 9 %; Guyana 26 %; PNG 20%

Copper: Chile 28 %; PNG 19 %; Peru 18 %; PDR Congo and Zambia > 80 %

Bauxite/aluminium: Ghana 17 %; Guyana 21 %; Jamaica 50 %; Suriname > 80 %

Changing international market structures

InformationInformationrevolutionrevolution

Trade houses are Trade houses are no longer ableno longer able

to make profits on to make profits on simple trade simple trade transactions.transactions.

Concentration/Concentration/consolidation:consolidation:medium-sized medium-sized

players areplayers aredisappearingdisappearing

Some tradingSome tradinghouses movehouses move

into new areasinto new areas(e.g. futures trade, (e.g. futures trade, physical broking)physical broking)

PenetrationPenetrationinto trading atinto trading atdomestic leveldomestic level

Penetration Penetration into value-addedinto value-addedactivities (e.g. activities (e.g.

service “packages”,service “packages”, processing)processing)

Entry of Entry of new actorsnew actors

Before liberalisation

Government monopoly

Cooperative unions or large traders

Cooperatives/small traders

Producers

After liberalisation

Exporters

Changing domestic market structures

Large traders

Small traders/ cooperatives

Producers

Banks Banks

Foreign buyers Foreign buyers

Inte

grat

ion

Deman

d for

finan

ce

Government Government ensures qualityensures quality

Nee

d f

or e

xter

nal

age

nci

es (

incl

ud

ing

fore

ign

on

es, t

o p

rovi

de

serv

ices

(qu

alit

y co

ntr

ol, i

nsu

ran

ce)

Input supply

Input supply

??

Price risk exposure

There are many marketing forms

• Intra-company sales/purchases• Long-term contracts, with fixed or

reference prices• Countertrade• Fixed-price forward contracts, with one or

several deliveries• Price-to-be-fixed contracts• Spot sales/purchases

Following the commodity exchange - a brief example:

sugar

Where are sugar prices determined?

Raw sugar

1. Is the sugar exported?

2. If so, is the price “pooled” or not?

3. Is the price preferential?

If yes, under ACP quota: price is a function of EU price If yes, under USA quota: price is a function of No. 14 futures contract.

4. If not preferential, then probably, the reference price is the

New York No. 11 futures contract.

Seller

Buyer

EXW

FASFCA

FOB

CFRCIF

CIP

CPT/

DAF

DDUDDP

DEQDES

Domestic transport

Clearing at export port

International transport - who pays insurance?

Clearing at import port

Domestic transportAre import duties paid?

The flow of goods:

INCOTERMS

Raw sugar is generally sold FOB, white sugar CIF. What does this mean, and why is this so?

Sugar is generally sold against a reference price, for example, « 0.5 cents over New York No. 11 » – what does this mean?

A reference price is a price that market parties use as a starting point for their price negotiations. The price they agree on is likely to be different (related to quality, location, bargaining strength, etc.) from this reference price. In a physical trade contract, both the reference price and the differential can be made explicit (“Price-To-Be-Fixed” contract). The reference price is usually, but not necessarily, a futures market price.

Quantity Origin Grade Shipment Destination Futures Price BasisDates Month

BIDSArabica Washed3600 bags India Plantation A Mar - Apr Open May Less 19c/lb Fob

Robusta Unwashed1680 bags Cote d'Ivoire Grade 2 Apr Open May Less $100 C&F3360 bags Cote d'Ivoire Grade 2 May-Jun Open Jul Less $100 C&F

3600 bags India Cherry ab Mar-Apr (1800 each)Open May Less $40 Fob1800 bags India Cherry ab May Open Jul Less $40 Fob3600 bags India Cherry clean bulk Mar-Apr (1800 each)Open May Less $80 Fob 1800 bags India Cherry clean bulk May Open Jul Less $80 Fob

3600 bags Indonesia EK1 gr4 80 def May&Jun Open Jul Less $230 Fob

1280 bags Uganda Screen 15 Jun Open Jul Less $20 Fob2560 bags Uganda Screen 15 Jul-Aug (1280 each)Open Sep Less $20 Fob

OFFERSArabica Washed3600 bags India Plantation A Mar - Apr (1800 each) Open May Less 15c/lb Fob

If relevant futures markets exist, physical commodities are often priced on the basis of futures contracts. Eg, coffee:

Market and pricing structure - sugar

Sugar beet

Sugar cane Rawsugar

Refinedsugar

Consumers

Sugar beetproducers

Sugar caneproducers

Sugarmills

Sugarrefineries

Consumers

Much production is at a cost well above the world market price

CONSEQUENCES

AlternativesweetenersDemand at

times stimulated by high sugar prices

In some countries, run-down

Overcapacity

Most beet production is at a cost well above the world market price

Com

plex

pro

duce

r pr

icin

g ar

rang

emen

ts

Price paid by consumers varies very strongly from country to country

Government taxes/ subsidies

Sugar beet

Sugar cane Rawsugar

Refinedsugar

ConsumersInternationally traded

Internationally traded

White sugar

annual

Perennial(pro-cyclical investment)

Two different type of processing factories, but an identical product

Alternativesweeteners

ResearchByproducts

Sugar beetproducers

Sugar caneproducers

Sugarmills

Sugarrefineries

Consumers

Price/fashion/ health concerns

Processing

margins

Full production cost vs. price

Variable production cost vs. price

MOTIVATIONS

Alternativesweeteners

Production cost (e.g., function of maize price)

Value ofbyproducts

Sugar beetproducers

Sugar caneproducers

Sugarmills

Sugarrefineries

Consumers

May or may not be paid for quality/location

ADDITIONAL COMPLICATION: MARKET BARRIERS

Alternativesweeteners

Not always allowed

May be subsidized

May benefit from very low energy

costs

Producer price often determined by Government

Much trade takes place at preferential prices - e.g. ACP

Price paid by consumers is often effectively determined by Government

Commodity-related risks

Annual crops Perennial crops(e.g. cereals, cotton, e.g. tree crops (rubber, palm oil,soyabeans, sugar beet) coffee, cocoa) and sugar cane

Limited investment needs Large investment needs(e.g., small-scale mining) (most mining and petroleum

production; processing ofagricultural crops)

Risks depend on engagements:

Price trends

Price volatiliy

Seasonality

Quantity

30

50

70

90

110

130

150

1970 1980 1990 1998

basic foods

tropical beverages

vegetable oils

Agr. raw materials

Minerals & metals

1999

The declining price trend continues: deflated price indices, 1970-1999 (1980 = 100)

Sugar price volatility

1970 1975 1980 1985 1990 1995

Highest and lowest average monthly raw sugar price, and the yearly average, 1970-1997

3rd /4th week of December Harvesting of cotton by farmers, sorting and storage atfarm level.

1st /2nd week of January Delivery to buying stations, grading and purchase frombuyers, packaging and storage.

3rd /4th week of January Transportation to ginnery, grading and stocking of seedcotton.

1st/2nd week of February Ginning, baling and storage of lint and cotton seed untilend of November. Low exports in July/August because ofrains.

1st week of March Start of export of cotton bales

December-mid-January Maintenance of ginnery

Most commodities are seasonal - eg, cotton in Uganda

Seasons differ from country to country

“Exposure” of ginnery J F M A M J J A S O N D

Cotton lint

Raw cotton

Conditions do not remain the same. Eg, technological factors.

Explo

ratio

nPr

oduc

tion

Trans

port

Proc

essin

gM

arke

ting/

dist

ribu

tion

Info

rmat

ion

Easier identification of reserves has led to geographical diversification

Falling production costs; and competition from new products

Drastic fall in international shipping costs; bulk transport

Increasing flexibility of processing equipment

Just-in-time delivery; electronic trading

Highly competitive pricing.