Module 11 - Commodity Price Risk Management

Commodity price instability has a negative impact on economic growth, income distribution, and the poor. Early attempts to deal with commodity price volatility relying on direct government intervention (for example, price stabilization schemes, floor prices, and guaranteed prices) were generally unsuccessful. Although there may be a case for limited direct intervention in some circumstances, liberalization of markets has resulted in the need for market-based instruments to help manage commodity price volatility. Large commodity exchanges typically offer such products (for example, futures and options), but there are substantial barriers to developing these markets for all commodities and for helping farmers to access existing markets. Key investments needed to expand access to these services include: public goods (price information systems, data management systems); strengthening supply chain relationships; strengthening technical capacity in private service providers; and educating potential users.⁷

Although the old paradigm of domestic price protection and price stabilization increased instability in world markets, trade liberalization has increased the transmission of international price movements to domestic producers and consumers. Inability to manage this volatility destabilizes exchange rates and affects governments’ ability to maintain a stable economic environment. Low prices limit farmers’ incomes, and price volatility makes it difficult for farmers to plan production activities, allocate resources efficiently, and obtain credit. Inability to manage intra-seasonal price volatility threatens the profitability of market intermediaries such as traders, cooperatives, and processors, and the banks who lend to them.

Managing Commodity Price Risk

Governments in many countries have intervened in markets, often through state economic enterprises, to insulate producers and consumers from world prices. Most interventions have taken a nonmarket approach in the form of quota or buffer stock programs organized through state marketing boards. However, government interventions have been costly and have crowded out private sector initiatives.

Price risk management that relies on market-based products rather than government guarantees and subsidies will involve a substantially reduced overall role for government in administration. The long-term objective must be for government to assume a regulatory role, overseeing markets for risk management tools. However, the public sector can facilitate initial development of these markets and/or improve access to established foreign or international markets for these tools, thus ensuring that needs of the poor are adequately addressed. Market-based systems are most relevant for standardized commodities traded internationally in large volumes, mainly coffee, cocoa, rubber, cotton, grains, sugar, and oilseeds (and some livestock products) (box 11.5). They are less applicable to high-value, highly differentiated, or perishable products for which price risk is managed through forward contracts, often in the context of integrated supply chains.