Financial speculation, production challenges and policy instability generate volatility in commodity prices. Improved technology and information sharing may foster greater market efficiency.
Commodity price volatility hit the global agenda in 2007 when wheat prices rocketed due to a confluence of forces including export bans and crop failure, leading to bread riots in the likes of Egypt and Mozambique. While price shocks are nothing new, their effects today are more serious than in previous decades when agricultural production incentives among OECD countries generated enormous surpluses - "butter mountains" and "milk lakes" - which could be called upon to offset time-bound shortages.
Today, the European Union's Common Agricultural Policy and the US Farm Bill no longer provide direct subsidies simply to drive the production of volume. Parts of the EU CAP scheme pay farmers not to produce. As a result, those buffers have vanished.
A second shift is the increasing financialisation of commodity markets. Hedge funds and other short-term traders have long speculated in commodity futures markets, and economists have tended to argue that they add to market liquidity, smoothing out price changes and increasing market efficiency. With the advent of high frequency trading though, and abnormal 'flash crash' events, there are concerns about whether speculation has become excessive. Some academics, campaign groups and multilateral agencies, notably UNCTAD, are concerned about the role financial actors such as hedge funds and pension funds could play in distorting agricultural futures prices. Some contend that speculative levels have reached a point where commodity market fundamentals are routinely overridden by short-term herd behaviour and momentum effects.
Perhaps the most contentious issue has been the entry of large institutional investors such as pension funds, enabled by the creation of index funds and exchange traded funds which offer investors exposure to commodity futures in a long-term 'investment' format. These 'massive passives' allocate money to commodities for long-term diversification purposes, and thus constitute a persistent source of relatively price-insensitive 'long-only' positions. This leads to suspicions that they could increase resistance to downward price movements, and thereby create 'buoyancy' in futures markets. While there is anecdotal evidence from traders suggesting that commodity markets have been affected by index funds, there is no expert consensus. The difficulty lies in teasing out causation amidst a host of other price factors, and different studies have reached conflicting conclusions using different methods and data. Uncertainty in the academic debate has left the issue open to political battles. US regulators like Bart Chilton have stood up for strong regulation, but the Dodd Frank Act, which has provisions for restrictive position limits on commodity trading, faces stiff opposition as the actual rules are negotiated.
Impacts on African markets
How international futures markets affect the real price of food in Africa depends on how internationally integrated local markets are. Does the futures price of wheat on the Chicago Board of Trade impact the price negotiated between buyers and sellers in an African context? Perhaps. International futures markets can act as global price benchmarks which can affect local contracts and alter producer expectations and behaviour. And price volatility has second-order effects, for example making it more risky for banks to lend, increasing the cost of financing. Volatility in currency markets can also affect some commodity trades, notably dollar to euro volatility which is pertinent to the West African cotton market.
But in the main, financial actors are probably not the sole driver of commodity price volatility in Africa, or even the main one, says Marc Sadler, team leader of the agricultural risk management team at the World Bank. "Everyone pretty much agrees that this increased level of financialisation of commodities may have a tendency to push price movements slightly further and higher, but over a very short-term period."
While commodities like coffee are traded on international markets in London or New York, many relevant to Africa - such as millet, cassava and sorghum - are not. Yet prices for these commodities are also showing volatile trends, for more Africa-specific reasons, claims Mr Sadler.
Consumption in Africa is rising but in a predictable pattern, due to population growth, longer life-spans and rising incomes, with corresponding increases in protein intake, which takes its own toll on some commodities (one kilogram of meat 'consumes' around six kilograms of maize). These shifts are not transformative in nature, though. "We haven't seen huge industrialisation of agricultural commodities so there's not a big move to biofuels and so on, meaning you haven't seen the demand profile change dramatically," says Mr Sadler.
He believes the drivers of volatility are production-related: firstly, weather shocks and difficulties related to delivering inputs such as fertiliser. Secondly, "policy volatility", which includes measures such as export or import restrictions.
"Agriculture and food are intrinsically important to Africa," says Mr Sadler. "As underlying production is volatile, policymakers regularly face difficult decisions related to the significant pressure to keep food prices at stable and sustainable levels to keep consumers happy and to support farmers."
But by creating an atmosphere of uncertainty about prices, market interventions diminish the incentives of agricultural commodity producers to make long-term plans.
"Why am I, as a local trader, going to go and buy up 50 bags? Why am I going to agree six months in advance to buy 50 bags? Why am I going to store it?," asks Mr Sadler. Policy volatility profoundly deters risk-taking and investment.
"If an export ban comes down all of a sudden my market went from being East Africa to being my own country." A vicious circle ensues. The private sector claims it is not making investments because it does not trust the government to stay out of the market. Production sinks and prices rise, and at some point the government intervenes, and the private sector sees itself as vindicated. This kind of self-fulfilling prophecy has been a feature of Malawi's agricultural politics for many years.
Knowledge is power
There is broad agreement that severe price volatility benefits neither producers nor consumers. But attempts to fix or stabilise prices have a poor history. In vogue currently are efforts to improve the accuracy and reach of information flows upon which markets depend.
The Agricultural Market Information System (AMIS) was initiated by the French G20 Presidency, with a secretariat at the Food and Agriculture Orginisation of the United Nations. AMIS seeks to bring greater transparency and accuracy to production, consumption and stocks data and to provide policymakers the opportunity to consider commonly shared data and interact at moments of potential market stress through a mechanism called the 'Rapid Response Forum'.
National and local measures are also emerging in Africa. Ethiopia has formed a national commodity exchange, named the ECX, to connect buyers and sellers in a zero default market with reduced handling costs.
"The idea...came because we had very serious problems with contract default, a lack of transparency in the markets and weak coordination, because for a buyer and seller to find each other in the country was virtually impossible, so people typically trade with people that they know in order to reduce the risk of contract failure [thus] getting cheated on quality, getting a late or missing delivery, or not getting paid," says Eleni Gabre-Madhin, CEO of the ECX. "So on all sides, whether you're a buyer or seller, there's rampant contract default. Our promise to the country was: 'We are going to create a market where anybody can trade with anybody at any time, anywhere, through this national commodity exchange'".
The results, she claims, are already apparent. "We have a very aggressive price information system where people who did not have access to information are now inundated with market data, and that is changing the power in the market. Farmers who were the least empowered in our traditional market now negotiate in a much more informed way, even in rural markets. Even if they don't come to the exchange, or sell through the exchange, they have access to the exchange price information system, so they are now referencing off of the commercial price."
Jakaya Kikwete, president of Tanzania, visited Ethiopia in May to learn more about the ECX. "We have been thinking of setting up a commodity exchange in Dar es Salaam, and we've done some work," he told This is Africa. "Now that I've seen it, I believe that it can be done. We want it completed at the earliest possible time."
President Kikwete believes a commodity exchange could play a significant role in improving the functioning of national food markets. "Tanzania's struggle is to help the small farmer, who is really powerless in the face of the large traders who at times are not that merciful, and are trying to just buy at the lowest prices. We have tried initiatives like a warehouse receipt system. That has helped...but now we want to do it properly and a commodity exchange is the way."
Ms Gabre-Madhin is keen to support other African states to develop exchanges. "It's in our interest as an African market, as an African country, to help other African countries start developing their markets, so we can start talking to each other and develop a presence in global markets."
However, such exchanges are not without critics. Some analysts see potential for corruption in the grading and pricing of coffee since traceability is impossible once coffee enters the exchange. This loss of identity also diminishes buyers' abilities to inform consumers where their coffee comes from.
A further domestic measure for dealing with volatility drivers are those which improve how goods are distributed. Storage technology has progressed at impressive speed, with some of the best facilities in the world currently located in South Africa, whose best performing companies suffer just half a percent losses per year. And at the policy level, the political process through which market interventions are chosen - as they inevitably will be from time to time - could be more inclusive, with better communication between government and stakeholders, says Mr Sadler. Civil society and the private sector should be brought in early to discuss with the government the production and price problems at hand.
"Most African countries have a relatively vibrant civil society and a relatively vibrant private sector, and it's going to be a very different kind of outcome if you get them in early. If you say: 'You've got to make a profit, and we need the market. We need to work together - what ideas can you bring?'"
Additional reporting by Eleanor Whitehead