File Name: international commodity trading physical and derivative markets .zip
Commodity markets have displayed increased volatility and unprecedented movements of prices in recent years. Prices in all major commodity markets, including energy, metals and minerals, agriculture and food, increased sharply in to reach a peak in , declined strongly from the second half of and have been on an increasing trend again since the summer of To varying degrees, these price swings have been reflected in consumer prices, at times leading to social unrest and deprivation.
At the heart of current developments lies a series of changes in global supply and demand patterns as well as short term shocks in key commodity and raw material markets. The years to were marked by a major surge in demand for raw materials, driven by strong global economic growth, particularly in emerging countries such as China. This increase in demand will be reinforced by the further rapid industrialisation and urbanisation in countries such as China, India and Brazil.
Price movements have been exacerbated by various structural problems in the supply and distribution chains of different commodities, including the availability of transport infrastructure and services. These developments occur at a time when the competitiveness of European industry requires efficient and secure access to raw materials.
In addition, markets are experiencing the growing impact of finance, with a significant increase in financial investment flows into commodity derivative markets in recent years. Between and , for example, institutional investors increased their investments in commodities markets from 13 billion euro in to between and billion euro in While the financial crisis interrupted the upward trend, financial positions approached or even exceeded their peaks on many markets in and investment by index traders in particular has increased strongly.
While the debate on the relative importance of the multiple factors influencing commodities prices is still open, it is clear that price movements across different commodity markets have become more closely related, and that commodities markets have become more closely linked to financial markets. These developments have led to increased calls for policy responses to mitigate the negative effects of such movements on both producers and consumers, especially the most vulnerable ones.
They have generated attention at the highest political level including the latest G20 summits. The challenges of commodity prices and raw materials are closely intertwined and touch on policies in the areas of financial markets, development, trade, industry and external relations.
The European Commission has therefore taken a number of initiatives. In it already drew attention to the strategic importance of defining policies for raw materials by launching the raw materials initiative. Since then, it has taken actions within this framework to address sustainable access to raw materials both within and outside the EU, as well as on resource efficiency and recycling. It also began an in-depth reflection on commodities market in general and on food prices and security of food supply in particular.
In response to the financial crisis, it has launched a range of measures to improve the regulation, integrity and transparency of financial markets, and most recently it has made a proposal for the regulation of energy markets.
This Communication presents an overview of what has been achieved in each of these areas and of the steps which are planned to take the work forward. This work is part of the Europe strategy to ensure smart, sustainable and inclusive growth and is closely linked to the flagship initiative for a resource efficient Europe.
It will feed into the work of the G20 which agreed at the Pittsburgh summit "to improve the regulation, functioning, and transparency of financial and commodity markets to address excessive commodity price volatility".
This commitment was reinforced in November by the G20 summit in Seoul which pledged to address food market volatility and excessive fossil fuel price volatility.
Fundamentals, including unexpected changes in global economic conditions linked to the strong growth in demand of emerging market economies have played a key role in driving developments on commodity markets. Other factors that have also played a role are supply shortfalls and monetary policy, and in recent years, various ad hoc policy interventions. Export restrictions, border measures, and shifts in storage policies had an impact on food prices in the run up to the food price crisis.
Increased use of agricultural land for the production of renewable energy has strengthened the link between developments in agricultural and energy prices. Price movements have also been exacerbated by various structural problems in the supply and distribution chains of different commodities. Each commodity market functions differently depending on the nature of the commodity, the needs of traders and historical developments.
There is no single model for the organisation of commodity markets and hence of how prices evolve. Some commodity trading exhibits a high degree of standardisation, while on other markets the way in which trades are done may change according to the particular needs of individual market participants. Derivative markets based on commodities have existed for a long time and play a role in the hedging of exposures of both producers and users of various commodities.
Just as the underlying commodities can be traded in different ways, derivatives can be traded on a bilateral basis, generally called over the counter or OTC, or using organised exchanges.
Additionally, the role of financial institutions as well as the importance of derivatives is very different from one market to another. The following sections examine specific developments on the markets for energy and agricultural commodities and the increasing interdependence of commodities and related financial markets. Oil and petroleum markets are integrated, liquid and global, and are widely considered to be driven notably by economic fundamentals, but also by geopolitical considerations, the role of the Organization of the Petroleum Exporting Countries OPEC , and by non-physical trades.
There have been significant developments in terms of financial and derivative investment instruments and trading technologies. The G20 at the Seoul summit has highlighted the importance of well-functioning and transparent energy markets for economic growth. It has been working on physical market transparency, fossil fuel price volatility, and the phasing out of inefficient fossil fuel subsidies. The gas market, which is increasingly influenced by the development of non-conventional sources, has traditionally been based on long-term over-the-counter OTC contracts.
As a result of the proliferation of Liquefied Natural Gas LNG , gas is also increasingly traded on a global and liquid market which is being commoditized. Electricity is the least global energy market as its transport over long distances is restricted for physical reasons of non-storability and energy loss.
The geographic scope of the market is therefore smaller than for other energy commodities. EU electricity and gas markets are increasingly integrated as a result of the internal market. They have seen the development of energy exchanges or other organised markets and broker facilitated OTC markets which can be used both for physical delivery and hedging. It remains the case that market prices are highly sensitive to the availability of actual and expected generation as electricity cannot be stored on an industrial scale.
Most a gricultural commodities, in particular crops, are subject to strong seasonal production patterns, and their supply cannot always adjust rapidly to changes in prices or demand. This means that agricultural markets are characterised by a certain degree of variability. Structural factors such as demographic growth, pressure on agricultural land and the impacts of climate change may add to growing tensions on agricultural markets. However, the volatility of prices of agricultural commodities has recently increased to unprecedented levels.
This is the case both on the EU and international markets, and on spot and futures markets. As a result, commodity producers and traders are more exposed to market price developments and, although it is not the case in all agricultural sectors, are thus more prone to use futures markets to hedge risks.
Trade in options and in over-the counter derivatives is also growing. These factors explain to some extent the increased activity on European-based exchanges and raise two issues in particular: security of food supply and the need for increased transparency on agricultural derivatives markets. Security of food supply has been identified as one of the main drivers for future reform in the CAP. A strong agricultural sector is vital for the highly competitive food industry to remain an important part of the EU economy and trade and a major contributor to international markets.
This is why, in the context of the Doha Development Round the EU has agreed to an important agricultural package, conditional on reaching an ambitious, balanced and comprehensive overall agreement. Excessive volatility of food prices affects producers and consumers alike, and has serious effects on security of food supply for food importing developing countries.
During food price spikes — such as in - many of the poor in developing countries reduced their food intake. The food price increases may lead to another increase in malnutrition, humanitarian needs and social tensions and unrest among the weaker consumers in the world. While higher global prices could stimulate agricultural production, price transmission mechanisms are often imperfect. In many developing countries, commodity markets are often disconnected from world markets or, at best, world price signals are transmitted to domestic markets with considerable lags so that a domestic supply response is often delayed.
Several analyses by the Food and Agricultural Organisation, OECD, Commission and others have focused on supply and demand developments, exacerbated by short-term economic and policy factors including restrictions on exports that explain part of the observed extreme price volatility, including factors specific to financial markets that may have amplified price changes.
Despite remaining uncertainties, based on the outlook for agricultural commodities established by several organisations, including the latest Commission medium term projections, three conclusions are clear for agricultural commodities:. The combination of the above factors implies that higher prices for agricultural commodities will not necessarily result in higher incomes for farmers, especially if their margins are squeezed by increased costs.
In addition, potential problems for net food importing countries and more generally for the most vulnerable consumers are evident, stemming from price impacts on food inflation. While a certain degree of variability is an intrinsic part of agricultural markets, excessive volatility does not benefit producers neither users. Raw materials include metallic minerals, industrial minerals, construction materials, wood, natural rubber.
Unlike electricity, raw materials are traded globally. In relation to prices and markets, the key distinction is between those that are traded on stock exchanges and those that are not. For example, base metals such as aluminium, copper, lead, nickel, tin and zinc are traded on stock exchanges of which the London Metals Exchange LME is a global leader. The market for these materials is less transparent and the volumes traded are very small in comparison to other materials.
The global metal and mineral markets generally follow a cyclical pattern based on supply and demand. However, the period was marked by a major rise in demand for raw materials driven by strong global economic growth, in particular in emerging countries. This was reflected in unprecedentedly high price levels. Recent trends indicate that demand for raw materials will be driven once more by the future development of emerging economies and by the rapid diffusion of key enabling technologies.
A growing concern in these markets relates to measures imposed by certain countries to ensure privileged access to raw materials for their domestic industry including through export restrictions. These measures create distortions in the global markets and uncertainties in the regular flows of commodities. Such measures may affect developed and developing countries alike as virtually no economy is self-reliant for all raw materials.
Least developed countries in particular can be particularly dependent on commodity imports and therefore can be negatively affected by the absence or inadequacy of multilateral rules in some disciplines such as export duties.
Furthermore, companies respond to price fluctuations in various ways, such as stockpiling, negotiating long-term contracts or price hedging in the form of futures contracts.
Some of these reactions may exacerbate the tightness of supply. Commodity derivatives allow producers and users to hedge the risks associated with physical production and price uncertainty. They are also increasingly seen purely as financial investments. In this context, financial investment flows into commodity derivative markets have grown significantly in recent years see graph 1.
Commodity and financial markets are thus increasingly intertwined sharing a growing number of participants in search of risk management tools and investment opportunities.
The liquidity, efficiency and accessibility of spot markets are strengthened by well-functioning derivative markets, and vice versa. Adequate and reliable information on market fundamentals such as volumes of production and consumption, network and pipeline capacity etc, as well as the amount of trading that takes place in the commodity is necessary for transparent and orderly price formation both on the spot and derivative markets.
Derivative markets are however not only used by commercial companies for risk management purposes, but also by financial institutions as part of their risk allocation strategies. In addition prices of commodity futures i.
Graph 1: Transactions on commodity derivative markets Total open interest of futures and options. The very nature of a derivative contract is that its value depends on the value of the underlying market to which it refers.
This is particularly the case where the underlying market is a physical market. The prices of commodity derivatives and underlying physical commodities are therefore interlinked. Commodity derivatives markets therefore cannot be regarded in isolation from commodity markets and vice versa.
Identifying which way causation flows in the interaction between financial and physical markets is, however, a complex issue. Establishing these correlations is complicated by the fact that not all physical markets have the same features. A variety of factors have an impact, some of which are specific to individual markets and, as a result, different market dynamics are at play in the different sectors.
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Commodity markets have displayed increased volatility and unprecedented movements of prices in recent years. Prices in all major commodity markets, including energy, metals and minerals, agriculture and food, increased sharply in to reach a peak in , declined strongly from the second half of and have been on an increasing trend again since the summer of To varying degrees, these price swings have been reflected in consumer prices, at times leading to social unrest and deprivation. At the heart of current developments lies a series of changes in global supply and demand patterns as well as short term shocks in key commodity and raw material markets.
Schofield International commodity trading: Physical and derivative markets, Companies' role and analytical competence. Application of microeconomic methods to. While this theoretical definition is rather straightforward, its empirical application is rather discount rate on the value of a house, we can form the first derivatives, which asset p. These could peronautomationinfinancial, abgerufen am.
This book offers practical knowledge, analysis, trading techniques and methodologies required for the management of key international commodities.
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In economics , a commodity is an economic good , usually a resource , that has full or substantial fungibility : that is, the market treats instances of the good as equivalent or nearly so with no regard to who produced them. The price of a commodity good is typically determined as a function of its market as a whole: well-established physical commodities have actively traded spot and derivative markets. The wide availability of commodities typically leads to smaller profit margins and diminishes the importance of factors such as brand name other than price. Most commodities are raw materials , basic resources, agricultural , or mining products, such as iron ore , sugar , or grains like rice and wheat. Commodities can also be mass-produced unspecialized products such as chemicals and computer memory.
A commodity market is a market that trades in the primary economic sector rather than manufactured products, such as cocoa , fruit and sugar. Hard commodities are mined, such as gold and oil. A financial derivative is a financial instrument whose value is derived from a commodity termed an underlier. An increasing number of derivatives are traded via clearing houses some with central counterparty clearing , which provide clearing and settlement services on a futures exchange, as well as off-exchange in the OTC market. Derivatives such as futures contracts, Swaps s- , Exchange-traded Commodities ETC , forward contracts have become the primary trading instruments in commodity markets.
A commodity market is a market that trades in the primary economic sector rather than manufactured products, such as cocoa , fruit and sugar. Hard commodities are mined, such as gold and oil. A financial derivative is a financial instrument whose value is derived from a commodity termed an underlier.
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