Price volatility – causes and consequences

Johannesburg, South Africa (IRIN) – In the past four years, global prices of staples such as maize and wheat have twice hit record levels, driving hundreds of thousands of the world’s most vulnerable people further towards hunger and poverty.

It is the poorest people in the poorest countries who are most affected by the high price of staple foods.

Recent responses to high prices have increasingly tended to focus on reducing price volatility – sharp fluctuations in food prices.

G20 countries in their June 2011 ministerial declaration recommended measures such as building grain reserves, a global market information system and regulating financial transactions in commodities markets.

But economists like Brian Wright, professor of agricultural and resource economics at the University of California, Berkeley and Christopher Barrett, professor of applied economics at Cornell University believe more emphasis needs to be placed on underlying policy problems.

“Volatility is a symptom of a structural problem of low stocks,” says Wright. “When supplies get to certain low levels the prices become vulnerable to volatility.”

He makes a distinction between the impact of one-off production shortfalls and low grain stocks over a longer period: “Though [price] spikes do not indicate times of large aggregate food grain production shortfalls, it is easy to check that they do indicate times when aggregate stocks were low.”

Barrett would like to see more emphasis on boosting production and improving distribution systems to increase the supply of food and bring down prices. “Food price volatility gets addressed naturally as food supplies expand, bringing down prices and encouraging expansion of price-stabilizing inventories [stocks].”

Traditional policy responses to price volatility tend to benefit large farmers in developed countries and not the poor consumer or producer in a developing country, said Barrett.

“Every dollar spent on developing expensive reserves or marketing systems is a dollar taken away from improving yields, from developing drought-tolerant rice or setting up marketing infrastructure in a developing country,” he said.

The Food and Agriculture Organization (FAO) in its new annual report, advocates creating buffer stocks, but admits maintaining them is expensive.

Biofuels

Maximo Torero, director of the International Food Policy Research Institute’s (IFPRI’s) Markets, Trade and Institutions Division, highlights some “non-traditional” causes of price volatility: the increasing use of food crops to produce biofuels, extreme weather events, and an increased volume of trading in commodity futures markets.

He also notes that price volatility is common in agriculture because of seasonal variations.

The surge in demand for biofuel since 2006 caused a decline in aggregate grain and oilseed stocks that made markets and governments much more sensitive to routine disturbances, according to Wright.

“The increasing diversion of food crops like maize and soya to produce ethanol has been the new shock to the market that has kept stocks and supplies of food staples extra low… With low stocks otherwise – minor disturbances become major price movers,” he said.

In the USA, the amount of maize being diverted to ethanol production has increased rapidly – from less than 5 percent of total maize production in 1995 to more than 35 percent by 2010, according to the Earth Policy Institute. This year it will rise again.

“To put the magnitude of these reductions into perspective, a drought or pest infestation that reduced US maize output by 30 percent in a given year would be viewed as a production catastrophe,” said Wright.

Export restrictions can also cause sharp price rises – as in 2007-2008, when India and Vietnam decided to restrict exports to protect their own consumers.

Weather events/climate change

Sudden weather events like the drought in Russia in 2010, which destroyed wheat crops and in part triggered the spike in wheat prices that year, are another major factor, said George Rapsomanikis, an economist with FAO’s Market and Trade Division.

Wright believes that oil prices and government policy on biofuels, not just in the USA and Europe but also in Africa and Latin America, will continue to be major determinants of food price behavior in the future.

Low stocks of staples “made markets unusually sensitive to subsequent shocks such as high petroleum prices, the Australian drought [in 2006] and other regional production problems,” Wright said in a recent paper.

IFPRI – through simulated projections for the period 2010 to 2050 linking climate variability and food supplies – has shown that the rise in the price of staples could range from more than 20 percent for rice in the optimistic scenario (with high income and low population growth) to 50.4 percent for maize in the pessimistic scenario (low income and high population growth).

Futures

Another symptom, and possible cause, of higher price volatility is the significant increase in the volume of agricultural commodity futures traded on the Chicago Board of Trade, a leading agricultural futures exchange, said Torero.

A futures contract refers to an agreement between two parties to exchange a specified quantity and quality of a commodity at a specified price on a certain date in the future, according to IFPRI’s Hunger Index 2011, which focuses on price volatility. “Futures trading is used by agricultural producers to reduce the risk they face from changing prices, and by speculators to take advantage of price shifts in commodities.”

Food products are increasingly being viewed as an attractive and safe investment, prompted by the fact that demand for them will always grow as long as the world’s population grows. Investments in funds which include food commodities shot up from US$13 billion to $260 billion between the end of 2003 and March 2008, pushing up food prices, according to the Hunger Index.

Speculators usually make short-term investments. “As they swarm into a market, they exacerbate the initial increase in price, and when they flee a market, they contribute to a fall in prices… 98 percent of contracts are sold by investors who are interested in turning a quick profit,” said Torero, who also pointed out that for maize, the volume traded on exchanges is more than three times global production.

Wright says, however, that the futures market is more a symptom than a cause of price volatility. “If all parties agree that prices are stable, there will be little need for futures trading. But to argue that increased futures trading is a cause, rather than a symptom, of price increases, is to argue that speculation made food stocks increase, at a time when in fact the ratio of aggregate food grain stocks to consumption was near historical minima.”

Economists Christopher Gilbert of the University of Trento and Christopher Morgan of the University of Nottingham write in a new paper

that factors such as global warming, oil price volatility due to fluctuating biofuel demand, and investments in futures markets “may have led to a permanent increase in volatility (in recent years) in particular in grain prices “but we see little evidence that substantiates these claims, which we therefore regard as (perhaps reasonable) conjecture and not fact.”They suggest waiting for several more years before firm conclusions are possible.

jk/cb

– Provided by Integrated Regional Information Networks.

Article © AHN – All Rights Reserved
About the Author

Leave a Reply