Financing Food focuses on how derivative markets work and on speculation in food and agricultural products. This study demonstrates how the futures market for agricultural products, in particular, has changed and is being disrupted by new speculators, growing index funds and commodities funds.
This briefing paper aims to contribute to a better understanding of the so-called ‘financialisation’ of agricultural commodity markets. The briefing first explains how financial agricultural commodity markets work, with a main focus on the derivatives market, and who are the main financial actors involved. Without replicating the many existing and varying reports on the role of financial speculation in the rise and fall of food prices, the paper explains the increased role of financial speculators in the agricultural commodity markets and their impact.
Since the nature of the debate about food price increases is often quite technical and intangible, this paper has avoided many technical terms and complexities. This SOMO briefing aims to allow more people than only insiders to contribute to the current discussions about reforms of the derivatives market in agricultural commodities, and their financial players.
The sharp increase in the prices of food and agricultural commodities, as well as of oil, in 2007 and 2008, raised many concerns. The high price of basic food commodities contributed to social unrest and an increase in global hunger, undermining development and people’s right to food as defined in the Universal declaration of Human Rights. The IMF price index of internationally traded food commodities increased 130% from January 2002 to June 2008, and 56% from January 2007 to June 2008. This period of exceptionally steep price increases ended at the time the financial crisis intensified, mid 2008, with food commodity and oil prices showing a sharp decrease. However, late 2009, the Food and Agriculture Organisation (FAO) issued a new warning about rising food prices.
The causes of the sudden price increases and decreases have been described and discussed intensively in the last two years and continue to be the subject of much debate.
The role played by speculation in relation to the volatility of commodity prices is receiving wide-ranging attention from academics, international institutions, ournalists, market regulators, civil society and many others. Views and analyses vary widely, from firm support of ‘speculation caused price spikes’ and created a commodity bubble, to the standpoint that there is ‘no relation between speculative investment and price increases’. Taking a rather moderate approach in the debate, UNCTAD states that ‘the trend towards greater financialisation of commodity trading is likely to have increased the number and relative size of price changes that are unrelated to market fundamentals.’
The two fundamentals that traditionally constituted agricultural commodity prices are roughly described as demand side factors (e.g. more people needing food, income growth, and increased demands for bio-fuel) and supply side factors (e.g. yield growth or bad harvests, the prices of inputs, and availability of food reserves). Manipulation of these fundamentals, e.g. by keeping commodities away from the market (hoarding), causing a shortage that results in price increases, is the kind of speculation or price management that might still play a role in today’s commodity markets. In addition, the value of the US dollar, in which most commodity trading takes place, can play a role. This paper will focus on the role of financial markets, and especially derivatives markets, in agriculture commodities over the last decade.
Conclusion and recommendations
The financialisation of the agricultural commodity markets is the result of increasing capital flows from ‘non-traditional’ investors in commodity derivatives, especially agricultural commodity futures, and related investment instruments, serviced by large financial firms. Non-traditional speculators, who are not interested in the commodities themselves, have increased the interdependence between commodity and financial markets. The increasing demand, and at times sudden withdrawal, by non-traditional speculators on the agricultural commodity futures markets is considered by many to have influenced demand and supply fundamentals, thus contributing to raising and falling food prices.
Non-traditional speculators have so contributed to disrupt the traditional function of agricultural commodity futures markets to discover prices on the spot markets, and to be a reference for prices for futures contracts by which producers and especially end-users can protect themselves against risks.
In order to avoid that (excessive) speculation interacts with prices for food whose access is a fundamental human right, the following measures related to the financial agricultural commodity could be considered:
Deregulation of agricultural commodity derivatives markets and futures exchanges are reversed after public discussions and through legislative initiatives that:
substantially improve transparency, for supervisors and the public, of the OTC derivatives trading and their actors,
impose limits on all excessive and non-traditional speculators,
exclude the many risks of OTC commodity derivative trading as mentioned in this paper,
resolve the remaining risks of commodity exchanges such as unregulated clearing entities,
deal with the negative impacts of the composition of indexes and related investment instruments, and
question the social usefulness of speculation in agricultural commodities.
Special rules and instruments are introduced to prevent the domination of agricultural commodity derivatives markets and services by a small number of large banks that are highly interconnected and take many risks by trading with their own money. Their various functions in the agricultural commodity markets have allowed these few banks to make huge profits that encourage them even further to promote excessive speculation whose social usefulness is questionable.
Responsible investment strategies are being developed and implemented by corporate and institutional speculators and financial firms active in the agricultural commodity derivatives and related funds, in order to prevent their investments and services from contributing to increases in food prices for the hungry and poor, and from neglecting financing and income for farmers.
Alternative instruments for price setting and risk protection for producers and end-users, as well as for food production and trade, are further explored and developed, in order to guarantee prices that provide farmers with equitable incomes and poor consumers with food that is available at affordable prices.