TWN Info Service on WTO and Trade Issues (Apr10/01)
2 April 2010
Third World Network

Diverging views aired at the first Commodities Forum
Published in SUNS #6893 dated 29 March 2010

Geneva, 26 Mar (Riaz K. Tayob) -- The first Global Commodities Forum heard a wide range of often sharply diverging views from its various stakeholders on the policy challenges and the outlook for energy, mining and minerals at the two-day event hosted by UNCTAD and the Common Fund for Commodities.

The Forum, which ended Tuesday, was addressed by a number of Ministers, high-level policymakers, experts, academics and business leaders and organisations (including commodity traders and representatives of commodity/mercantile exchanges).

The differences expressed essentially ranged from calls for greater regulation of commodities trade to unequivocal support for unencumbered free markets, primarily between some academics and mainly representatives of business/commodity exchanges, respectively.

There were also differences of interpretation on the oil price spike over three years from 2007 to 2009 where oil prices increased from US$30 to US$75 while spiking at US$150.

According to Mr. Ian Taylor, Managing Director of Vitol (the world's largest independent energy trader), the fundamental cause of the increase and spike was strong growth in demand not matched by sufficient investment in all parts of the industry, including exploration, shipping and refining.

However, Prof. Christopher Gilbert of the University of Trento, Italy quoted diverse sources including George Soros, for the view that "bubble economics may provide a cohesive explanation of the economic events of the past decade."

These divergences, also raised in the forum plenary, were epitomised at the press briefing with UNCTAD Secretary-General, Supachai Panitchpakdi, Professor Machiko Nissanke, School of Oriental and African Studies, University of London, and the CEO of the London Metal Exchange, Martin Abbott. Based on UNCTAD studies, Supachai questioned the views of Abbott about the efficient functioning of markets. Supachai viewed as complete nonsense and misunderstanding the view that discussions on volatility were conducted to kill off the market.

At the close of the forum, Supachai said that the straightforward discussions at the forum gave ground for hope that it should be useful, and be on an annual basis to serve the multilateral stakeholder community. After careful deliberations and that in the light of inadequate regulation, he said, participants had proposed a number of groundbreaking initiatives, including an international association for commodity financiers to serve commodities market participants better. The forum, it was agreed, can become a neutral high level one, organised annually.

The conference plenary sessions considered a number of issues including boom, bust and partial recovery in oil, gas and other energy markets; current state and prospects for minerals and metals; causes of commodity price volatility; addressing volatility: options for regulation; and, policy challenges for metal- and mineral-exporting countries. Parallel events included sessions on commodity finance and legal and regulatory issues in commodity finance.

In opening the forum, Supachai said that the commodities economy is of crucial importance to developing countries: over 85 developing countries are dependent on commodities for more than 50% of their export earnings. The commodities boom, which began in 2002 after more than two decades of declining commodities prices, provided a golden opportunity for commodity exporters to re-invest windfalls back into development and poverty reduction programmes. However, the current global economic crisis put an abrupt stop to the boom years and by end-2008, prices had slumped.

Increased stability in commodities markets would be more conducive to development from the perspective of both exporters and importers, and there is a need to identify a better mix of policy and market mechanisms that could contribute to market stabilisation, and how exporters and importers can limit their exposure to commodity price volatility and mitigate the detrimental effects of commodity price swings.

Supachai emphasised the importance of dialogue amongst key stakeholders, and the collective search for better solutions. Commodity booms have been a regular feature of international commodity markets. Other challenges include afflictions such as Dutch disease, the resource curse, and excessive speculation in commodities futures markets.

Also at the opening session, Ambassador Jean Feyder, President of the Trade and Development Board of UNCTAD, said UNCTAD had been most active on the issue of commodities in the 70s and 80s. The financial crisis had raised that issue of finding the optimal balance between self-regulation and how to achieve markets that are more stable without excessive intervention.

Mr. Germanico Pinto, Minister of Non-Renewable Natural Resources, Ecuador, and President of OPEC, said that responses of governments to the recent economic crisis demonstrated the importance of coordinated efforts and that the challenges of energy security and climate security cannot be met by countries alone. It was essential that the market is justified by fundamentals.

Mr. Ali Mchumo, Managing Director of the Common Fund for Commodities, said that the costs of market volatility are not evenly distributed but concentrated at the base of the pyramid (with producers). When markets crash, the poor are left to clear up the mess absorbing all the costs.

Ambassador Marwa Kisiri, speaking for the African, Caribbean and Pacific countries said that many ACP countries have faced a long term declining trend and have difficulty in adapting to increasing harsh international competition. Countries continued to face constraints on the supply side and in market access for processed products.

Dr. Mohamed Saleh Al-Sada, Minister of State for Energy and Industry Affairs, Qatar, said that while market fundamentals undoubtedly played a role in the price variations recently, the strong influence of speculators cannot be ruled out. Speculation is often fuelled by market uncertainty and in the oil market it stemmed from a lack of transparent data. There is a disparity between oil and gas prices, the oil price has recovered, while the recovery in gas prices has been far less than the oil equivalent. This difference needs to be addressed.

On the impact of hedge funds and index instruments on oil prices, Prof. Gilbert of the University of Trento, told a forum session on "Causes of Commodity Price Volatility", that because hedge funds are large they can and do move markets. But it was less clear that they often move prices away from fundamental values. On index investments, he said that there were two possible interpretations. First, index-based investment pushed prices away from their fundamentally-based values, and hence additional controls may be required on futures market activity to prevent a repetition of the 2008 bubble. A second view that index-based investment is driven by views about the likely future evolution of the macroeconomic fundamentals that drive commodity prices, particularly perceptions of likely demand growth in China and parts of developing Asia. On this view, there was no commodity price bubble, the summer 2008 price collapse was temporary and the result of the financial crisis.

Dr. Hu Jiangyun, Divisional chief of the Development Research Centre of the State Council of the Peoples Republic of China, said one of the causes of commodity price fluctuations was price control and oligopoly by multinational corporations in some commodity markets. He added that there is a passive acceptance of the price decision especially by developing countries. He said that neither suppliers nor buyers can decide commodity prices. However, prices which are seemingly induced and anticipated by the futures market are actually controlled by a few multinational corporations (MNCs) in the specific markets. China is one of the main suppliers and consumers of commodities. It has suffered huge losses and paid high costs for a long period. Some factors will contribute to the reduction of price volatility like, suitable economic development pattern, efficient use of resources and sustainable development, and balance of the interests of different parties, he said.

Jiangyun proposed capacity building and better use of risk management instruments, to enhance cooperation between suppliers and consumers. He added that countries should fight against market monopolies in line with economic laws. International organizations, like UNCTAD and WTO, should establish and perfect commodity price-coordinating mechanism.

Summarising the outcome of another plenary session on "Addressing Volatility: Options for Regulation", with a panel composed of mainly representatives of commodity exchanges, moderator Mr. Dan Day Robertson said that the panellists expressed vehement support for free markets and that since prices move up and down because of market forces, the infrastructure of producers should rather be looked at. Some panellists criticised the international commodity agreements, specifically citing the case of copper, and called it a massive failure. They also criticised attempts to fix prices through regulation.

The views of the panel session were questioned by the representative of Eon, the German energy company, who said that because all the panellists made money from increases in volatility on the trading side, it was no wonder that their recommendation was that no regulation was necessary.

Prof. Nissanke also challenged the panels' characterisation of proposals for regulation. She denied that regulation was proposed for price fixing purposes. Heterogenous traders' interest, she said, provide an important function of liquidity in the market. However, at times in the futures markets positions are taken which are not necessarily in relation to the function of the market.

On market volatility, at the press briefing on the Forum, Martin Abbot, CEO of the London Metal Exchange, said that there were always wide swings in the market. It was interesting that smaller swings were seen on commodity exchanges as compared to commodities not traded on exchanges. This was good evidence that the involvement of funds and speculators reduced volatility.

He said that the assumptions made about recent swings in commodity prices because financial players were entering and retreating from the markets (in the period 2007 to 2009), was not true. The primary driver for price movements and trading was the unexpected demand out of Asia and particularly China which saw an expansion of GDP that no one thought possible in 2008. It was logical that when one has unexpected expansion, then one can have volatile expansion and this showed that markets have worked very well. The idea of artificially setting a fixed price was impossible and destructive, he argued.

Nissanke said that academic research had shown that there were two forces at work: market fundamentals and financialisation of commodity markets, with strong feedback effects and intensification. These were taking placing on derivatives markets, where there was no need to take final physical delivery and one could have positions with liquidities to play around - and what their effects were on prices. Nissanke said her research showed that activities in futures prices can influence spot prices through profit arbitrages, leading not only to changes in precautionary demand for holding physical commodities, but also to shifts in market sentiments. Explaining the effects of speculation, she said that generally, speculation is not always destabilising and can be stabilising. Speculators can loose out if they do not have regard for fundamentals. Speculation can be stabilising by enhancing liquidity, when counter-parties take a position, this makes markets work.

However, there were other speculations, with big commodity price swings coming from derivative market activities. When all index traders took positions in the futures markets, commodities became part of their portfolios. In asset markets there are always possibilities to make profit riding on price movements, and can vary from fundamentals.

Generally, the Efficient Markets Hypothesis works, where markets are tranquil and generally stable. However there are conditions where the hypothesis breaks down. Where price signals are not giving market fundamentals, then price does not act as a hedging instrument for physical commodity stakeholders. For efficient markets to work, you always need information fundamentals.

When big financial institutions enter the market, they can create the "weight of market effect". Large players can act and take positions and that can create shifting price dynamics. As Charles Kindleberger put it, agents in the market are rational but markets are irrational she said. And there is a need to deal with this issue when the market moves from fundamental equilibrium to bubble equilibrium. When markets are efficient, there is no need to intervene, but what is to be done when markets are not efficient, she asked.

It was not possible to deal with this, as before, with buffer stock and export quotas. Regulation has to be much smarter and sophisticated than previously and she referred to the International Food Policy Research Institute proposal.

[The IFPRI is a two pronged scheme including small physical food reserves be established for release in emergencies, and an innovative virtual reserve backed by financial funds and intervention mechanisms in futures markets to prevent spikes and keep prices close to fundamentals, as described in the slides distributed at the meeting.]

On the ratio between real contracts for delivery and the size of the futures market, Abbot said that a mature physical commodities market would trade at around 30 to 40 times the underlying amount of material. One would expect an efficient market to trade at many times the underlying size of the commodity, he said.

Nissanke said that the efficient markets hypothesis works when there is instantaneous access to information, where the market can absorb the information, where all agents are price takers and nobody has a position on price movements, in other words where there is perfect competition. When those conditions fail, then markets do not work as (described in) the textbook.

Abbot cited the 1985 UN price stabilisation programme and the illicit activities in tin that created the largest single default on the LME, to support his views on unencumbered free market activity.

Asked what happened with nickel at the LME in the recent past Abbott, said that when the world supply of nickel got to two or three hours worth of consumption, we did put in a fixed limit that allowed people to roll the position for one day and take a financial penalty. Within a matter of days there was enough nickel arriving in the warehouses so the short sellers could satisfy their delivery requirements. That was an extraordinary situation but it is also a situation catered for in the exchange. If one has markets in times of extreme stress then one has to impose extraordinary rules on occasion.

Challenging some of Abbot's views, Dr. Supachai said that facts and figures presented at the forum showed that when the financial asset market began to collapse, there was an influx of excessive liquidity in addition to what has been circulating in the commodities markets. It was unprecedented, with increases in the order of hundreds of percent. If that has not brought anything strange to the market, then that must be strange, he said.

Fundamentals, he said, have not changed very much. If one looked at the graphs between 2007, 2008 and 2009, there was a huge spike in 2008. Just at the same time when people were selling off in the derivatives markets from the financial assets side, the money was transferred into the commodities market and there is a peak. It is just normal economic reasoning to see that prices in some metals were going up in 2009 because of the stimulus measures. Recession has shown that it has an effect on the commodities: the peak and the drop between 2008 and 2009 is just huge. And 2009 is when trillions of stimulus measures kicked in.

Energy is a clear case, Supachai said. In the past couple of years there has been no drastic change in the level of demand for energy. In fact for OECD countries, we have seen demand dropping. Only demand was increasing on the Asian side. There has been little change in fundamentals, and yet oil prices moved from US$30 a barrel to US$147 a barrel within about a years time. This just cannot be explained by fundamentals, and that markets work well. Markets may work well in some cases, but he expressed doubts that markets work well in all cases.

It is a fatally flawed argument to say that "we are trying to fix prices forever and to say that is price stability." That is not the purpose. Price stability in economic terms means that the price will have to move along with the fundamentals, Supachai explained. It does not mean "no price movement". That is not economic.

Dr. Supachai said: "We don't want to fix at any price. We need people who explore and produce minerals to make profits so they can invest. What we are looking for is an orderly trade. Whatever the exchange can do for those countries who participate (in) it would be in their benefit, particularly for the poor countries. Those countries would like to know where they are headed. This is why we are talking about volatility. We are not talking about volatility because we want to kill off the market. That is complete nonsense and misunderstanding. We want a larger degree of stability, because we need to help countries to make plans, to have benefits, to have transparency and governance, and so on. We have to look at the bigger picture, not just micro-economic somewhere in the exchange." +