Price fluctuations big risk
Feb 28, 2010
EXECUTIVE TALK <br><br>As maize farmers cry out on the further drop in prices (The New Vision February 24, 2010, page 27), it is important that all stakeholders in the maize industry understand the different types of price risk they face.
EXECUTIVE TALK
By Tumwesigye Amos
As maize farmers cry out on the further drop in prices (The New Vision February 24, 2010, page 27), it is important that all stakeholders in the maize industry understand the different types of price risk they face.
Production and marketing of primary commodities play a dominant role in most developing economies.
Commodity prices are unstable and often fluctuate from 50% below to 150%, above their average price. During the last crop season, maize prices ranged between sh550 – sh580 per kilo for unclean maize grain and sh750 – sh800 for clean maize.
This season the maize grains go for sh300 and sh460 for unclean maize and clean maize, respectively.
Recent trends towards economic liberalisation have led to the dismantling or reform of many commodity price stabilisation schemes and other policies designed to protect domestic commodity prices from fluctuating as much as world prices.
This has shifted the responsibility for commodity price risk management away from the government onto the households, firms, and cooperatives that produce, market, and consume the commodities.
Participants in the supply chain and the risk they face differ significantly by commodity type and country but generally fall into three main categories; micro, meso and macro.
At the micro level, farmers engage in producing commodities and are directly impacted by price risk.
Producers typically hold net long positions, a situation where participants have already purchased (or promised to purchase) a particular amount of the commodity at a particular price, without having an offsetting agreement to sell the commodity.
In this case a price decrease can lead to losses because the purchased commodity has to be sold at a lower price. This leads to problems in planning production, allocating resources efficiently, obtaining inputs, and obtaining credit.
It also weakens the entire supply chain and create negative indirect impacts on other participants like income disasters for families, poverty, and food insecurity.
At the meso level, price fluctuations directly affect input suppliers, financial institutions, producer organisations, traders, processors, importers, and exporters.
These participants serve as intermediaries by providing resources to facilitate the production, processing, and marketing of commodities.
They may hold net long or net short positions. Net short positions are a situation where a participant has sold (or promised to sell) a cer amount of commodity at a particular price, without an offsetting agreement in place to buy the commodity. In this case a price increase will lead to losses.
Risk exposure at this level unfolds to participants as traders and processors often buy from producers before they have a contract to sell what they have purchased.
An inability to manage the resulting price risk from their exposed long position results in fluctuating profits, potentially catastrophic losses, an inability to forecast cash flows, and difficulty obtaining credit.
The financial institutions that lend to participants face the same type of risk as their borrowers.
Borrowers who don’t generate profit will not be able to repay their loans. High risk of borrower default results in high risk of profit loss in the lending sector.
This risk is often reflected in terms of high interest rates and reductions in the availability of credit to the agriculture sector. At macro-level, price risk is mainly for governments.
Governments face a variety of indirect risks from commodity price fluctuations such as adverse impacts on trade balances, lower levels of foreign reserves, lower tax receipts, and high default levels in credit markets, budget shocks, and requests for intervention.
As a result, social, political, and economic instability can become a major issue during periods when commodity prices fluctuate to unusually high or low levels.
As Uganda experiences adverse maize grain price fluctuations this season, it is imperative that all commodity market participants understand the types of price risk faced, their effects and cautiously think through ways to address them.
The author is the country manager of ACE Audit Control & Expertise (U) Ltd
By Tumwesigye Amos
As maize farmers cry out on the further drop in prices (The New Vision February 24, 2010, page 27), it is important that all stakeholders in the maize industry understand the different types of price risk they face.
Production and marketing of primary commodities play a dominant role in most developing economies.
Commodity prices are unstable and often fluctuate from 50% below to 150%, above their average price. During the last crop season, maize prices ranged between sh550 – sh580 per kilo for unclean maize grain and sh750 – sh800 for clean maize.
This season the maize grains go for sh300 and sh460 for unclean maize and clean maize, respectively.
Recent trends towards economic liberalisation have led to the dismantling or reform of many commodity price stabilisation schemes and other policies designed to protect domestic commodity prices from fluctuating as much as world prices.
This has shifted the responsibility for commodity price risk management away from the government onto the households, firms, and cooperatives that produce, market, and consume the commodities.
Participants in the supply chain and the risk they face differ significantly by commodity type and country but generally fall into three main categories; micro, meso and macro.
At the micro level, farmers engage in producing commodities and are directly impacted by price risk.
Producers typically hold net long positions, a situation where participants have already purchased (or promised to purchase) a particular amount of the commodity at a particular price, without having an offsetting agreement to sell the commodity.
In this case a price decrease can lead to losses because the purchased commodity has to be sold at a lower price. This leads to problems in planning production, allocating resources efficiently, obtaining inputs, and obtaining credit.
It also weakens the entire supply chain and create negative indirect impacts on other participants like income disasters for families, poverty, and food insecurity.
At the meso level, price fluctuations directly affect input suppliers, financial institutions, producer organisations, traders, processors, importers, and exporters.
These participants serve as intermediaries by providing resources to facilitate the production, processing, and marketing of commodities.
They may hold net long or net short positions. Net short positions are a situation where a participant has sold (or promised to sell) a cer amount of commodity at a particular price, without an offsetting agreement in place to buy the commodity. In this case a price increase will lead to losses.
Risk exposure at this level unfolds to participants as traders and processors often buy from producers before they have a contract to sell what they have purchased.
An inability to manage the resulting price risk from their exposed long position results in fluctuating profits, potentially catastrophic losses, an inability to forecast cash flows, and difficulty obtaining credit.
The financial institutions that lend to participants face the same type of risk as their borrowers.
Borrowers who don’t generate profit will not be able to repay their loans. High risk of borrower default results in high risk of profit loss in the lending sector.
This risk is often reflected in terms of high interest rates and reductions in the availability of credit to the agriculture sector. At macro-level, price risk is mainly for governments.
Governments face a variety of indirect risks from commodity price fluctuations such as adverse impacts on trade balances, lower levels of foreign reserves, lower tax receipts, and high default levels in credit markets, budget shocks, and requests for intervention.
As a result, social, political, and economic instability can become a major issue during periods when commodity prices fluctuate to unusually high or low levels.
As Uganda experiences adverse maize grain price fluctuations this season, it is imperative that all commodity market participants understand the types of price risk faced, their effects and cautiously think through ways to address them.
The author is the country manager of ACE Audit Control & Expertise (U) Ltd