Commodity prices and commodity agreements

The market for commodities is particularly susceptible to sudden changes in conditions of supply conditions, called supply shocks. Shocks such as bad weather, disease, and natural disasters are largely unpredictable, and cause commodity markets to become highly volatile. In comparison, markets for the final products derived from these commodities are much more stable.

As with petrol pump prices, the prices of finished goods rarely reflect changes in the prices of basic commodities from which they are derived. For example, cocoa and sugar prices fluctuate considerably as harvests vary from year to year, but the prices of confectionery rarely change from year to year. There are many reasons for this, including the following:

1. The cost of the commodity input, such as cocoa, represents a small proportion of total costs of the final product, such as a bar of chocolate. The price of chocolate is largely determined by the refining, manufacturing, and packaging costs of the manufacturer, and the retailer’s costs including labour, rents and marketing costs.

2. Indirect taxes, like VAT, often form a larger proportion of the price than commodity costs, and such indirect taxes tend to remain stable of time.

3. The existence of stocks of commodities act as a buffer against sudden changes in commodity prices, so manufacturers will be using old stocks purchased at the old prices.

4. Futures contracts help reduce some of the underlying volatility in commodity markets. In the case of cocoa, the large confectioners, such as Nestle and Cadbury-Schweppes, agree cocoa prices in advance by fixing contracts with suppliers, such as those based in the Ivory Coast and Ghana, the two largest cocoa exporters.

5. Manufacturers and retailers may choose not to pass on cost changes following commodity price changes for a number of reasons, such as a preference for stable prices, or the need to remain price competitive.

Commodity agreements are arrangements between producing and consuming countries to stabilise markets and raise average prices. Such agreements are common in many markets, including the market for coffee, tea, and sugar.

Example - The International Cocoa Agreement

In 2003, an agreement was made between the seven main cocoa exporting countries, Cameroon, Ivory Coast, Gabon, Ghana, Malaysia, Nigeria and Togo, and the main importing countries including the EU members, Russia, and Switzerland. The main purpose of this agreement was to promote the consumption and production of cocoa on a global basis as well as stabilise cocoa prices, which had been falling steadily. The agreement was planned to continue until 2010.

Commodity agreements often involve intervention schemes, such as buffer stocks, and usually only last for a few years, whereupon they are re-negotiated. They differ from cartels such as OPEC, largely because discussions and negotiations involve both producer and consumer countries, unlike cartels, which are established to protect the interest of producers only.