Commodity Market Outlook: Commodity Market Outlook: Sources of Price VolatilitySources of Price Volatility

((Impacts of Price VolatilityImpacts of Price Volatility))

T. Randall FortenberyProfessor

School of Economic SciencesWashington State University

Volatility PerceptionsVolatility Perceptions

Biofuel production has driven up commodity prices, and increased

commodity price volatility.

BackgroundBackground

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Avg. Daily Ethanol Production vs Monthly Corn Price

Avg. Daily Ethanol Produciton

Preliminary data compiled by D. Zaks at the Center for Sustainability and the Global Environment (SAGE), University of Wisconsin, May, 2008.  Funded by NASA Earth Science Program.  Do not distribute without explicit permission.  For more information, please contact:  jfoley@wisc.edu.

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Global Distribution of Grains and Pulses to Food, Feed and Ethanol

Preliminary data compiled by D. Zaks at the Center for Sustainability and the Global Environment (SAGE), University of Wisconsin, May, 2008.  Funded by NASA Earth Science Program.  Do not distribute without explicit permission.  For more information, please contact:  jfoley@wisc.edu.

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Global Distribution of Oilseeds to Food, Feed and Biodiesel

Actual Corn Price Compared to Price Actual Corn Price Compared to Price

Expected from Supply/Demand SystemExpected from Supply/Demand System

Actual Corn Price Compared to Actual Corn Price Compared to

Price Expected from Price Expected from

Supply/Demand SystemSupply/Demand System

Biodiesel Yield from Vegetable Oils

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Is it Really Food vs. Is it Really Food vs. Fuel?Fuel?

Volatility PerceptionsVolatility Perceptions

Speculative activity in the derivative (especially futures) markets has resulted in

increased price volatility and inefficient price discovery.

Empirical EvidenceEmpirical Evidence• Work by the CFTC looking at 2008 oil prices

suggested that speculators were not the cause of either price levels or price volatility

• Similar results were found by Irwin et. al looking at soybean markets.

Volatility PerceptionsVolatility Perceptions

International economic events have become more important than basic market

fundamentals in determining price levels and volatility.

Malaysia's Land Development Authority FELDA has announced plans to immediately establish 100,000 hectares (250,000) of oil palm plantations in the Brazilian Amazon.

The agency will partner with Braspalma, a local company, to form Felda Global Ventures Brazil Sdn Bhd. FELDA will have a 70 percent stake in the venture.

"As a start, 20,000ha in Tefe will be opened for oil palm planting. After that, between 3,000ha and 5,000ha will be opened yearly," said Deputy Prime Minister Datuk Seri Najib Razak. "Felda wants to emulate Petronas as a global player," he added, referring to Malaysia's national oil company.

Amazon palm oil: Palm oil industry moves Amazon palm oil: Palm oil industry moves into the Amazon rainforestinto the Amazon rainforest

Rhett Butler, mongabay.comRhett Butler, mongabay.comJuly 9, 2008July 9, 2008

Oil palm plantations and heavily logged forest near Lahad Datu, Malaysia. Photo by Rhett A. Butler

Malaysia, Indonesia to curtail palm oil production due to low prices(11/8/2008) Malaysia and Indonesia C countries that account for more than 85 percent of global palm oil production — will cut production in an effort to shore up collapsing palm oil prices, reports The Jakarta Post. The decline in palm oil prices is expected to slow expansion of oil palm plantations in Indonesia and Malaysia, a development that will please environmentalists who blame the palm oil industry for large-scale destruction of rainforests across Southeast Asia.

November 11, 2008November 11, 2008Monogabay.comMonogabay.com

Fundamentals Still Fundamentals Still MatterMatter

• Land Use

• Asian Demand

• Alternatives Uses

Contract ExpirationsContract Expirations• Sept. 30 2009 2.8 million acres

o Tx 561K, Colo 409K, Ks 331K, NDak 192,o SDak 184K, MT 138K

• Sept. 30, 2010 4.5 million acres

• Sept. 30 2011 4.4 million acres

• Sept. 30 2012 6.5 million acres

CRP OBJECTIVESCRP OBJECTIVES• Upland Bird Habitat 250,000 acres• Bottomland hardwood trees 500,000 acres• Non-flood plain wetlands 250,000 acres• Flood plain wetlands 500,000 acres• Longleaf pine plantings 250,000 acres• Prairie pot hole duck habitat 100,000 acres• State acres for wildlife 500,000 acres

OUTLOOKOUTLOOK• We have likely entered a sustained period

of higher average prices, coupled with increased volatility. Sources of volatility vary, and policy strategies to “control” volatility are at risk of causing, not solving, concerns related to market risk.

• Tensions between various use categories will result in considerable political pressure to manage who can and cannot engage in trade, especially in derivative and forward markets.

ConclusionsConclusionsWe have likely entered a new pricing regime relative to basic commodity prices.

Both price levels and price volatility will continue to exceed levels experienced through 20006/07.

We will likely see several proposed “solutions” to commodity price activity initiated through political institutions. This will be a global phenomenon, and many of the proposals will be short-sighted and off target.

Much of the political motivation for “managing” markets makes overly simplistic assumptions relative to causality.

Creative risk management becomes important

THANK YOUTHANK YOU