June 17, 2024

Companies Hedge Bets at a Cost to Consumers

The price swings have been eye-popping. In March, cocoa futures plummeted 12 percent in less than a minute and then quickly recovered in a “flash crash” that left traders mystified. Cotton futures have fluctuated so wildly that they flipped market circuit-breakers on about two-thirds of the trading days this year. Last November, sugar futures fell more than 20 percent over two days, their biggest two-day sell-off in at least 17 years, and they often swing more in one day than they used to move in a month.

Arcane to the layman, commodities futures are essential to many businesses, like food manufacturers and fuel suppliers, which use them to help set prices and predict costs for items as varied as corn flakes, blue jeans and mocha lattes. Farmers use them to decide which crops to plant. And they keep the wheels of industry turning smoothly by acting like insurance policies to hedge the risks inherent in buying and selling raw ingredients.

But when prices move erratically, it increases the cost of buying the futures and options that protect companies against such changes. Those added costs find their way to the grocery store and the shopping mall.

Consider home heating oil, for example. Sean Cota, a propane gas and heating oil supplier in Bellows Falls, Vt., signs contracts with customers to supply oil to them during the winter heating season.

Since Mr. Cota typically buys oil only as he needs to supply it, he uses heating oil futures and options as a form of insurance to protect himself against unexpected jumps in prices. Seven or eight years ago, he said, such protection added 2 to 6 cents to each gallon of heating oil he bought. These days, volatile oil prices mean it costs him 37 cents a gallon for such hedging — an extra cost that he expects to add to customers’ heating oil bills, which are already higher because the price of oil has risen sharply in the last year.

“It is affecting my company drastically,” said Mr. Cota, who has been lobbying in Washington for restrictions on financial flows into the commodities markets. “I pass the extra cost on to customers, but sometimes I just have to swallow it.”

Volatility can drive prices down as quickly as it pushes them up. On Thursday, prices for a wide range of commodities plunged, with the broad CRB commodities index closing down 4.9 percent.

Making the situation more confounding for businesses is that commodities have become more volatile for reasons that no one fully understands.

Much of the fluctuation is caused by economic supply and demand. Stockpiles of goods like cotton, corn and coffee are at historically low levels, setting markets on a hair trigger. Demand for many commodities is rising as developing countries like China and India become wealthier and buy ever more food and oil.

But other factors, like investor concerns about a weak dollar, oil disruptions in the Middle East and changing perceptions of the global economy, have also fed rapidly changing prices.

Hedge funds and other speculators have become an increasing force in the commodities futures market, attracted in part by a switch to computerized trading. Critics say the technological switch is altering the dynamics of the commodities markets, just as it has in the stock market, which suffered its own 600-point “flash crash” last May.

The traditional players like grain elevators or cotton merchants are being overshadowed by the new breed of financial speculators, including high-frequency traders, who use automated programs to buy and sell repeatedly at machine-gun speeds.

The exchanges, which profit from the increased trading levels, say high-frequency trading now makes up 10 to 20 percent of the futures trading in many agricultural commodities, nearly a quarter of the trading in metals and 30 percent in energy futures markets.

The roller-coaster ride is also reviving claims that commodity prices are being pushed around by the flood of billions of dollars into futures markets from so-called index funds. These funds have grown in popularity over the last decade, favored by ordinary investors as well as institutions like pension funds and university endowments, all of whom now regard commodities as financial investment assets and important protections against inflation.

A growing body of research into the last commodity price run-up, in 2008, has turned up little evidence that investment futures funds were a primary cause.

Nevertheless, many companies and traders believe that these index investment flows have significantly contributed to commodity price increases.

Whatever the cause, the result has been higher prices for consumers. “It is inevitable the consumer is going to pay more in a riskier, more volatile environment around commodities,” said Troy Alstead, the chief financial officer of Starbucks. The coffee company raised the price of some drinks in its stores last fall and announced an average 12 percent rise in the price of its bagged coffees this spring.

A spokesman for the Commodity Futures Trading Commission said that it was monitoring the markets but that volatility was an expected part of market dynamics.

However, it also has a real cost for many businesses.

In the meat industry, JBS, one of the country’s biggest meat processors, traditionally insured against price swings by buying and selling futures on the Chicago Board of Trade.

Article source: http://www.nytimes.com/2011/05/06/business/economy/06commodities.html?partner=rss&emc=rss

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