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Adapting to an uncertain future

By By Gail Stevens | Published:  28 December, 2009

Commodity producers hit by volatile prices are looking for effective hedging tools to mitigate the risks.

The unprecedented volatility in commodity prices over the past 12 months and the uncertain future of global demand has placed a number of African commodity producers under increased pressure to search for effective hedging tools.

Commodity prices plummeted in the last quarter of 2008, following the demise of Lehman Brothers, leaving a number of producers grappling with reduced prices. The producers were further impacted by contracting global demand – with major economies such as China slicing commodity imports, as the global gloom of recession spread from developed to emerging markets. Prices have however rebounded this year, with the Dow Jones UBS Index up 15 percent year-to-November, lifted by a 64 percent rise in metals. However, markets are set to continue to be volatile, and global markets continue to suffer shocks – such as Dubai’s proposal to renegotiate its $59 billion bond debt – which puts pressure on commodity prices.

In addition to price volatility, African producers also have to grapple with investors questioning the commodity contagion story. Debate is raging over whether commodities are on a path to a long term upward price trend, supported by rising demand in Asia, or whether the most recent slump in prices was a conclusion of another boom and bust cycle. The latter would mean the markets are set for a period of stable prices ahead, which would deter investors looking to set up long positions in commodities.

With such an uncertain future, Africa’s producers and investors have been seeking further hedging tools to ensure they are not caught out. Requests for increased hedging tools drove the Johannesburg Stock Exchange to expand its commodities futures offering in September to list Rand-denominated futures referencing Chicago Mercantile Exchange platinum, gold and crude oil futures. This is to enable the local market to trade cash-settled Rand-denominated contracts tracking global market prices, as opposed to just local prices.

“We introduced the new products at the request of the market,” says Chris Sturgess, JSE’s general manager of commodity derivatives. “The majority of the volume traded is done by South Africans and we also see participation from other Southern African countries.” The JSE, which saw commodities derivatives trading rise 54 percent for the year up to July, also saw increased interest in agricultural derivatives products – including maize, wheat, sunflower and soya beans. The maize contract has been the most actively traded of all agricultural trades this year, making up about 54 percent of contracts. Over 2.2 million agricultural derivatives contracts – futures and options – were traded on the JSE for the year up to October 2009.

“The client base trading commodity derivatives are farmers, millers, end users, co-operatives, banks, traders and also speculators,” notes Mr Sturgess.

Over-the-counter derivatives – privately negotiated non-exchange traded agreements – have also seen increased demand, and the International Swaps and Derivatives Association has been requested to set up legal frameworks in new African jurisdictions. Isda is a global derivatives industry body designed to reduce risks in private derivative contracts. According to a London-based senior official at Isda, the larger proportion of the requests has been commodity driven – with Nigeria, Ghana, Zambia, Uganda and Kenya getting the most mentions. “It is very interesting to see which countries are on the agenda,” he says “Our involvement comes from member involvement. They tell us which jurisdictions are becoming more important and we go in to liaise with the local authorities to get the legal framework set up.”

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