Commodities

Vincent Nwanma

Commodities are an important sector of most developing economies and revenues from exports of these commodities dominate foreign exchange earnings. In some cases, earnings from the sale of commodities dominate government revenues as well. Domestically, a majority of the workforce – in some cases, as high as 65% – is often employed in the sectors that produce these commodities.

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Thus, covering commodities is not just about price-changing factors or events – such as a change in the expected output level as a result of weather conditions – although these are critical issues in this beat. Rather, it is a way of writing about development and of the lives of people working in agriculture.

For this reason, covering commodities can be quite fascinating and if you do business journalism, it can be one of the few beats that let you write about a broad range of issues beyond the narrow issues of markets and prices. When youths in the Niger Delta in Nigeria demonstrate in a political protest, this can have an impact on crude oil production in that country. Or when the labor movement in that country protests the hike in prices of petroleum products, this too could disrupt oil production. In the same way, a commodities reporter should not ignore a peasant uprising, which has the potential of affecting crop production, depending of course on the commodities involved in a given a country or region.

Good coverage of commodities will accordingly include social, labor, political, as well as policy issues. It will also include the fiscal implications of changes in prices of commodities, as well as plans by governments to diversify their revenue bases away from these commodities. Often, a fall in the price of a commodity leads to fiscal imbalance, as governments find it difficult to match planned expenses with dwindling revenue.

The deterioration of economic conditions, including the escalation of the debt burden in developing countries that began in the 1980s, has been blamed partly on the fall in the prices of primary commodities, which are the major export items of these countries. When prices of these commodities collapsed on the international market, developing countries found it difficult to meet basic needs at home, and subsequently defaulted on their debt obligations to creditor nations.

When prices of commodities fall, the impact of this reverberates throughout the formal as well as the informal, rural economy. A fall in prices of cocoa, for instance, means that government revenue falls significantly. So does the income of cocoa farmers and workers employed on cocoa farms.

Ghana is currently number two in world cocoa production, behind her neighbor, Cote d'Ivoire. The collapse of cocoa price in the international markets from the 1970s was partly responsible for Ghana's economic downturn that lasted up to about mid-1990s, when the country began its Economic Recovery Program.

Similarly, commodities production often involves the whole family. In a typical village in Ghana, the farmer's wife and children are involved in cocoa production. The same is true of coffee in Kenya. This implies also that social events that affect members of the family could also impinge on coffee production. Once, in 1999, the prices of Kenya's coffee fell following an excess supply of the commodity on the international market. The excess supply resulted from the participation by school children, who were on a forced holiday as a result of a strike by their teachers.

Comparative Advantage

Some people have used the concept of Comparative Advantage to justify the fact that developing countries produce commodities while others produce hi-tech products. The concept says that countries should specialize in the production of those commodities where they have a relative cost advantage compared with other countries. Developing countries, these people argue, are sufficiently endowed with unskilled labor and land required for the production of commodities at comparatively low costs.

Developing countries worry, however, that if they focus on commodities, they will be stuck in a low level equilibrium trap. Comparative advantages can change over time, as countries can learn how to produce manufactured products, as East Asia so amply demonstrated. But learning to produce manufactured goods can only come by producing manufactured goods. Limiting themselves to commodity production condemns them to low-margin, less lucrative activities. All these make it difficult for commodity producers to improve their lot, as earnings from their operations remain low year after year.

Increasingly, developing countries have turned to the possibility of entering into higher value added activities related to commodities, such as food processing. In many cases, doing so would save enormously on transportation costs, and in that sense represent part of a country’s natural comparative advantage – if it can acquire the requisite skills and technology.

Why are Ghana and Cote d'Ivoire, for instance, unable to process all or a significant proportion of their cocoa beans into butter, which they can then export at higher prices? And why are Nigeria and other developing country oil producers content with exporting crude oil, instead of refined products? These are pertinent questions that a commodities reporter should strive to find answers to, in an effort to understand the problems faced by producers of these commodities.

Indeed, from the perspective of some, the current international economic arrangements are little different from those that prevailed under colonialism. Under colonialism, developing countries simply served as sources of raw materials that fed industries located in the developed countries. Farms and mines in Africa and other regions produced the commodities that kept the industrial machinery of the West running. That process continued and contributed the present wide margin between the industrialized West and poor suppliers of commodities.

Today, most developing countries are simply supplying cheap goods to the developed world. Take a look at the list of regular commodities: coffee, copper, cocoa, diamond, gold, and palm oil. These are produced by developing countries, among which are the poorest nations of the world. According to one source, Africa produces 95% of the world's diamonds; 55% of gold; 2/3 of cocoa, and about 3/5 of palm oil. Yet the African continent has the largest number of poor countries than any other region in the world.

In some cases, the problem is that much of the return from the natural resources goes to the international firms extracting the resources or marketing the commodity. Competition in some areas dominated by the advanced industrial countries (such as investment banking or aluminum) has often seemed more limited than in the commodities produced by developing countries, which means that the advanced industrial countries can extract a mark-up over their (marginal) costs of production, while the developing countries cannot. In only a few instances, notably oil, have commodity cartels attempting to restrict competition and raise prices worked.

When the World Bank urged developing countries to grow commodities as part of their development strategies of the last few decades it didn't think about what would happen if everyone else did as well. What economists call the global general equilibrium effect comes into play, so that when everyone plans to increase production, which appears so profitable at current prices, overall price falls. A single country, Vietnam, brought down the price of coffee markedly as it increased its production in the late nineties.

In some cases, the international financial institutions have indirectly pushed commodity production, lowering the prices of commodities relative to those of manufactured goods. Education programs focusing on primary education, for instance, may do this. Even more so, tax policies (such as the V.A.T.) which discourage the formal sector at the expense of the informal sector. (While the V.A.T. in principle taxes everyone equally, in practice in most developing countries, it is only collected from the formal sector.)

Commodity producers have long suffered from price instability – and sometimes there behavior contributes to it. High prices elicit large increases in supply, which in turn leads to a burst in the price, and this in turn leads to a contraction in the domestic economy. The government spends the next year or two blaming the collapse of prices for its failure to do some of the things it had planned to achieve (and many of the failures may genuinely have been caused by the collapse of commodity prices.).

Many African countries have suffered from this phenomenon. From the oil price shocks of 1973-74 and 1978-79, to the boom for cocoa and coffee exporting countries in 1976-77, commodity price increases resulted in increases in government revenue and this in turn led to growth in government spending. Foreign investors, seeing the strength of government revenues, willingly lent the government more money, so that spending outstripped revenues. However, given the fluctuations in these prices, African governments subsequently experienced declines in finances and hence ability to maintain the expenditure levels and projects already begun by the state. The fixed debt burdens made matters even worse.

The impact of such reverses in government’s finances is often worsened by the effect of overvalued currency. When commodity prices are strong, the currency strengthens. While the strong currency impedes the growth of the export sector, it actually encourages importation of goods. This phenomenon contributed significantly to the recurring balance of payments problems experienced by many developing countries in the 1970s and 1980s.

Long-term decline in commodity prices

There is another important aspect of dependence on commodity exports. In the long term there has been a decline in commodity prices that was emphasized by the great Latin American economist Raoul Prebisch, and formed part of the argument for import substitution – moving into manufactured goods – that dominated Latin American development strategies in the 50s, 60s, and 70s. The countries that have been most successful in development have moved out of a dependence on commodity exports into manufacturing (though there are a few developed countries that are relatively dependent on commodities). In the short term, however, after commodity prices hit around a 50-year low towards the end of 2001, they began a strong rise over the next several years, driven primarily by strong demand from China, stalling only when the global financial crisis really began to bite in the middle of 2008.

To avoid the instability and the risk of a particularly large, long-lived decline in a specific commodity, countries are increasingly recognizing that they must diversify. Many Asian countries have been successful in this strategy. They have diversified their export bases, despite the comparative advantage they had on some commodities. The reporter should follow governments’ programs or initiatives aimed at achieving this. Why, for instance, was Malaysia able to diversify out of dependence on rubber at independence, but Ghana failed to diversify out of dependence on cocoa?

Unequal International Relations

Most countries that produce commodities are often too weak to influence the level of output – to raise or cut output – or the price at which they sell their products, or even to impose standards. For instance, milk producers in Europe have succeeded in reserving the term ice cream for products made with cream. But the developing countries cannot do the same. In the case of cocoa, producers have had to battle the decision by major consuming nations to use cocoa substitutes for the manufacture of chocolate.

The use of such artificial additives reduces the amount of cocoa butter that chocolate manufacturers buy from the producers. This impacts negatively on the income of producing countries, and has been partly responsible for the fall in the price of cocoa. Members of Cocoa Producers Alliance (COPAL) have for long resisted this scheme by cocoa consuming nations.

“Exploiters” Vs “Owners”

While the production of many commodities is labor-intensive, generating employment for a high percentage of the workforce in developing countries, this is not true for some commodities, especially mining, gas, and oil, which today are highly capital-intensive.

This explains the fact that after more than 40 years of oil exploration in Nigeria, most Nigerians are still operating at the fringes of the industry that accounts for over 90 percent of the country's foreign exchange earnings and about 80 percent of government's total revenue. The industry thus remains in the hands of multinational oil companies, most of them having their headquarters in Europe and North America.

Some estimates by the government put the level of local content of the industry as low as five percent, especially in the deep offshore region that requires highly sophisticated engineering technology.

Meanwhile, Niger Delta, home of Nigeria's oil and gas resources, remains one of the poorest regions in the country, despite several years of crude oil exploitation and production. From destruction of farmlands to pollution of rivers, and forced relocation of homelands, the oil industry has impacted negatively on the daily lives of ordinary people in the region.

Therefore, covering the oil and gas industry in Nigeria is not just simply about reporting on Nigeria's total output as determined by OPEC quota. It is not simply about writing on oil block bidding rounds and the millions of dollars offered by the companies. Nor is it only about the huge crude oil discoveries being made by the companies in the new frontiers – the deep/ultra deep offshore region. Much more than these, reporting on this sector challenges the reporter to probe into the activities of oil companies who daily suck millions of dollars out of the ground and beneath the water, and juxtaposing these with the degree of their responsiveness to their host communities.

Balanced coverage of the economic impact of these extractive industries thus requires an examination of the revenues accruing to the government, the jobs that are created by the expenditure of those revenues as well as within the extractive industries, and the jobs that are lost as a result of the increase in the exchange rate (referred to as the Dutch disease problem, after the Netherlands, where it was closely studied after the discovery of North Sea gas).

When in July 2002 about 2,000 Ijaw women invaded and occupied the facilities of an oil company in Nigeria, what were the women's complaints? What pushed the women, young and aged, some carrying their suckling children, to occupy oil export terminals and sack workers at flow stations? And why did the Ugborodo community decide to fight through the women, instead of men and young men, who had traditionally done such agitations for them in the past? These are some pertinent questions to which a reporter in this case should be interested in finding answers.

In the Ugborodo community’s case, for instance, the women protested alleged neglect of the community by the company since it started operations in the area. They had suffered because the oil development had led to the pollution of their water and destroyed their farmlands. They demanded provision of employment by the company to citizens of the community, in addition to other amenities, such as potable water, electricity, roads, etc.

The invasion of oil facilities by the women was a new strategy adopted by oil-producing communities in their efforts to wrest compensation or other forms of benefits from oil companies. Previously, young men of the communities led such protests, but security forces, usually sent by the government to quell those protests, stopped them, usually with force. The community reasoned that the security forces would be lenient with the women.

The strategy worked. Although the government sent in soldiers to affected oil facilities, the soldiers refrained from harming or manhandling the women, who occupied the facilities for 10 days. The siege ended only after the company had signed an agreement with the community, committing itself to the enhancement of the quality of life in the Ugborodo communities through regular offers of jobs to the people, and establishment of income- and wealth-generating schemes. The company also promised to help the communities through the provision of vital infrastructure such as school blocks, town halls, electricity and potable water.

Wars over gems

Commodities have become unwilling tools in the hands of prosecutors of wars in several countries today. From Angola through the Democratic Republic of Congo, to Sierra Leone, and Liberia, diamonds, and other precious metals to a lesser extent, have played significant roles in the sustenance of the wars.

While these commodities are usually not the reasons for the wars, warlords and their supporters have found in them convenient means of earning resources to continue the wars, sometimes against world opinion and opposition. To circumvent international financial and weapons sanctions, such military leaders target mineral-rich regions in their countries for occupation. This enables them to mine these resources illegally, which they subsequently export, even against procedures designed to prevent profiting from these illegal activities.

This has given rise to the concept of “Conflict” or “Dirty” Diamonds. Revenues earned from their exports are used to acquire arms and ammunitions that are in turn used in further prosecution of the wars, many of which have been extremely costly in terms of human lives. The presence of diamonds in Africa has helped to fuel conflicts, which perhaps could not have lasted as long, if the parties to the war had had no access to such minerals.

Commodities and Corruption

Unfortunately, not all of the revenue from the sale of commodities (especially gas, oil, and mineral resources) goes to provide public services or the promotion of development. Some of it goes into corruption – to the officials in the state-owned enterprises, or to those in the government itself.

Nigeria has earned several billions of dollars from exports of crude oil, especially since the early 1970s. (Over a period of 25 years beginning from the early 1970s, the World Bank says that Nigeria earned over $200 billion from the exploitation of oil resources.) Despite this, poverty is widespread--with about 70 percent of the population now living below the poverty line-defined as people living on less than one US dollars a day. Much (some claim most) of the money earned from oil and gas has gone to government officials, including military officers who ruled the country for most of the years since it gained independence in 1960. Thus, despite the enormous wealth flowing from oil revenue, the country today is poorer in many ways than it was a quarter century ago. A return to civilian rule through elections has not changed this, nor has the dramatic rise in oil prices over the past five years, while civil unrest in the oil producing regions has continued.

Covering commodities entails scooping out the sources and magnitudes of corruption, and ascertaining what the country is doing about it. By its nature, corruption is designed to be hard to detect; but in the area of commodities, its presence can often be detected indirectly. What price is the government receiving for the oil or gas that it is selling, and how does it compare with international standards? Sometimes, the problem lies as much with the multinationals, who are attempting to cheat, than with the government. For instance, Alaska noted that the amounts that the oil companies were claiming as their “net receipts” from the disposition of Alaskan oil was less than it should be; it required hard detective work – a few pennies a barrel can add up to billions of dollars; Alaska succeeded in forcing the oil companies to repay a substantial sum, in excess of a billion dollars.

There are other “tell tale signs” of potential corruption: Was there, for instance, an open process of bidding? How many bids were submitted? Recently, there has been a major initiative to induce foreign companies to “publish what they pay,” to disclose what checks they are sending to the government. If the government does not encourage such initiatives, and even more if there is active resistance, there are grounds for suspicion.

Marketing

The extractive industries are, however, not the only source of problem. Many countries established government-run commodity-marketing boards, to purchase commodities from farmers and sell them, either domestically or abroad. Some of these boards are inefficient, some are corrupt; the result is that there is a large disparity between the price paid by consumers and the price received by the farmer. Many countries have, accordingly, eliminated these marketing boards, especially under pressure from the international economic organizations. But matters have not necessarily improved for the farmers. While the hope was that a competitive marketing system would develop, in too many cases the government monopoly has been replaced by a monopoly, sometimes as a result of limitations in capital (only a few can afford the cost of buying a truck, and there is no rental market), sometimes as a result of mafia-like activities.

Market boards for marketing often do not work well. Relations between producers and those responsible for marketing their produce have often been tense, even in more developed countries. In the United States, many commodities are marketed through cooperatives but these are less lucrative ones such as cranberries, oranges, raisins, almonds.

The issue of marketing has become extremely contentious in many countries, with the international economic institutions pushing for privatization, and those that have not already privatized citing the myriad of problems that have arisen in those that have. Covering these disputes requires ascertaining why in the case of this particular country do the advocates of privatization believe it will work well; what attributes does it have of the “success cases.” Similarly, are the critics simply motivated by the loss of income, or are there genuine concerns? What attributes does the country have of those countries where privatization has not lived up to its promise?

In those countries where privatization has occurred, but a competitive marketing system has not developed, it is important to ask, why? And what is the government planning to do about it?

Specific Issues to Consider in Covering Commodities

In covering commodities, it is important to focus on three key elements: government policies, the underlying forces of demand and supply, and market structure.

Government Policies

Most African countries are exporters of commodities, which in most cases form the bulk of state revenue. As a result, governments have evolved policies to regulate the commodities markets. Even with the advent of deregulation and market reforms, there is still an on-going debate within many African countries as to the extent to which they should liberalize their commodities markets.

In Ghana, for instance, cocoa is the leading foreign exchange earner. In the period from independence in 1957 to about 1962, Ghana was the world- leading producer of cocoa. For most of the period and even after that, government has been the dominant player in the cocoa business, acting through the Cocoa Marketing Board, COCOBOD.

Through COCOBOD, government controls the industry via policy measures (such as specifying the marketing channels for cocoa beans, and prescription of acceptable farming practices), as well as fiscal controls. However, from the late 1990s, the government began to liberalize the cocoa industry, with the licensing of privately owned produce buying companies. This was partly in response to the prodding by international agencies, including the World Bank. This introduced some level of competition in the marketing of cocoa produce in Ghana.

In Nigeria, the government has been in partnership with multinational oil companies for the exploration and production of crude oil. Under the arrangement, the government holds an average of 57 percent in the joint venture projects, and the partners contribute to the projects in proportion to their shareholding. These joint ventures account for about 98 percent of Nigeria’s crude oil production, the remaining being produced by local entrepreneurs.

While this arrangement has worked for most operations onshore, the government has introduced another form of funding, known as the Production Sharing Contract (PSC). Under a PSC, the oil company funds the entire project, and recoups its investment from the crude oil, which it shares with the government on a pre-determined ratio. Government is applying this funding arrangement to the development of oil fields in the deep offshore region, where costs are getting higher.

Depending on the commodity produced in the country, there are accordingly a wide range of government policies that the government might have. Among the pertinent questions to ask are: What has informed such policies? Are there any pressures on the government to effect changes? What are the sources of these pressures, and what motivates them? How have such reforms worked elsewhere? Why, for instance, did Nigeria choose its particular form of arrangements with the multinationals, rather than a straight bonus bid, or a straight royalty bid? Has it generated as much revenue? As stable a revenue flow as alternative arrangements might have?

The Supply And Demand Conditions of the Market

Commodities markets react to various supply and demand conditions prevalent at a particular point in time. Besides spot market situations, the markets also react to the conditions expected to prevail in the markets at some future time. Therefore, it is important for the reporter to know what the situation of a given market is now, and what it will likely be in, say three months' time. In each market, there are specific factors affecting demand and supply, and specific sources from which one can learn about what market participants think what is happening now, and in the future.

Good coverage, however, may entail going beyond the Internet sources. In covering commodities with known cycles or seasons, such as cocoa, it may be a good idea for the journalist to talk to producers (farmers, in the case of cocoa) and other operators in the market, such as officials at COCOBOD in Ghana, for their expectations for the seasons.

Cocoa

It may be necessary to visit some cocoa farms to see the state of the cocoa trees and the amount of pods on them. Farmers have a way of telling the expected level of output from the number of pods on the cocoa trees by a certain time of the year or month.

The reporter should ask practical questions to the farmers. What are their expectations? What factors have influenced such expectations – pests, late or early rainfall, availability of essential inputs, such as insecticides and other chemicals?

In Ghana, for instance, the main crop season begins around late September/early October. Therefore, the best time for such a visit to the cocoa producing regions could be June/July. By this time the farmers would have formed their expectations of the coming season. They would have looked at different factors that could affect output in the coming season.

Farmers have specific times/months of the year during which they have to spray their farms against insect attacks, according to COCOBOD. Officials of COCOBOD say failure by farmers to adhere to this timetable may affect the effectiveness of the chemicals against the black pod disease and other attacks. Therefore, a reporter should be interested, not just in whether the farmers did spray their farms, but whether they did so at the appropriate time specified by the board. If not, why not?

Mining

In mining, such as gold mining, the time horizon is markedly different from that of agricultural commodities like cocoa. Gold mining is quite capital-intensive, and every stage involved in employing capital is a potential factor in the supply process.

The actual mining is part of a long process that begins with the award of prospecting licenses at a concession or block. During the prospecting stage, the mining company assesses, through a chemical process called assay, the quality of the ore on its concession.

Through this process, it determines whether or not the amount of gold, say per kg of ore on the concession, is sufficient to warrant committing men and materials to the actual mining process. In other words, the company decides whether the quantity of gold in its concession is in a commercial quantity that can be mined profitably.

Even at this stage, the reporter should note the supply story here. What is the prospect of the company finding enough gold ore in the concession? What does the assay result say – negative or positive? From recent events, though, the authenticity of such a result must be taken with good caution. (The company may worry about the impact of any public statement on its share value.)

Normally, the result would also indicate the ore type on the concession. Is it oxide or sulphide ore? The difference affects the process that will be employed in the mining process. Miners say that the molecules in the sulphide ore are tightly bonded, and therefore hold the gold particles much more tightly than in oxide ore, which has a looser bonding.

This affects the type of ore treatment plant(s) that the company will install, for instance. The outcome of this stage is a potential commodity story, since, either way, it will impact on the supply situation in the market. At Ashanti Goldfields Company’s mine in Obuasi near Kumasi in Ghana, for instance, the company has both sulphide and oxide treatment plants, for the treatment of the different ore types.

Mining contracts are also important commodity stories. The reporter should find out whether the mining company will undertake the actual mining by itself, or will contract it out to another party. If so, he should find out who the mining contractors are. Where are they from? What is their background, and what jobs have they executed previously? These will give the reporter some background information on the mining contractors, and probably explain the company’s choice of the contractors.

The time that the mining contractors begin to mobilise their equipment on site is also a good story. The amount of equipment needed may be affected by a number of factors, including the depth of sand to be scrapped before getting to the acceptable ore quality, especially in surface mining.

The reporters should find out about the amount of earth that will be scrapped, and as well, where that material will be taken to – it could be used to refill an existing pit, say an old or abandoned mine, etc.

Because a mine is a long-term investment, those undertaking the development of a mine must form expectations concerning future prices. It is important to know what those expectations are (and how they change over time), and how sensitive profits are to those expectations. Will a drop of 20% in the price lead to the abandonment of the mine? Is the concession being bought as, in effect, an option, only to be developed if the price increases enough? Is there a contract provision that inhibits such speculative behavior, e.g. requiring the forfeiture of a large deposit?

By the same token, it is important to know how the mining company handles its price risk, and how strong its financial position. Is there a serious risk of bankruptcy, interrupting the development of the mine?

Market Structure

Market conditions reflect the actions (and sometimes, inaction) of the players – the chain of actors that runs from the producers, through the middlemen and brokers or buyers to the final consumers. These actors play different roles in markets or industries, depending on the fundamental structure of the market concerned.

A market structure can give leverage to some companies over others. In the extreme case of a monopoly, the firm has power over the level of output and the price at which it sells its product.

At the other extreme of perfect competition, there is no one firm that has market power; there are a myriad of relatively small firms. Between these two extremes lies the real world where firms operate – there is usually some competition, but far from perfect competition. Thus the reporter should be able to understand the market structure, how it is changing, and how various proposed policy reforms would affect the different participants in the market. A major issue that should be of interest to the reporter is the source of market power. What factors confer market power on some firms (or countries, as the case may be)? How can a firm sustain its dominant power over a period of time in the industry?

Answers to these and similar questions will help the reporter understand the activities of the firms he is covering – and hence the course of events in the industry or sector.

Tips for Covering Commodities:

  • Read as much as possible about the industry you cover, to get a good knowledge of its operations.
  • Know the operators – producers, intermediaries, and final consumers, and how these interact in the industry.
  • For commodities with known cycles, be conversant with such cycles, and know what to expect in each period.
  • Commodities are full of breaking news. Follow the news as it breaks and get a long-term picture of where the industry is headed.
  • Occasionally visit the operational bases – farms in the case of cocoa coffee, etc; and mines and oil platforms.
  • Know the stakeholders of the industry you cover. These include all the people whose lives are affected in any way by the operations of the industry.
  • Have good contacts among analysts who specialize in the industry you cover. These may be employees of banks, consultancies, etc.
  • Be good at simple calculations, since you would need these frequently.
  • Be conversant with national and international regulations that affect the industry.
  • Have a good knowledge of the demand and supply factors in the industry. Changes in these are often at the center of most disputes in commodity markets.

Publication Information

Type Backgrounder
Program Journalism Backgrounders
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