EU wants to tame ‘financialisation’ of commodity markets

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This article is part of our special report Raw Materials.

Speculation on commodity markets and excessive concentration in the mining industry is hampering companies' access to resources at competitive prices, in turn affecting economic growth and prompting EU policymakers into action.

While global metal and mineral markets generally follow a cyclical pattern based on supply and demand, the 2002-2008 period was marked by unforeseen high prices triggered by soaring demand in emerging countries, according to the European Commission.

Currently, worldwide consumption is picking up after a slowdown due to the economic and financial crises, and is forecast to grow steadily in the coming years, due to continued strong demand from economies such China and India.

Price volatility

However, in recent years, commodity markets have experienced increased volatility and unprecedented price movements that cannot always be linked to changes in supply and demand.

This trend can be perceived in all major commodities, including energy, metal, mineral, agriculture and food markets. And there is a growing consensus that excessive speculation on commodity derivative markets plays a major role in spurring volatility.

In February, the European Commission proposed to tackle the challenges in commodity and raw materials markets, also pointing to that argument.

"It is clear that price movements across different markets have become more closely related, and that commodity markets have become more closely linked to financial markets," the EU executive noted.

"In order to secure supplies of raw materials for European industry for the coming years, we need to link this policy with our reforms of the regulatory framework for financial markets," said Commission President José Manuel Barroso, stressing the need for better understanding of synergies between the two.

'Financialisation' of commodities markets

Sujiro Seam, deputy director for food security and economic development at the French Foreign Ministry, said keeping an eye on price volatility is important because the existing tensions between supply and demand will only increase in the long term as supply will be crunched by increasing demand.

Seam added that commodity markets have seen a tendency towards greater "financialisation," with investment bankers developing commodity-led products, adding to volatility.

In some cases such volatility means "disconnection between price evolution and fundamental elements of the markets," the expert added, explaining that actual production, consumption or stocks of commodities no longer determine the prices.

Much international attention has focused on agricultural commodities and on how volatility of food prices affects producers, consumers and security of supply. But parallels can be drawn with trade in raw materials, as "financial markets don't make any distinction between the different commodities, be they agricultural, energy or mineral," said Seam.

Therefore, any action taken to improve transparency of financial markets will indirectly help mineral markets as well, stressed Seam.

The European Commission's plans to curb speculation on commodities include forcing traders to disclose their positions and imposing so-called "position limits" to stop mega-trades that could upset markets.

The EU executive also plans to review the bloc's legislation on market abuse and on markets in financial instruments to improve the integrity, transparency and stability of commodity derivatives markets.

Iron, steel moving to quarterly trades

Downstream industries in the manufacturing sector – the steel and car industries in particular – have voiced concerns over fair access to raw materials at affordable prices.

Rising raw material prices are reducing profit margins in the manufacturing industry, carrying a threat of factory closures, lay-offs and the relocation of industry to cheaper regions.

European steel and engineering industries, represented by Eurofer and Orgalime, for example, have called on EU governments and authorities to tackle competition distortions in raw materials markets and "to prevent speculation on raw materials in order to support the long term future of the industrial value chain in Europe".

They are particularly worried about the high degree of market concentration in the seaborne iron ore market, with just three companies (Vale, BHP Billiton and Rio Tinto) controlling almost three quarters of the global market, which has given them a significant pricing power.

Robrecht Himpe, CEO of ArcelorMittal Flat Carbon Europe, explained that over the past 20-30 years prices of iron ore have been very low – around $40 dollars a tonne – as supply was greater than demand, materials suppliers were scattered and deals were based on yearly contracts.

This was the case for decades until 2004, when China's ramping up of steel production created for the first time an imbalance between supply and demand, and prices started to rise. In parallel, consolidation took place between global iron ore exporters Vale, BHP Billiton and Rio Tinto.

At the beginning of 2010 the 'big three' moved from the traditional long-term yearly contract pricing to a quarterly sales system for raw materials in an effort to move closer to higher spot market prices. This revolutionary move saw iron ore prices in the first quarter of 2011 rise to $130 per tonne from $70 in the first quarter of 2010, Himpe said, adding that current spot prices between India and China are at $190.

According to Eurofer, the move to quarterly pricing has significantly increased the price volatility of raw materials.

European steel and engineering industries stress that iron ore is "the basis for the EU's most important value chain" and if unjustifiable pricing jeopardises steel production in Europe, "severe consequences for the whole value chain" should be expected, with millions of jobs affected in different sectors.

In order to bring in price stability and to give markets a known price for a six-month period, iron ore futures markets are currently being developed by banks. But some argue that the markets are not mature enough to have futures markets on iron ore yet.

EU industry ministers meeting

EU industry ministers will meet next week to debate the Commission's raw materials strategy, including aspects related to financial markets.

"The conclusions are very good," said a diplomat from one of the big EU member states, saying the draft text recognises "the link between price volatility and the development of financial market" and in particular "the derivatives market".

"The Council now clearly says that the transparency and integrity of those markets needs to be improved," the diplomat said, adding this was "something that had not been said until now".

"And this axis is the priority of the French Presidency of the G20," the diplomat added with satisfaction.

In November 2008, the European Commission presented a new integrated strategy for raw materials, suggesting three pillars for the EU's policy response to global resource scarcity:

An updated version of the 2008 plan was presented in February this year, with raw materials issues elevated to become a full part of the bloc's free trade agreements.

Commodity markets were included in the plan at the last minute, after France insisted on highlighting the link between speculation and the rise in commodity prices.

  • 9-10 March 2011: EU Competitiveness Council to address raw materials and commodity markets.

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