Procurement Intelligence Unit

The commodity prices we see and pay are not a true reflection of supply and demand.

The volatility we see is not only inconvenient and risky, it also obscures the true state of the underlying market.

Without a thorough understanding of the market we are not in a position to secure supply. The fact is, in the next twenty years we are going to run out of many of the materials required to produce the products we consider essential. Meanwhile, we are being distracted by price volatility.

The price of the commodity most critical to the world economy, oil, is influenced by politics as much as by actual demand and true supply capacity. OPEC is in a position to manipulate the supply of oil at will, and governments use oil embargoes to exert political pressure. Luckily, oil consumption changes relatively slowly, and can be tracked physically. Supply can also be tracked relatively easily. We know the total global production capacity, and we know when new capacity is commissioned or decommissioned.

We can look at long-term moving average prices, and get a pretty good understanding of the effect that changes in supply and demand are having on prices. We have grown to expect periods of high oil price, and have developed tools to help us avoid being burnt during these peaks. We are also very aware of the fact that oil supply will not last forever, and have invested in alternatives, although we have some way to go.

Things can be a lot more challenging with other commodities, for example the unusual metals that go into our electronics. Demand is often difficult to predict, as a new technology dependent on the ingredient in question could take off at any time, and supply can be controlled by a single organisation or government. Worse still, it has been shown that even when traders do have good information to hand, these facts tend not to be reflected in market prices. Nathan Fleming at MIT has written a paper ("Metal Price Volatility: A Study of Informative Metrics and the Volatility Mitigating Effects of Recycling") that discusses volatility in metal prices, and the fact that they do not tend to reflect the market situation.

Indium is a relatively rare transition metal that has been used in manufacturing in small quantities for a century. Demand has grown rapidly recently as it is used to manufacture solar cells and transparent electrodes, a critical feature of touch screen displays. In the last decade, prices have gone from US$50 a kilo to over US$1000 a kilo, and in late 2011, they fell back to US$600. These fluctuations somehow detract from the fact that this is a metal that is hard to substitute, in high demand and finite. In fact, we will run out of indium completely by 2029, or sooner if demand continues to rise.

One thing we can learn from volatility is what people are willing to pay. We know that when oil prices cause petrol prices to spike, motorists absorb this cost while only moderating their consumption slightly.

I believe wild variations in commodity prices have distracted us from the inescapable fact that the underlying price trend for many commodities is moving steeply upwards. These rises will continue and accelerate, as they are due to genuinely increasing demand and the fact that these resources are finite. These rises cannot be avoided by hedging, and ultimately we will have to either pay more than our competitors for these materials, or find an alternative.

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