Evolution of commodity price benchmarks

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3 Evolution of commodity price benchmarks The first price benchmarking mechanism was the London Tea Auction, the longest running organized commodity market it traded tea from 1679 to Competitive price benchmarking, as it is known today began during the mid- to late- 1800s in two parallel tracks: o o In North America, where Chicago became the trade hub for various grains produced in the midwestern region of the United States. On the two sides of the Atlantic where the global cotton market emerged with various trading hubs, including Alexandria, Liverpool, New York, and New Orleans. Commodity Futures Exchanges, led by the Chicago Board of Trade and several Cotton Futures Exchanges, flourished in the late 19 th and early 20 th centuries. They all suffered from depression-led protective trade policies, but they were resurrected after the collapse of Bretton Woods in early 1970s. Financial derivatives were also introduced in the 1970s. Today many, but not all, commodities are traded at Futures Exchanges.

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5 Commodity price formation Price signals generated at futures exchanges or auctions Price Benchmarks Spot transactions Price signals generated from OTC transactions Price Reporting Agencies (PRAs)

6 What is a Futures Exchange? A futures exchange is a central marketplace where futures contracts and options on futures contracts trade. Futures traded on a futures exchange allow the sellers of the underlying commodities the certainty on the price they will receive for their products at the market. To maintain liquidity, contracts trading on an exchange have standardized sizes, expiration dates, and, for options, strike prices. This standardization contrasts over-the-counter (OTC) contracts where buyers and sellers agree to the terms on an individual basis. Before formal stock and futures exchanges, parties traded with one another directly. As such, activities were fragmented, and it was not always possible to offset a position with an equal and opposite position. This fragmentation is still a concern today in the over-the-counter (OTC) marketplace. Source: Investopedia

7 What is a Price Reporting Agency? Price-reporting agencies (PRAs) are publishers that report on and bring transparency to the physical commodity markets. They are a longstanding and critical part of the global commodity market infrastructure. They provide transparency, allowing markets to function efficiently. PRAs publish price assessments of the prevailing open-market price level in specific physical markets according to specific published methodologies. Within the commodities space, PRAs assess the price of numerous energy, agricultural, chemical and metal commodities. They publish their assessments daily, weekly or monthly, and allow access to them in exchange for a subscription fee. PRAs also publish databases, analysis and real-time market news, and some are involved in related businesses, such as consultancy and conferences. PRAs are independent of the markets they report on and have no vested interest in the level of any price assessment that they publish. PRAs compete with one another to publish the most accurate and most relevant assessment of a commodity s price. Source: Massey, D. (2016). Introduction to Price Reporting Agencies. In Managing Energy Price Risk, ed. V. Kaminski. London: Incisive Media.

8 Difference between a Futures Exchange and a PRA The core activity of a Futures Exchange is to facilitate trading of futures and options contracts. Reporting prices is not the core activity of a Futures Exchange. Prices are a byproduct. The core activity of a Price Reporting Agency is to produce a report which contains market analysis and prices. Reporting prices is the core activity of a Price Reporting Agency.

9 Major Price Reporting Agencies Source: Sapient Consulting, Changing Paradigms in Commodity Markets: What are Price Reporting Agencies Doing to Remain on Top of their Game?, Fall 2014 Edition.

10 Issues with PRAs and price benchmarks May 13, 2013 February 10, 2014 February 10, 2014 April 5, 2012

11 Issues with PRAs: Market evolution and Transparency Evolution: Commodity markets are evolving both from a market and a policy perspective. The evolution implies that the way PRAs report prices may change. For example, a trend that began a decade ago is that commodity trading activity moves East. In other words, the traditional commodity pricing centers of Chicago, London, and New York are being replaced by Dalian, Shanghai, and Singapore. Transparency: A key issue with PRAs has been transparency. In simple terms, do the prices they report reflect supply and demand conditions or they have been influenced by commercial interests? I what follows I will discuss the experience on evolution (East Asian LNG market) and transparency (U.S. chicken market).

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13 Natural gas prices: U.S., Europe, Japan US$/mmbtu, nominal 20 Japan (LNG) Europe 5 United States 0 janv-00 juil-01 janv-03 juil-04 janv-06 juil-07 janv-09 juil-10 janv-12 juil-13 janv-15 juil-16 janv-18 Source: World Bank. Note: Last observation is May 2018.

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15 Liquefied Natural Gas (LNG) price benchmarks US$/mmbtu, nominal Spot (Asia) LNG (Japan) août-10 avr-11 déc-11 août-12 avr-13 déc-13 août-14 avr-15 déc-15 août-16 avr-17 déc-17 Source: Statistics of Japan, World Gas Intelligence, and World Bank. Note: Last observation is April 2018.

16 Chicken Wars November 22, 2016 Major poultry companies, including Pilgrim s Pride Corp. and Tyson Foods Inc., starting Monday will be required to submit documents verifying the accuracy of information they want included in a key industry benchmark used to set chicken prices at U.S. supermarkets. The first major change to the Georgia Dock index s formulation in more than four decades comes amid growing questions about the index s accuracy. The benchmark, provided by the Georgia Department of Agriculture, has drawn scrutiny after a Wall Street Journal article...

17 Chicken prices US$/kg, nominal 2,60 2,40 2,20 2,00 Discontinued series (Georgia Dock index) 1,80 Current Series (Urner Barry price) 1,60 1,40 1,20 janv-07 janv-08 janv-09 janv-10 janv-11 janv-12 janv-13 janv-14 janv-15 janv-16 janv-17 janv-18 Source: Georgia Department of Agriculture (Georgia Dock), (Urner Barry), and World Bank. Note: Last observation is June 2016 (Georgia Dock) and May 2018 (Urner Barry).

18 The chicken stakes are not trivial! Historically, the discontinued price has averaged 11 percent above the current price. During July 2015-June 2016, the discontinued price averaged 35 percent above the current price, i.e. a 24 percentage-point difference. In 2016, the U.S. consumed 13.5 million tons of chicken, according to the US Department of Agriculture. Total chicken expenditure in the U.S. during 2016 was $33.6 billion (evaluated at the discontinued prices) or $27.6 billion (evaluated at the current prices). It gives a $6 billion difference (or $18 per person).

19 The Chicken Wars continue November 17, 2016 November 3, 2016 February 10, 2018 November 15, 2017 February 10, 2018 February 8, 2018

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21 Conclusion Price Reporting Agencies, which complement Futures Exchanges, play a key role in the commodity market chain. They provide price information, especially for thinly traded commodities or where the market structure is characterized by oligopolies or oligopsonies. There have been concerns with PRAs. Most concerns, however, apply to the information supplied to the PRAs from commodity suppliers and consumers, not the way PRAs run their operations. Two problems with PRAs are: o The evolving nature of commodity markets o Likely collusion among supplier of information

22 Some (personal) thoughts Regulation: Some regulation may be warranted on the way information is supplied to the PRAs as well as transparency on the methodology used by the PRAs. Lessons from the energy markets summarized by IOSCO may be applicable. Competition: Competition always helps, both from private and public sector as well as International Organizations. Resources: More resources should be allocated to Agencies dealing with price information (e.g., International Organizations, line Ministries, as well as statistical agencies, both national and international). Hence, the quantity and quality of price information will be enhanced. Incentives: The returns from ensuring accuracy of information are lower than the returns from more publishing journal articles, citations, downloads, views, likes, and interviews with high profile news outlets.

23 Literature Baffes, John (2018). Competitive Price Benchmarking in Global Commodity Markets: What Does History Teach Us? Draft, Development Prospects Group, World Bank. Johnson, Owain (2018). The Price Reporters: A Guide to PRAs and Commodity Benchmarks. New York: Routledge. IOSCO, International Organization of Securities Commissions (2012). Principles of Oil Price Reporting Agencies, Final Report. Report in response to the G20 Leaders Cannes Summit Final Declaration. In collaboration with IEA, IEF, and OPEC. Massey, D. (2016). Introduction to Price Reporting Agencies. In Managing Energy Price Risk, ed. V. Kaminski. London: Incisive Media. Oxford Economic Forum (2018). Oil Price Benchmarks. May, Issue 113. The Oxford Institute for Energy Studies, University of Oxford. World Bank. Pinksheet: Commodity Prices. Washington, DC: World Bank.

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