Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Courses
  • Find a Job
  • Tutoring
  • Home
  • Economics, Finance, & Analytics
  • Investments, Trading, and Financial Markets

Commodity Price Risk - Explained

What is a Commodity Price Risk?

Written by Jason Gordon

Updated at April 17th, 2022

Contact Us

If you still have questions or prefer to get help directly from an agent, please submit a request.
We’ll get back to you as soon as possible.

Please fill out the contact form below and we will reply as soon as possible.

  • Marketing, Advertising, Sales & PR
    Principles of Marketing Sales Advertising Public Relations SEO, Social Media, Direct Marketing
  • Accounting, Taxation, and Reporting
    Managerial & Financial Accounting & Reporting Business Taxation
  • Professionalism & Career Development
  • Law, Transactions, & Risk Management
    Government, Legal System, Administrative Law, & Constitutional Law Legal Disputes - Civil & Criminal Law Agency Law HR, Employment, Labor, & Discrimination Business Entities, Corporate Governance & Ownership Business Transactions, Antitrust, & Securities Law Real Estate, Personal, & Intellectual Property Commercial Law: Contract, Payments, Security Interests, & Bankruptcy Consumer Protection Insurance & Risk Management Immigration Law Environmental Protection Law Inheritance, Estates, and Trusts
  • Business Management & Operations
    Operations, Project, & Supply Chain Management Strategy, Entrepreneurship, & Innovation Business Ethics & Social Responsibility Global Business, International Law & Relations Business Communications & Negotiation Management, Leadership, & Organizational Behavior
  • Economics, Finance, & Analytics
    Economic Analysis & Monetary Policy Research, Quantitative Analysis, & Decision Science Investments, Trading, and Financial Markets Banking, Lending, and Credit Industry Business Finance, Personal Finance, and Valuation Principles
  • Courses
+ More

Table of Contents

What is a Commodity Price Risk?How Does Commodity Price Risk Work?Groups affected by Commodity Price RiskFactors affecting commodity pricesAcademic Research for Commodity Price Risk

What is a Commodity Price Risk?

Commodity price risk refers to financial losses that may occur to both the consumer, and the producer when there is a change in commodity prices. A risk for the buyers is that the prices for commodities may be high. Take an example of the carpenters. They have to buy wood to make furniture. If the wood prices go up, it will also mean that the costs of buying furniture will be higher. The producers will have lower profits because there will be few buyers.

Back to:INVESTMENTS & TRADING

How Does Commodity Price Risk Work?

Generally, producers face the risk of low commodity prices. For instance, if in the first year of planting the prices of crops are high, the farmer plants more hoping for higher profit margins. What will happen when the prices suddenly fall? The farmer makes losses. Commodity price risk does not happen just like that. Factors including weather, technology, politics, market conditions, and seasons affect commodity prices. Financial instruments like futures and options are now in the market to control commodity price risk.

Groups affected by Commodity Price Risk

  • Producers including farmers, mining companies, oil companies, and car manufacturers face price risks on their production inputs
  • Consumers face price risk when the prices go up as this affects their demand for commodities
  • Imposing tariffs on exports causes prices to go up. Exporters also experience hardship in the markets when this happens
  • Governments face price risks, especially when it comes to revenue generation. An increase in prices causes the government to generate more revenue

Factors affecting commodity prices

  • Politics

An increase or decrease in commodity prices can occur due to political factors. In the USA, for example, manufacturers import steel and aluminum from foreign countries. In 2018, President Trump imposed tariffs on the imports. The tariffs' goal was to increase the prices of aluminum, and steel in the USA compared to other countries. China did not take this lightly. They later imposed their tariffs on agricultural products from the US. The low demand for agricultural produce from China meant the crops had to be bought by other countries. As a result, the crop prices in the US market reduced in 2019.

  • Weather conditions

Change in seasons and weather conditions largely affect the prices of commodities. Farmers harvest plenty of farm produce towards the end of summer, making prices fall in October. The fluctuation of prices during the major seasons' causes crashes in the stock market. Seasons like drought and floods temporarily lead to a hike in the prices of commodities.

  • Transportation and storage costs

The type of commodity will determine its storage mechanism. The commodities that have a physical form need storage spaces before distribution. The cost of storage always affects the overall price of a commodity.

  • Technology

Technology has an intense impact on commodity prices. Improvements in technology can cause the prices of a commodity to drop. Take an example of aluminum. It was a valuable metal until new procedures were developed to isolate it. Its value then dropped, and its price in the market decreased.

  • Production costs

Capital, labor patterns, raw materials, and production tools have a great influence on the commodity's final price. If the cost of production is high, the commodity price will also be high. However, if the production cost is low, the commodity price will be low. Using hedging futures to control the prices of a commodity Futures markets protect consumers and producers against price fluctuations. A producer faces the risk of prices going down, while consumers face the risk of prices hiking. Hedging protects both parties against financial loss. Futures contracts have periods, and consumers and producers get to choose according to the risks they face. Investors, traders, speculators, and other people in the market can use the futures markets.

commodity price risk

Was this article helpful?

Yes
No

Related Articles

  • Equity Risk Premium - Explained
  • Required Rate of Return - Explained
  • Money Market Fund - Explained
  • Modern Portfolio Theory - Explained



©2011-2023. The Business Professor, LLC.
  • Privacy

  • Questions

Definition by Author

0
0
Expand