The minister of Finance Professor Mthuli Ncube recently announced government plans to launch a commodities exchange by the end of November 2020. This exchange would offer farmers and producers opportunities to enter sale contracts in advance guaranteeing their income and also the level of income if all goes well. All very exciting stuff but exactly does a commodity exchange work and is it a panacea to the problems farmers and producers have faced in the past?

Commodity exchange

Firstly this is not a strange idea but international best practice. Commodities are traded on many exchanges in similar fashion. You will find the most popular ones reported on are Oil (Brent Crude), Soya beans and my personal favourite pork bellies. The market is not a spot market where farmers arrive with truckloads of produce and sell. It is a future contract market. To understand the concept of a future contract better you can read this article on financial derivatives. What will happen on the exchange is contracts for sale in future will be agreed. Say you have crops in the field. You believe your sugar beans will be grade 2 and you expect to harvest in 3 months time. You can go to the market and agree a delivery contract for a certain number of tonnes at that date. When the date arrives you deliver to the contract writer (buyer).

Those are the basic workings of these contracts but they can get a little more complex and exciting. In an over the counter market contracts do not have a named supplier and so the contracts themselves can be bought and sold. So you could just buy a contract. If you recall when the world oil price fell below zero earlier in the year this was the problem. Contracts which where close to due had no producers demanding them. This really would put a lit of power in farmers hands.

Advantages

We’ve already looked at how it can put power in suppliers hands through contracts being transferable. Farmers also get guaranteed buyers for produce at future dates. There is the possibility of opening up financing through these contracts. Upon proving to a financial institution or intermediary that they have both contract and the goods are expected to be ready at future date they can borrow against future earnings. Contrast these situations with the idea of farmers driving from the back of beyond to farmers markets with produce that must be sold same day or be lost. The concept can smooth the cash flow of farmers which is often characterised by peak and troughs.

Disadvantages

All Rose’s have thorns and so too does this one. As with all things announced by the government the devil is in the details. The year 2020 has seen better results from most of these announcements than we have seen in the past but we always stand wary. The details could prove to be a problem. Another problem that could affect the commodities market is speculation. Speculators are a normal part of all efficient markets, however, when markets reward speculators over general participants there may be a problem. In an over the counter system any one individual could buy up all the contracts for a certain commodity. Then suddenly genuine farmers are in a predicament because they must go to this individual to buy contracts. The individual can turn around and make a deal with farmers to supply the commodities and share the proceeds. Finally, the advantage to farmers can be outweighed by the advantage to buyers depending on who is more organised. You can draw a parallel to the current system with the Grain Marketing Board or Cotton farmers where government as a buyer is very rigid. While we can attribute this to economy and bureaucracy the organisation of the two parties is the key factor. The government agencies are a single cohesive organism while the farmers are hardly organised.

While a lot is still up in the air we do not have a long wait to find out how the commodities market will work.