Managing Commodity Price Risks: A Technical Overview

Managing risks in highly volatile commodity markets remains one of the major challenges of development, especially for the poorest countries. During 1983-2003, prices of many commodities fluctuated from below 50 percent to above 150 percent of their average prices. More than 50 developing countries depend on three or fewer leading commodities for more than one half of their export earnings. In Africa, commodities account for about three quarters of total merchandise exports. In many of these countries, commodity production and trade affect the livelihood of millions of people, the government’s fiscal revenue and public expenditure, as well as the country’s trade balance, foreign reserve and creditworthiness. Poverty reduction is a major objective in addressing the challenge of commodity risk management.

This paper presents a technical framework for the management of commodity price risks. The framework includes the following:

• Proper diagnosis of price risk problems – macro, meso, and micro-level exposures
• Review of price risk solutions including past approaches used by governments in an attempt to absorb the financial impacts of price volatility and a review of market-based approaches, which alternatively, are designed to transfer price risk from one market participant to the other.
• Operational lessons learned from attempts to help developing countries make use of existing market-based tools.