MFRE Faculty Spotlight is a series of posts highlighting the work of the MFRE Faculty team members, a group of accomplished professors specializing in topics in the Food and Resource Economics sector such as agricultural commodity markets, environmental economics and policy, food security, trade policy, and natural resource management.
This week we shine the spotlight on Dr. James Vercammen and his new study regarding the effects of the current COVID – 19 pandemic on commodity prices.
As part of COVID-19 research projects being undertaken by UBC researchers, MFRE Professor, Dr. James Vercammen wrote a paper analyzing the early effects of COVID-19 on commodity markets. The study focuses on the market forces affecting the price of soft red winter (SRW) wheat. Even though it is made with data at the very early stages of the pandemic, it shows how the beliefs of market participants can strongly affect the prices for the major commodities.
In his project, titled “COVID – 19 pandemic and its effect on commodity prices”, Dr. Vercammen analyzes how the public sentiment of uncertainty regarding the impacts of COVID-19 makes markets react differently than they would normally do. For example, prompting the hoarding of staple food products, an increase in commodity stocks and the development of a global recession that affects the demand for commodities. He explores how these factors are affecting commodity cash, futures and options prices, and how these extraordinary events are increasing price volatility.
To explore more on the subject and on his paper, Dr. Vercammen answered the following questions for us:
1. What prompted you to write this paper (Information Rich Wheat Markets in the Early Days of COVID‐19)?
Based on the economic principles in the graduate class that I teach in the Master of Food and Resource Economics at the UBC Faculty of Land and Food Systems, I understood that the emergence of a full-blown COVID-19 pandemic will have a major impact on agricultural commodity prices. Examining commodity futures and option prices is an excellent way to make sense of the various economic forces that strongly impact the price of food-based commodities, (such as wheat, corn, and coffee) during a global crisis. The editor of the Canadian Journal of Agricultural Economics liked my idea, and he agreed to publish my paper in a special COVID-19 issue of the journal after undergoing rigorous review.
2. In typical times, what can people infer from commodity futures and option prices? What is the difference between the two?
Futures markets are very useful because they allow us to view the forces of supply and demand separately for current and future time periods. Normally storage keeps the prices in sync and so we expect commodity prices to gradually increase throughout the year to reflect the cost of storage. For the case of COVID-19, the short term hoarding of staple foods by consumers who were worried about food shortages, and the prospect of a glut of food in the future due to corn shifting out of ethanol production and a recession-induced weak demand for livestock feed created some unique dynamics for the futures and options prices.
It is not possible to bring food from the future back to the current time period and so the alternative was for short term futures prices to spike up and long term futures prices to spike down to encourage consumers to buy food later, rather than in the short term. Option prices reveal traders’ beliefs about how volatile commodity prices are expected to be in the future, the higher the price volatility means higher option prices. They are an excellent way to quantify the level of uncertainty in the supply and demand fundamentals. Not surprisingly, the option prices rose in tandem with the growing uncertainty about COVID-19 impacts on short-run and long-run food supply and demand.
3. What is the link between agricultural commodity prices and consumer behaviour?
Food supply chains are built to minimize inventory costs and so in normal times at the processor level, there is not much slack in the system. This means that if consumers perceive future food shortages and begin to hoard, the shortages can be self-fulfilling and rapidly escalate, even though there is an abundance of food at the farm level. With processed food products such as pasta, prices are fixed with long-term contracts and thus higher prices typically do not emerge in the short run to discourage hoarding. The current situation with meat is important because if disruptions of meat processing plants due to COVID-19 continue for an extended period of time then we will likely see shortages with very high meat prices at the retail level, and surpluses with very low meat prices at the farm level. Poultry, beef and pork are all impacted and so there is little scope for substitution by consumers. Hoarding of meat by consumers can make the situation much worse.
4. Why did you choose to examine this particular commodity – soft red winter (SRW) wheat?
Soft Red Winter (SRW) wheat, which is a major crop in the province of Ontario, is an important commodity for futures and options trading. The short-run surge in the demand for wheat that resulted from the short run surge in the demand for flour by house-bound consumers makes wheat an interesting and highly relevant case study during a global crisis such as a pandemic.
5. In your paper, you predicted the longer-term prices for agricultural commodities, such as wheat, will fall to lower levels than pre-COVID-19, due to a recession. Can you expand on this?
Lower grades of wheat are a substitute for corn and other livestock feed grains. A global recession will reduce incomes in countries such as China, and this will result in a significant reduction in the demand for meat. The lower demand for meat will result in fewer animals being produced and therefore a lower demand for feed grains. The resulting lower price of feed grains will put downward pressure on substitute commodities such as wheat. The global recession will also reduce the demand for crude oil. The resulting lower price for oil will reduce the demand for corn used in ethanol. With more corn available for livestock feed, the price of feed grains will further decrease, and this will once again put downward pressure on the price of wheat.
Read more about the details of the research project HERE and read the full article HERE.
About Dr. James Vercammen
James Vercammen is a professor at The University of British Columbia in the Faculty of Land and Food Systems, Sauder School of Business and the Master of Food and Resource Economics (MFRE) program. His research interests include the properties of agri-environmental contracts such as the trade-off between risk and incentives. James teaches managerial economics, government and business and commodity price analysis. James recently completed a four-year term as editor of the American Journal of Agricultural Economics.