Deutsche Bank – Responsibility
March, 2012

Agricultural commodities – What drives food prices?

As a Bank we have been concerned by the growing number of people who find themselves in food poverty and we have looked carefully at the causes of rising and volatile food prices. There is no consensus on the subject and the views on the contributing factors vary widely.

We recognize that the proper functioning of agricultural markets have wide social ramifications. Therefore, as we continue to examine the matter, we intend to proceed with caution and we will refrain from launching new staples-based public exchange-traded products this year.

Our review shows that agricultural prices, at their core, are driven by fundamental factors. Increasing demand for agricultural products is the result of population and income growth, dietary shifts in developing countries and, bio-fuel production. This rising demand is not met by output growth leaving prices on an upward trend. Agricultural production and food availability is constrained by various factors including water scarcity, climate change, lack of infrastructure, inequitable land access, and harvest waste. Restrictions on international trade and national subsidy policies exacerbate the effects of these trends, as do weather events.

The international community needs to address these issues on a coordinated basis, and the Action Plan on Agriculture adopted by the G-20 at the Cannes Summit is an important step toward it.

Some academic research suggests an impact on prices (both up and down) from speculative activity, but most of the peer-reviewed, academic literature suggests that the fundamentals of demand and supply are the dominant drivers of commodities prices. More research is needed in order to assess the true impact of speculation.  We will sponsor such efforts, including by our own research teams.

At the same time, it is widely accepted that derivative markets for agricultural products provide hedging - through futures, options, swaps and other tools - and bring liquidity to the markets (by allowing sellers to find buyers and vice-versa), thus contributing, in principle, to decrease volatility. They also provide strong price signals to which supply will react within the constraints of growing seasons. They provide the certainty which encourages longer term investment in infrastructure and farming technology.

We agree with international policy makers that transparency in agricultural commodity derivatives markets should be enhanced and measures to avoid misconducts strengthened. Significant regulatory changes have already been decided upon or are under consideration in both Europe and the US. These reform aim at tightening conduct requirements to avoid manipulation; additional reporting requirements to increase transparency; position limits or similar measures such as position management; and new trading and clearing rules for OTC derivative contracts. Deutsche Bank is supporting these efforts to implement appropriate regulation across all relevant futures exchanges and markets.  We believe this is essential to allow these markets to function well as instruments of hedging and price discovery.