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Posts Tagged ‘spot market’

Coffee strengthens

Your Americano, Latte or Cappuccino may soon be more expensive. This is because coffee bean prices are rising. A combination of continuing growth in demand and poor coffee harvests in various parts of the world have led to a rise in both Arabica and Robusta prices, with the International Coffee Organization’s Composite Indicator price (in US dollars) having risen by over 30% since mid-January this year (see chart below: click here for a PowerPoint)

Supply has been affected by droughts in Brazil and Vietnam, two of the world’s biggest coffee producers, and by pests (the Coffee Berry Borer) in the Kilimanjaro region of Tanzania and in other East African countries. Global exports of coffee in July 2016 were 22% down on the same month in 2015.

The growing shortage and rising current (spot) prices is reflected in future prices. These are prices determined in the market now for trading at a specified future date (e.g. in three months’ time). Future prices depend on predictions of the balance of demand and supply in the future. According to the MarketWatch article below, “Analysts at Société Générale in a note predicted that prices could climb about 30% further by the end of next year”. The current (mid-September) spot price of robusta coffee beans is around $0.96 per lb. The December 2016 future price is around $1.48.

So what effect will this have on the prices in Starbucks, Costa or Caffè Nero? And what effect will it have on ground or instant coffee in supermarkets? To quote the MarketWatch article again:

A research report from the US Department of Agriculture found that, on average, a 10% increase in green-coffee-bean prices per pound would yield a 2% increase in both manufacturer prices and at the register in places like Starbucks Corp.

This is because the cost of coffee beans is just one element in the costs of coffee roasters and coffee shops. Also these companies use futures markets to smooth out the prices they pay. They hold stockpiles of coffee, which they build up when prices are low and draw on when prices are high. This helps to reduce fluctuations in retail prices.

So don’t worry too much about the price of your morning coffee – at least, not yet.

Articles
Why a surge in coffee-bean prices may not hit the Starbucks set—yet MarketWatch, Rachel Koning Beals (9/9/16)
Wired coffee prices may not slip far News Markets, David Cottle (9/9/16)
Late-harvest woes prompt Brazil coffee harvest downgrade Agrimoney (7/9/16)
Look Out, Latte Lovers: Brazil Drought Hurts Espresso Beans Bloomberg, Fabiana Batista and Marvin G. Perez (13/9/16)
Why Your Morning Coffee Is About to Become Even More Expensive Fortune (28/7/16)
Climate change brews a storm for East Africa coffee farmers Business Daily (East Africa), Paul Redfern (4/9/16)
Coffee Market Report ICO (August 2016)

Data
Commodity Prices Index Mundi
Historical Data on the Global Coffee Trade ICO
ICO’s Coffee Trade Statistics Infographic for July 2016 ICO blog (31/8/16)

Questions

  1. What determines coffee futures prices?
  2. How are the price fluctuations of coffee in coffee shops related to the price elasticities of demand and supply? What determines these elasticities?
  3. Why does a strengthening (an appreciation) of the currency of a coffee exporter affect (a) the price of coffee to producers in the country; (b) international coffee prices in dollars?
  4. Are poor coffee harvests on balance good or bad for coffee producers? How does this depend on the market price elasticity of demand? Does the answer vary from producer to producer?
  5. How does speculation affect coffee prices (both spot and future)? Is such speculation of benefit to (a) the coffee consumer; (b) the coffee grower?
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The Big Six: for how much longer? (Elizabeth’s post)

The energy market is complex and is a prime example of an oligopoly: a few dominant firms in the market and interdependence between the suppliers. Over 95% of the market is supplied by the so-called ‘big six’ and collectively they generate 80% of the country’s electricity. There are two further large generators (Drax Power Limited and GDF Suez Energy UK), meaning the electricity generation is also an oligopoly.

This sector has seen media attention for some years, with criticisms about the high profits made by suppliers, the high prices they charge and the lack of competition. Numerous investigations have taken place by Ofgem, the energy market regulator, and the latest development builds on a simple concept that has been a known problem for decades: barriers to entry. It is very difficult for new firms to enter this market, in particular because of the vertically integrated nature of the big six. Not only are they the suppliers of the energy, but they are also the energy generators. It is therefore very difficult for new suppliers to enter the market and access the energy that is generated.

Ofgem’s new plans will aim to reduce the barriers to entry in the market and thus make it easier for new firms to enter and act as effective competitors. The big six energy generators are vertically integrated companies and thus effectively sell their energy to themselves, whereas other suppliers have to purchase their energy before they can sell it. The regulator’s plans aim to improve transparency by ensuring that wholesale power prices are published two years in advance, thus making it easier for smaller companies to buy energy and then re-sell it. Andrew Wright, the Chief Executive of Ofgem, said:

These reforms give independent suppliers, generators and new entrants to the market, both the visibility of prices, and [the] opportunities to trade, [that] they need to compete with the largest energy suppliers…Almost two million customers are with independent suppliers, and we expect these reforms to help these suppliers and any new entrants to grow.

Although such reforms will reduce the barriers to entry in the market and thus should aim to increase competition and hence benefit consumers, many argue that the reforms don’t go far enough and will have only minor effects on the competitiveness in the market. There are still calls for further reforms in the market and a more in-depth investigation to ensure that consumers are really getting the best deal. The following articles consider this ongoing saga and this highly complex market.

Ofgem ramps up scrutiny of Big six accounts Telegraph, Denise Roland (27/2/14)
Energy firms told to trade fairly with smaller rivals BBC News (26/2/14)
Energy regulator Ofgem force trading rules on ‘big six’ suppliers Financial Times, Andy Sharman (26/2/14)
Ed Davey calls on Ofgem to investigate energy firms’ gas profits The Guardian, Sean Farrell and Jennifer Rankin (10/2/14)
UK forces big power companies to reveal wholesale prices Reuters (26/2/14)
Watchdog unveils new rules on Big six energy prices Independent, Tom Bawden (26/2/14)
Energy Bills: New rules to boost competition Sky News, (26/2/14)

Questions

  1. What are the characteristics of an oligopoly?
  2. Explain the reason why the vertically integrated nature of the big six energy companies creates a barrier to the entry of new firms.
  3. What are the barriers to entry in (a) the electricity supply market and (b) the electricity generating market?
  4. What action has Ofgem suggested to increase competition in the market? How effective are the proposals likely to be/
  5. Why is there a concern about liquidity in the market?
  6. If barriers to entry are reduced, how will this affect competition in the market? How will consumers be affected?
  7. Why are there suggestions that Ofgem’s proposals don’t go far enough?
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Chocolate prices set to soar

Your favourite chocolate bar or your drink of hot chocolate could soon be much dearer. Since March, the price of cocoa has risen by 34% and much of this increase remains to be passed on to the consumer. The price of cocoa butter is up 70% since the beginning of the year.

On the demand side, sales of luxury cocoa-rich chocolate and hot chocolate have been rising and chocolate manufacturers, with relatively low forward purchases of cocoa, are likely to have to buy more in spot markets. What is more, there is growing speculative demand as traders anticipate higher prices to come.

On the supply side, dry weather in West Africa, where 70% of cocoa beans are produced, has led to a fall in output. Estimates suggest that cocoa production in the 12 months to end-September 2013 will be 2.7% down on the previous 12 months. Supply is expected to be 60,000 tonnes less than demand, resulting in a fall in stocks from 1,833,000 to 1,773,000.

The following articles look at the ‘crisis’ for chocoholics and at the market conditions that lie behind it.

Articles
Craving for a chocolate fix? Prepare to pay more Reuters, Lewa Pardomuan and Marcy Nicholson (15/9/13)
Hot chocolate demand sends cocoa prices soaring Financial Times, Emiko Terazono (15/10/13)
Price of chocolate ‘to triple’ The Telegraph (8/10/13)
Paying more for chocolate? You will be CNN Money, Alanna Petroff (14/10/13)
Chocolate Prices Soar in Dark Turn The Wall Street Journal, Leslie Josephs and Neena Rai (22/9/13)
Chocolate prices could increase as cocoa costs soar BBC News, Nigel Cassidy (21/10/13)
… and on a lighter note: Rising Prices Signal A ‘Devastating’ Global Chocolate Crisis: Should Government Act To Save Us? Forbes, Doug Bandow (14/10/13)

Data
Cocoa beans: monthly price Index Mundi
ICCO daily prices of cocoa beans International Cocoa Organization (click on calendar to select month)
Production of cocoa beans International Cocoa Organization (click on Statistical Data links in right hand panel
Monthly review of the market International Cocoa Organization

Questions

  1. What happened to cocoa prices from January 2009 to March 2013? Explain this movement in prices.
  2. Why have cocoa prices risen so much since March 2013? Illustrate your analysis with a supply and demand diagram.
  3. If the demand for luxury chocolate fluctuates considerably with the state of the business cycle, what does this suggest about the income elasticity of demand for luxury chocolate?
  4. How would you establish whether or not cheap chocolate is an inferior good?
  5. If cocoa prices rise by 34%, what determines the percentage by which a bar of chocolate will rise?
  6. What determines the difference between cocoa futures and spot prices?
  7. How realistically could government intervention improve the lot of chocoholics?
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Tackling market power in the UK power industry

The UK electricity supply market is an oligopoly. Over 95% of the market is supplied by the ‘big six’: British Gas (Centrica), EDF Energy, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six also generate much of the electricity they supply; they are vertically integrated companies. Between them they generate nearly 80% of the country’s electricity. There are a further two large generators, Drax Power Limited and GDF Suez Energy UK, making the generation industry an oligopoly of eight key players.

Ofgem, the energy market regulator, has just published a report on the wholesale electricity market, arguing that it is insufficiently liquid. This, argues the report, acts as a barrier to entry to competitor suppliers. It thus proposes measures to increase liquidity and thereby increase effective competition. Liquidity, according to the report, is:

… the ability to quickly buy or sell a commodity without causing a significant change in its price and without incurring significant transaction costs. It is a key feature of a well-functioning market. A liquid market can also be thought of as a ‘deep’ market where there are a number of prices quoted at which firms are prepared to trade a product. This gives firms confidence that they can trade when needed and will not move the price substantially when they do so.

A liquid wholesale electricity market ensures that electricity products are available to trade, and that their prices are robust. These products and price signals are important for electricity generators and suppliers, who need to trade to manage their risks. Liquidity in the wholesale electricity mark et therefore supports competition in generation and supply, which has benefits for consumers in terms of downward pressure on bills, better service and greater choice.

So how can liquidity be increased? Ofgem is proposing that the big six publish prices for two years ahead at which they are contracting to purchase electricity from generators in long-term contracts. These bilateral deals with generators are often with their own company’s generating arm. Publishing prices in this way will allow smaller suppliers to be able to seek out market opportunities. The generating companies will not be allowed to refuse to contract to supply smaller companies at the prices they are being forced to publish.

In addition, Ofgem is proposing that generators would have to sell 20% of output in the open market instead of through bilateral deals. As it is, however, some 30% of output is currently auctioned on the wholesale spot market (i.e. the market for immediate use).

But it is pricing transparency plus small suppliers being able to gain access to longer-term contracts that are the two key elements of the proposed reform.

Articles
UK utilities face having to disclose long-term deals Reuters, Karolin Schaps and Rosalba O’Brien (12/6/13)
Ofgem set to ‘break stranglehold’ in the energy market BBC News, John Moylan (12/6/13)
Ofgem plan ‘to end energy stranglehold’ BBC Today Programme, John Moylan and Ian Marlee (12/6/13)
Ofgem outlines proposals to ‘break stranglehold’ of big six energy suppliers on electricity market The Telegraph (12/6/13)
Ofgem widens investigation into alleged rigging of gas and power markets The Guardian, Terry Macalister (6/6/13)
Ofgem moves to break stranglehold of ‘big six’ energy suppliers Financial Times, Guy Chazan (12/6/13)
Ofgem to crackdown on Big Six energy suppliers in bid to cut electricity prices Independent, Simon Read (12/6/13)

Reports and data
Opening up Electricity Market to Effective Competition Ofgem Press Release (12/6/13)
Wholesale power market liquidity: final proposals for a ‘Secure and Promote’ licence condition – Draft Impact Assessment Ofgem (12/6/13)
Electricity statistics Department of Energy & Climate Change
The Dirty Half Dozen Friends of the Earth (Oct 2011)

Questions

  1. What barriers to entry exist in (a) the wholesale and (b) the retail market for electricity?
  2. Distinguish between spot and forward markets. Why is competition in forward markets particularly important for small suppliers of electricity?
  3. How will ‘liquidity’ be increased by the measures Ofgem is proposing?
  4. To what extent does vertical integration in the energy industry benefit consumers of electricity?
  5. What is a price reporting agency (PRA)? What anti-competitive activities have been taking place in the short-term energy market and why may PRAs not be ‘fit for purpose’?
  6. Do you think that the measures Ofgem is proposing will ensure that the big generators trade fairly with small suppliers? Explain.
  7. What are the dangers in the proposals for the large generators?
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Fury at fuel prices

Whilst perhaps not an essential in the sense of needing it to live, petrol is about as close as you can get to a ‘non-essential necessity’ these days. Most families have a car (many have more than one) and despite the hikes in petrol prices we’ve seen across the UK, demand for petrol has remained high: it is a prime example of a good with a highly inelastic demand.

Over the past few years many families have chosen to forego their holidays abroad and instead have taken to summer vacations across the UK in a bid to save money. However, with the summer season approaching and families beginning to think about where to go or plan their trips, one thing that should be considered is the cost of travel. Petrol prices across Europe have risen faster than those in the UK over the past year and this may pose a significant cost and possibly deterrent to European travel. As Sarah Munro of the Post Office said:

‘The high fuel price increases in Europe mean that UK holidaymakers should plan their routes carefully in advance to cut costs’.

Petrol prices were found to be the lowest in Luxembourg at 128p per litre and the highest in Norway at 182p – a definite deterrent to filling up your tank in Scandinavia. Despite motorists’ constant exclamations of the price of petrol in the UK, of the 14 countries surveyed the UK came in as the 4th cheapest at 136p. It also had the smallest increase since 2010 of 14p, compared to the average of the countries surveyed of 27.8p.

Although the higher fuel prices have been fuelled (no pun intended) by rising wholesale oil prices, when crude prices started to fall, petrol prices didn’t decline to match. This has sparked an inquiry into petrol prices, with demands for more transparency into the price setting behaviour of firms. The British Petrol Retailers’ Association is planning on referring its concerns to the Office of Fair Trading. So the moral of the story: petrol prices are high in the UK, but if you’re going on holiday this summer, you’ll probably find that many other countries across Europe have even higher prices, so planning is essential.

Holiday hike: European petrol prices soar by up to 35 per cent Daily Mail Online, Sarah Gordon (10/6/11)
UK holidaymakers ‘face high petrol prices’ BBC News (10/6/11)
Petrol prices are 35% higher in Europe than last summer Mirror, Ruki Sayid (10/6/11)
Motoring coalition calls on EU to investigate soaring price of petrol Telegraph, Rowena Mason (10/6/11)
Motoring groups demand petrol price investigation BBC News (30/5/11)

Questions

  1. How are European petrol prices set?
  2. Why does the exchange rate against the dollar have a big impact on oil prices?
  3. Why have petrol prices in the UK not increased by as much as other European countries over the past year?
  4. Why is there likely to be an investigation into how prices are set? Which factors do you think will be considered?
  5. The Telegraph article talks about the sport market. What is this and how does it affect how petrol prices are set?
  6. Why does petrol have such inelastic demand?
  7. If a higher tax is imposed on petrol, why is it that much of the cost will be passed on to consumers in the form of a higher price? Illustrate this on a diagram.
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