The largest percentage of Kenya’s population are farmers. A key concern for this population is the price volatility associated with the commodities especially when it comes to food crops such as maize, beans and other cereals. The price of basic food commodities recently has been unstable leaving most Kenyans unable to purchase these commodities in bulk. An example is the current price volatility in tomatoes that has rendered them three times more expensive their original price. With the accelerated development speed, Kenya is in a position to establish its own commodity market. A commodity is a good produced to fulfill wants or needs. A farmer and a seller will then be able to fix a price for her produce to be purchased in the future and this benefits both parties in terms of price volatility.
Currently, most farmers sell their produce at local spot markets where the contracts are immediately settled, with money and the commodity changing hands. The same commodities are traded on the international markets and have fungibility, which means that the international market treats the commodities as equivalent no matter who produces them. For example, a kilogram of grade 1 tea produced in Kenya is equivalent to a kilogram of grade 1 Tea produced in China.
Commodity futures are derivative contracts that enable the purchaser, usually farmers, to fix the price that they will receive at a given future date for a given quantity of their produce. This helps reduce price uncertainty and revenue volatility, which eventually leads to more productive farming. Commodity derivative exchanges are platforms where commodity futures contracts trade. These features of commodity futures markets make them very beneficial for the Kenyan producers and exporters.
A commodity futures market enables risk transfer amongst farmers and other market participants. By entering into futures contracts, a farmer can effectively set the price that they are willing to receive for their produce at a future date. This enables them to make prudent decisions on the whole production process ranging from the cost of production to the final quantity produced. This should ultimately lead to less dissatisfaction and increased agricultural productivity.
One challenge with this arrangement is that, futures contracts are done in the future and the price is set now. When the price set goes above the market price the seller is set to gain and the buyer is set to purchase commodities at a very costly price and vice versa. If the price goes lower than what the market has risk management becomes an issue, thereby giving the rise of a new derivative referred to as an option where the person conducting the transaction has a right and not the obligation to proceed with the transaction.
Secondly, speculative transactions are bound to increase and a rise in institutional investors who aim at making money based on speculations. If it is predicted that the price of tomatoes will go up in October one buys contracts and exercises them during the month of October thus locking in a cheaper price now, when prices go up they exercise the contract and buy the tomatoes at a lower price and sell them at market price. If a seller speculates that the price of tomatoes will go down they lock in a higher price today to sell the tomatoes at a higher price in future thus increasing capital gains.
By Nicholas Koigu