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oth the need for and the opportunities in commodity futures are rising by the day – provided of course, this important activity is viewed from its basic tenet of helping the players to better manage and hedge the attendant risks through efficient price discovery methods adopted by the exchanges that provide this important service. 

The reality however, is starkly different since the emergence of commodities as an independent asset class in 2003. Since then, the entry of cross spectrum of shallow and deep pocketed individual and institutional investors the basic nature of the commodity futures industry as a whole is now seen to be taking on frightening proportions worldwide – thanks to the collective greed of all sets of players including the governments of the countries that have supported the growth of this vital economic activity for the supposed benefit of the players in the commodity markets.

 Frequently – and more frequently these days – there have been questions raised whether and to what extent is trading in commodity futures beneficial to the actual and serious players in the commodity markets in particular and therefore, also in general for the economy in which they operate. For obvious and not-so-obvious reasons, the market and economic analysts have always differed on the subject.

Type on the popular internet search engine Google:

1. commodity derivatives – there are 2,020,000 mentions
2. commodity derivatives – (how) important – 1,820,000 mentions
3. commodity derivatives – benefits – 1,810,000 mentions
4. commodity derivatives – drawbacks – 1,164,000 mentions
5. commodity derivatives – good – 1,800,000 mentions
6. commodity derivatives – bad’ – 1,560,000 mentions
7. commodity derivatives – risky – 457,000 mentions
8. commodity speculation – need to regulate – 417,000 mentions

 For better, if not conclusive, opinion about the elusive importance of commodity derivatives, this ad hoc search highlights the preference or otherwise for commodity derivatives, especially in starkly or rather fiercely divided opinions on the subject. For various reasons, including the various disasters like Sumitomo Bank’s losses in copper futures trading, the LTCM disaster, the Enron and many others over the past few years, there has been opposition to the financial and commodity derivatives as a whole.

Like it or not, India too has begun to voice its displeasure in the rising wave of speculator-driven trading in commodity derivatives. Remember Petroleum Secretary MS Srinivasan calling for `Halt (in) trading of crude oil on exchanges’ to bring overheated oil prices under check? (NYT report in Hindustan Times – November 9, 07, pg 21)  Or for that matter, the subtle observation of Forward Market Commission (FMC), the commodity market regulator who said recently: “If physical delivery of goods happen then the future’s market would be stable.” 

Even voices are varied as those of Mohammad Alipour-Jeddi, the head of market analysis of OPEC, and William F Galvin, the secretary of state in Massachusetts have blamed speculators for rising (crude oil) prices. There is enough crude oil in the markets, Alipour-Jeddi said. Bottlenecks in refining and `speculative activities” are forcing prices higher, he was quoted (in the above mentioned article). 

In defense of derivatives trading as a whole and that of the commodity exchanges that offer such facilities, Richard Schaeffer, Nymex chairman, had said “Nymex is just a central point where buyers and sellers can come to exchange their wares. We don’t make the prices, we make the prices known”. 

Yes, may be this is not like a car owner / driver having driving license runs over a pedestrian – consciously or unconsciously – saying that he has the license and the right to drive, but for some unknown reasons, is not pulled up by the police standing in his own booth nearby who prefers to remain silent, or look elsewhere. 

So, the fact that it is the speculators the world over and not the actual players in the commodity market who are driving the prices of the commodities cannot be denied or overlooked – even if we do not talk of the passively observant regulators and their political bosses who seem to be enjoying the rising tide in the futures industry as a whole.   

According to the Futures Industry Association (FIA), the futures industry’s growth rate in the second half of 2007 accelerated substantially from what was seen in the first half of the year. Total volume on derivatives exchanges worldwide reached 11.4 billion contracts in the first nine months of 2007, up 26.6% from the previous year. That compares to a growth rate of just 16.1% in the first five months of the year, and 18.9% for the whole of 2006. 

Even in India, the companies participation in commodity futures has surged to around Rs 4,500 crore against the daily commodity futures trading volumes of around Rs12,000 crore. And despite the all round noises from the concerned quarters to allow institutional players (domestic and foreign) in the Indian commodity futures markets – banks, brokerages, players and investors in the commodity markets (both physical and futures), the commodity exchanges themselves and of course, the FMC, the market regulator – the government does not seem to be too convinced about the prevailing perception of commodity futures trading and the rising misuse – if not menace – there in.  

It is possible that because of the Indian government’s discomfort on commodity futures, the overdue proactive policy moves are taking more than expected time. In a way, the government seems to be concerned about the commodity futures trading activity turning into yet another financial bubble which if left unchecked as in the international markets would result in uncalled for troubles.  Like it or not, the unchecked commodity derivatives trading is partly contributing to higher prices of commodities in the open market, both domestic and international. In turn, this is goading the inflation dragon to raise its head. And at a time when the ruling UPA government is trying to douse fires of suspicion in both its own Left Wing partners as also the opposition, and preparing for early elections, looking at the controversial subject of commodity futures is surely not good politics.  

So, in India at least, the government seems to be letting the `children’ or the neo-converts play small games in the nascent commodity futures market. But the issue of the controversial importance of commodity derivatives is unlikely to remain under the carpet for long, even internationally.