What is commodity risk?

Commodity risk is the threat of changes to a commodity price that may have a negative effect on future market value and income.

Where have you heard about commodity risk?

You’ll have heard the phrase 'commodity risk' in the news whenever the price of raw materials goes up. It creates price risk for the producer, and in some cases a price increase has to be passed on to the consumer. This is what causes the price of petrol to fluctuate, for example, and if it’s been a particularly poor harvest food prices can also rise.

What you need to know about commodity risk.

Generally speaking there are three types of commodity:

• Agricultural; including wheat, coffee and sugar
• Energy; including oil, gas and coal
• Metal; including silver, gold, copper and aluminium

And a business or entity that produces, exports or buys commodities faces four specific risks:

• Price risk occurs when global and local prices or exchange rates move adversely
• Quantity risk occurs when the availability of commodities changes
• Cost (input) risk occurs when changes to the price of commodities have a negative impact on business costs
• Political risk occurs when compliance or regulation affects the price or availability of commodities

You can protect yourself from commodity risk by purchasing goods in advance or negotiating future contracts, which agree a fixed price and predetermined trade date. Commodities derivatives, which are a form of security, can also be used to hedge risk.