Risk management in the rubber industry

The Rubber Economist Ltd

It is recognised by many that risk management is an important step to sustain the natural rubber (NR) industry. With unfair advantages inherent in the synthetic rubber (SR) sector, it is necessary for governments to seek to help small farmers who can not afford to protect themselves. NR and other commodity prices are quite volatile when compared to prices of industrial products. There have been many attempts at the international level to establish stabilization mechanisms to deal with commodity price volatility, but these schemes are based on export earnings rather than a single set of commodities. There have been many commodity agreements, but all have failed (including INRA) and the first account of the CFC, which was established to provide liquidity to the integrated price stabilisation programme, has not been used for this purpose. Many governments have responded to commodity price volatility with schemes involving large-scale interventions in markets, often carried out by state economic enterprises, and usually aimed at insulating producers from world prices. Over the past decade, there has been widespread recognition of the adverse effects of these interventions, and adjustment programs have sought the elimination or reform of these programs. An unintended consequence of these reforms has been to shift price risk from governments back to producers.

Risk management markets provide the mechanism to exchange and to redistribute risks from those unable or unwilling to bear them to those who wish to benefit from taking them. Risk management instruments include stabilization programmes and funds, marketing strategies involving the timing and sales and purchases, long-term contracts with fixed prices, forward contracts, the use of futures or options to hedge prices through commodity exchanges and over-the-counter (OTC) markets and the use of swaps and commodity-linked bonds. Many of the risk management instruments have been used in the rubber industry and the most popular are futures and forward contracts. Despite many benefits of these instruments, one important problem is that it is not attainable by rubber smallholders because of the small quantity they produce. The existing risk management instruments are only used by international rubber dealers and large processors, but not small farmers.

The World Bank International Task Force (ITF) undertook a mission to Thailand in February 2001 to look at the possibility of providing market-based price insurance in the Thai rubber sector. This market-based approach to risk management is very useful to the NR industry, to the millions of smallholders dependent on it and to many NR producing countries. The interest in the market-based approach to NR will not only help lift smallholders out of poverty, but also the assure the long-term supply of NR. NR pricing is complicated. Even though there are NR futures markets, there is a strong relationship between these and other major physical markets. Even though there are no options traded in these markets at the moment, there has been interest by some financial institutions to provide this type of contract to NR producers and consumers. The interest in the price insurance scheme may provide the basis for NR futures exchanges to introduce NR options.

It is quite possible that the price insurance scheme may provide more than simple protection against short-term volatility. The price insurance mechanism may help to improve price discovery to reflect a more accurate demand/supply balance and to provide timely information on prices and increase transparency for both producers and consumers. Increasing liquidity in futures markets may also bring in speculators, who are motivated by profits and tend to buy when prices are low and sell when prices are high. This in itself may reduce peaks and troughs and price volatility. More importantly, by giving the insurance as well as the correct price signal, NR producers may increase investments that otherwise would have been diversified to other investments because of the uncertainty in rubber prices. This may postpone the long-term shortage, which will eventually come as industrialisation develops. Therefore the market approach to risk management, along with related subjects concerning prices and the pricing of NR, is crucial to help sustain the industry. Thailand opened its first NR futures market in May 2004 and is now considering establishing an agency to help small farmers to purchase futures contracts to protect themselves from price instability. This is the first step and there is much more work required.

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