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Main Factors that Impact Futures Prices


The futures price of any commodity is affected by two factors. One is the general factor which affects all the commodities in varying degrees. This includes the general economic growth within the country, the overall business sentiment and international political and economic stability. During periods of economic growth the general consumption is higher and the expectation is that the prices in the future will increase. The second factors concern the specific commodity and the different aspects of its production and consumption.

Let us take an example of an agricultural commodity - Soybeans

Around 85% of the total usage is to prepare soybean meal (used to feed livestock and poultry) and soybean oil. The remaining 15% is used for human food products. The major producers are US, Brazil, Argentina, China and India in that order. US production is around 38% or 81 million ton of soybeans out of a global production of 210 million ton.

The factors affecting the production of soybeans are:

  1. Demand of poultry and meat increases the demand of soybeans as soybean meal is a primary source of animal feed. Future increase in demand of poultry would lead to increased demand for soybean which would lead to higher price level in the future.
  2. The alternative of soybean meal is corn. If there is excess production of corn the farmers would prefer to use cheaper corn for farm feed rather than soybean. This would reduce the demand of soybean. Hence substitute products keep a tab on the increase in the price of soybean.
  3. It requires good rainfall for a successful crop. If the weather is too dry or there is excess rainfall there is an adverse effect on the growth of the beans. Hence future weather patterns also play a major role in the price of the crop.
  4. Although US produces a major proportion of the crop the weather conditions in other parts of world also play a major role. If climatic conditions in any one of the major producing regions is favorable or unfavorable it would have an instant effect on the price level.
  5. China is a major importer of the crop, importing more than 60% of total imports. As the Chinese economy expands there is a greater preference for poultry and meat products which would increase the demand of soybeans. For the past couple of years it has played a major role in lifting up the price of the crop.
  6. The level of exports and the amount of crop which is carried over from the previous year also plays a major role. If external demand is high and there is less carry over crop it will lead to much higher increase in the price of the crop.

Once all these considerations are factored in a trader can use it to benefit from speculative trading within this commodity.


Soybean Price Chart

futures-prices-impact.png

Source: CBOT

As the graph shows there is a steep decline in the price after the beginning of the financial crisis in 2008 which is marked with 1.

Also it can be seen that the overall increase in the price of soybeans is following a larger macro trend of going upwards which is shown by pointer 2. This trend can be explained by the enormous demand within China in the last decade. As affluence increases people shift to dairy and meat products to fulfill the requirement of proteins within their diet instead of cereal crops like rice and wheat. This leads to higher requirement of feed crops which is one of the major uses of soybeans.

Crude Oil Factors
We can look at another major commodity which has a major impact in our lives and which is the most actively traded commodity in the world, crude oil. Currently the global consumption is around 88 million barrels a day. US is the major consumer using around 19 million barrels per day or around 23%. China consumes around 9 million barrels a day or around 10%. It is estimated that the consumption by China will cross US by 2030. Top 5 producers are Russia, Saudi Arabia, US, Iran, and China. They produce approximately 10.9, 9.9, 8.5, 4.2, 4.0 million barrels of oil per day respectively.

Factors which affect the price of Crude oil are:

  1. The major factor affecting the price of crude oil is the overall health of the US and global economies. During a period of recession or slow economic growth there is less demand for oil, causing the price to contract.
  2. Oil prices are affected heavily by political events globally. Some of the major oil producing countries like Russia, Saudi Arabia, Iran, and Iraq have a history of political instability or they sometimes arbitrarily reduce their production levels, which can have a major impact on the price of oil.
  3. OPEC is a group of oil producing nations which act together in order to ensure a sustainable price level for oil. They comprise of 12 nations and have a production ability of around 30 million barrel per day. This is a major part of the total production and any new announcements or statements by OPEC regarding their pricing strategy, production, etc. has a major effect on the crude prices.
  4. Crude oil demand and supply has very complex factors. Some of them are international politics, demand by emerging economies, new technologies to harness alternative source of energy and many more. 
  5. Long term trends also play a major role. This includes the discussion over peak oil, according to which the maximum production level has been reached in most of the regions and the total production will decline unless newer oil fields are found or better techniques to extract oil are found.


Crude Oil Price Chart

crude-oil-price-chart.pngLooking at the price of oil for the last 30 years:

  1. In the first point the overall price is range bound around the $20 per barrel mark in the 80s and 90s. There is only one single spike caused due to the events of the Gulf war
  2. In the second point there is a massive increase in the price of oil. This increase can be correlated with the increase in the stock market and the overall expansion of the world economy. Also a major factor playing during this time was the increased demand from China, India and Brazil.
  3. In the third point we can see a sudden decrease in the price of oil reducing to almost 25% of its original value in a very short time. This decrease is led by the financial crisis and a contraction of most of the economies in the world. However these movements also have to do with sentimental play of various factors instead of actual supply and demand of the commodity.
  4. Finally in the fourth point we see a quick rebound of oil prices to $100 per barrel range where it has held steady for the past 4 years. This level matches the supply and demand outlook of the commodity in the global market.

There is an opportunity to profit from favorable price movements if close watch is kept on the overall international scene. This is the most liquid commodity and has a huge number of varying businesses, consumers and traders actively trading on the futures exchange.

NEXT: What is a Futures Clearing House?


Introduction to the Futures Market Tutorial

1) Introduction to the Futures Market
2) History of the Futures Market
3) How the Futures Market Works
4) Difference between a Forward and Futures Contract
5) Participants in the Futures Market
6) Main factors that impact Futures Prices
7) What is a Futures Clearing House?
8) Risks in the Futures Market

 

 

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